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UST MASTER FUNDS, INC.
Money Fund
Government Money Fund
Treasury Money Fund
UST MASTER TAX-EXEMPT FUNDS, INC.
Short-Term Tax-Exempt Fund
STATEMENT OF ADDITIONAL INFORMATION
August 1, 1995
This Statement of Additional Information is not a prospectus but should be read
in conjunction with the current prospectus for the Money Fund, Government Money
Fund and Treasury Money Fund of UST Master Funds, Inc. ("Master Fund") and the
Short-Term Tax-Exempt Fund of UST Master Tax-Exempt Funds, Inc. ("Master Tax-
Exempt Fund") dated August 1, 1995 (the "Prospectus"). Much of the information
contained in this Statement of Additional Information expands upon the subjects
discussed in the Prospectus. No investment in shares of the portfolios
described herein ("Shares") should be made without reading the Prospectus. A
copy of the Prospectus may be obtained by writing UST Master Funds c/o Mutual
Funds Service Company, 73 Tremont Street, Boston, MA 02108-3913 or by calling
(800) 446-1012.
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TABLE OF CONTENTS
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INVESTMENT OBJECTIVES AND POLICIES...................................... 1
Additional Information on Portfolio Instruments.................... 1
Additional Investment Limitations.................................. 6
NET ASSET VALUE AND NET INCOME.......................................... 10
ADDITIONAL PURCHASE AND REDEMPTION INFORMATION.......................... 11
INVESTOR PROGRAMS....................................................... 12
Systematic Withdrawal Plan......................................... 12
Exchange Privilege................................................. 13
Other Investor Programs............................................ 13
DESCRIPTION OF CAPITAL STOCK............................................ 14
MANAGEMENT OF THE FUNDS................................................. 16
Directors and Officers............................................. 16
Investment Advisory and
Administration Agreements........................................ 18
Service Organizations.............................................. 20
Expenses........................................................... 22
Custodian and Transfer Agent....................................... 22
PORTFOLIO TRANSACTIONS.................................................. 24
INDEPENDENT AUDITORS.................................................... 26
COUNSEL................................................................. 26
ADDITIONAL INFORMATION CONCERNING TAXES................................. 26
Generally.......................................................... 26
Short-Term Fund.................................................... 27
YIELD INFORMATION....................................................... 28
MISCELLANEOUS........................................................... 30
FINANCIAL STATEMENTS.................................................... 31
APPENDIX................................................................ A-1
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INVESTMENT OBJECTIVES AND POLICIES
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This Statement of Additional Information contains additional
information with respect to the Money Fund, Government Money Fund and Treasury
Money Fund of Master Fund (collectively, the "Taxable Funds") and the Short-Term
Tax-Exempt Fund of Master Tax-Exempt Fund (the portfolios are referred to
individually as a "Fund" and collectively as the "Funds"; Master Fund and Master
Tax-Exempt Fund are referred to individually as a "Company" and collectively as
the "Companies").
The investment objective of the Money Fund and the Government Money
Fund is to seek as high a level of current income as is consistent with
liquidity and stability of principal. The Money Fund generally invests in money
market instruments; the Government Money Fund generally invests in obligations
issued or guaranteed by the U.S. Government, its agencies or instrumentalities
and in repurchase agreements collateralized by such obligations. The investment
objective of the Treasury Money Fund is to seek current income consistent with
liquidity and stability of principal. The Treasury Money Fund invests primarily
in direct short-term obligations issued by the U.S. Treasury and certain
agencies or instrumentalities of the U.S. Government with a view toward
providing dividend income that is generally considered exempt from state and
local income taxes. The investment objective of the Short-Term Tax-Exempt Fund
("Short-Term Fund") is to seek a moderate level of current interest income
exempt from Federal income taxes consistent with stability of principal. The
Short-Term Fund invests substantially all of its assets in high-quality
Municipal Securities (as defined in the Prospectus) and, except during temporary
defensive periods, maintains at least 80% of its assets in tax-exempt
obligations. All Funds invest in instruments that generally have remaining
maturities of not more than 13 months. The following policies supplement the
Funds' investment policies as set forth in the Prospectus.
Additional Information on Portfolio Instruments
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Variable and Floating Rate Instruments
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With respect to variable and floating rate instruments described in
the Prospectus, United States Trust Company of New York ("U.S. Trust" or the
"Investment Adviser") will consider the earning power, cash flows and other
liquidity ratios of the issuers of such instruments and will continuously
monitor their financial ability to meet payment on demand. In determining
dollar-weighted average portfolio maturity and whether a variable or floating
rate instrument has a remaining maturity of 13 months or less, the maturity of
each instrument
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will be computed in accordance with guidelines established by the SEC.
Repurchase Agreements
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The repurchase price under the repurchase agreements described in the
Prospectus generally equals the price paid by a Fund plus interest negotiated on
the basis of current short-term rates (which may be more or less than the rate
on the securities underlying the repurchase agreement). Securities subject to
repurchase agreements are held by the Funds' custodian (or sub-custodian) or in
the Federal Reserve/Treasury Money book-entry system. Repurchase agreements are
considered loans by a Fund under the Investment Company Act of 1940 (the "1940
Act").
Securities Lending
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When the Money Fund or Government Money Fund lends its portfolio
securities, it continues to receive interest or dividends on the securities lent
and may simultaneously earn interest on the investment of the cash loan
collateral, which will be invested in readily marketable, high-quality, short-
term obligations. Although voting rights, or rights to consent, attendant to
securities lent pass to the borrower, such loans may be called at any time and
will be called so that the securities may be voted by a Fund if a material event
affecting the investment is to occur.
When-Issued and Forward Transactions
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When a Fund agrees to purchase securities on a "when-issued" or
"forward commitment" basis, the custodian will set aside cash or liquid
portfolio securities equal to the amount of the commitment in a separate
account. Normally, the custodian will set aside portfolio securities to satisfy
a purchase commitment and, in such case, the Fund may be required subsequently
to place additional assets in the separate account in order to ensure that the
value of the account remains equal to the amount of the Fund's commitment. It
may be expected that a Fund's net assets will fluctuate to a greater degree when
it sets aside portfolio securities to cover such purchase commitments than when
it sets aside cash. Because a Fund will set aside cash or liquid assets to
satisfy its purchase commitments in the manner described, the Fund's liquidity
and ability to manage its portfolio might be affected in the event its forward
commitments or commitments to purchase "when-issued" securities ever exceed 25%
of the value of its assets.
A Fund will purchase securities on a "when-issued" or "forward
commitment" basis only with the intention of completing the transaction. If
deemed advisable as a matter of investment
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strategy, however, a Fund may dispose of or renegotiate a commitment after it is
entered into, and may sell securities it has committed to purchase before those
securities are delivered to the Fund on the settlement date. In these cases,
the Fund may realize a taxable capital gain or loss.
When a Fund engages in "when-issued" or "forward commitment"
transactions, it relies on the other party to consummate the trade. Failure of
such other party to do so may result in the Funds incurring a loss or missing an
opportunity to obtain a price considered to be advantageous.
The market value of the securities underlying a "when-issued" purchase
or a forward commitment to purchase securities and any subsequent fluctuations
in their market value are taken into account when determining the market value
of a Fund starting on the day the Fund agrees to purchase the securities. The
Fund does not earn interest on the securities it has committed to purchase until
they are paid for and delivered on the settlement date.
Stand-By Commitments
--------------------
The Short-Term Fund may acquire "stand-by commitments" with respect to
Municipal Securities held by it. Under a "stand-by commitment," a dealer or bank
agrees to purchase from the Short-Term Fund, at the Fund's option, specified
Municipal Securities at a specified price. The amount payable to the Fund upon
its exercise of a "stand-by commitment" is normally (i) the Fund's acquisition
cost of the Municipal Securities (excluding any accrued interest which the Fund
paid on their acquisition), less any amortized market premium or plus any
amortized market or original issue discount during the period the Fund owned the
securities, plus (ii) all interest accrued on the securities since the last
interest payment date during that period. "Stand-by commitments" are exercisable
by the Short-Term Fund at any time before the maturity of the underlying
Municipal Securities, and may be sold, transferred or assigned by the Fund only
with the underlying instruments.
The Short-Term Fund expects that "stand-by commitments" will generally
be available without the payment of any direct or indirect consideration.
However, if necessary or advisable, the Fund may pay for a "stand-by commitment"
either separately in cash or by paying a higher price for securities which are
acquired subject to the commitment (thus reducing the yield to maturity
otherwise available for the same securities). Where the Short-Term Fund has
paid any consideration directly or indirectly for a "stand-by commitment," its
cost will be reflected as unrealized depreciation for the period during which
the commitment was held by the Fund.
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The Short-Term Fund intends to enter into "stand-by commitments" only
with banks and broker/dealers which, in the Investment Adviser's opinion,
present minimal credit risks. In evaluating the creditworthiness of the issuer
of a "stand-by commitment," the Investment Adviser will review periodically the
issuer's assets, liabilities, contingent claims and other relevant financial
information.
Municipal Securities
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The Short-Term Fund invests primarily in Municipal Securities as
defined in the Prospectus. Municipal Securities include debt obligations issued
by governmental entities to obtain funds for various public purposes, including
the construction of a wide range of public facilities, the refunding of
outstanding obligations, the payment of general operating expenses, and the
extension of loans to public institutions and facilities. Private activity bonds
that are issued by or on behalf of public authorities to finance various
privately operated facilities are included within the term "Municipal
Securities" only if the interest paid thereon is exempt from regular Federal
income tax and not treated as a specific tax preference item under the Federal
alternative minimum tax.
The two principal classifications of Municipal Securities are "general
obligations" and "revenue" issues, but the Short-Term Fund's portfolio may also
include "moral obligation" issues, which are normally issued by special-purpose
authorities. There are, of course, variations in the quality of Municipal
Securities, both within a particular classification and between classifications,
and the yields on Municipal Securities depend upon a variety of factors,
including general money market conditions, the financial condition of the
issuer, general conditions of the municipal bond market, the size of a
particular offering, the maturity of the obligation, and the rating of the
issue. The ratings of Moody's Investors Service, Inc. ("Moody's") and Standard
& Poor's Ratings Group ("S&P") described in the Prospectus and Appendix hereto
represent their opinion as to the quality of Municipal Securities. It should be
emphasized that these ratings are general and are not absolute standards of
quality, and Municipal Securities with the same maturity, interest rate, and
rating may have different yields while Municipal Securities of the same maturity
and interest rate with different ratings may have the same yield. Subsequent to
its purchase by the Fund, an issue of Municipal Securities may cease to be
rated, or its rating may be reduced below the minimum rating required for
purchase by the Fund. The Investment Adviser will consider such an event in
determining whether the Short-Term Fund should continue to hold the obligation.
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The payment of principal and interest on most securities purchased by
the Short-Term Fund will depend upon the ability of the issuers to meet their
obligations. Each state, the District of Columbia, each of their political
subdivisions, agencies, instrumentalities and authorities, and each multistate
agency of which a state is a member, is a separate "issuer" as that term is used
in this Statement of Additional Information and the Prospectus. The non-
governmental user of facilities financed by private activity bonds is also
considered to be an "issuer." An issuer's obligations under its Municipal
Securities are subject to the provisions of bankruptcy, insolvency, and other
laws affecting the rights and remedies of creditors, such as the Federal
Bankruptcy Code, and laws, if any, which may be enacted by Federal or state
legislatures extending the time for payment of principal or interest, or both,
or imposing other constraints upon enforcement of such obligations or upon the
ability of municipalities to levy taxes. The power or ability of an issuer to
meet its obligations for the payment of interest on and principal of its
Municipal Securities may be materially adversely affected by litigation or other
conditions.
Private activity bonds are or have been issued to obtain funds to
provide, among other things, privately operated housing facilities, pollution
control facilities, convention or trade show facilities, mass transit, airport,
port or parking facilities and certain local facilities for water supply, gas,
electricity or sewage or solid waste disposal. Private activity bonds are also
issued to privately held or publicly owned corporations in the financing of
commercial or industrial facilities. State and local governments are authorized
in most states to issue private activity bonds for such purposes in order to
encourage corporations to locate within their communities. The principal and
interest on these obligations may be payable from the general revenues of the
users of such facilities.
Among other instruments, the Short-Term Fund may purchase short-term
General Obligation Notes, Tax Anticipation Notes, Bond Anticipation Notes,
Revenue Anticipation Notes, Tax-Exempt Commercial Paper, Construction Loan Notes
and other forms of short-term loans. Such instruments are issued with a short-
term maturity in anticipation of the receipt of tax funds, the proceeds of bond
placements or other revenues. In addition, the Fund may invest in long-term
tax-exempt instruments, such as municipal bonds and private activity bonds, to
the extent consistent with the maturity restrictions applicable to it.
From time to time, proposals have been introduced before Congress for
the purpose of restricting or eliminating the Federal income tax exemption for
interest on Municipal Securities. For example, under the Tax Reform Act of
1986, interest on certain private activity bonds must be included in an
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investor's Federal alternative minimum taxable income, and corporate investors
must treat all tax-exempt interest as an item of tax preference. Master Tax-
Exempt Fund cannot, of course, predict what legislation may be proposed in the
future regarding the income tax status of interest on Municipal Securities, or
which proposals, if any, might be enacted. Such proposals, while pending or if
enacted, might materially adversely affect the availability of Municipal
Securities for investment by the Short-Term Fund and the liquidity and value of
its portfolio. In such an event, Master Tax-Exempt Fund would re-evaluate the
Fund's investment objective and policies and consider possible changes in its
structure or possible dissolution.
Opinions relating to the validity of Municipal Securities and to the
exemption of interest thereon from Federal income tax are rendered by bond
counsel to the respective issuers at the time of issuance. Neither Master Tax-
Exempt Fund nor the Investment Adviser will review the proceedings relating to
the issuance of Municipal Securities or the basis for such opinions.
Miscellaneous
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The Funds may not invest in oil, gas, or mineral leases.
Additional Investment Limitations
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In addition to the investment limitations set forth in the Prospectus,
the Funds are subject to the investment limitations enumerated below, which may
be changed with respect to a particular Fund only by a vote of the holders of a
majority of such Fund's outstanding Shares (as defined under "Miscellaneous" in
the Prospectus).
No Fund may:
1. Purchase securities on margin, make short sales of securities, or
maintain a short position;
2. Act as an underwriter of securities within the meaning of the
Securities Act of 1933, except insofar as the Taxable Funds might be deemed to
be underwriters upon disposition of certain portfolio securities acquired within
the limitation on purchases of restricted securities; and except to the extent
that purchase by the Short-Term Fund of Municipal Securities or other securities
directly from the issuer thereof in accordance with the Fund's investment
objective, policies and limitations may be deemed to be underwriting;
3. Purchase or sell real estate, except that each Taxable Fund may
purchase securities of issuers which deal in
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real estate and may purchase securities which are secured by interests in real
estate; and except that the Short-Term Fund may invest in Municipal Securities
secured by real estate or interests therein;
4. Purchase or sell commodities or commodity contracts, or invest in
oil, gas, or other mineral exploration or development programs;
5. Invest in or sell puts, calls, straddles, spreads, or any
combination thereof; and
6. Issue any senior securities, except insofar as any borrowing in
accordance with a Fund's investment limitations might be considered to be the
issuance of a senior security.
In addition, the Money, Government Money and Treasury Money Funds may
not:
7. Make loans, except that (i) each Fund may purchase or hold debt
securities in accordance with its investment objective and policies, and the
Money Fund and the Government Money Fund may enter into repurchase agreements
with respect to obligations issued or guaranteed by the U.S. Government, its
agencies or instrumentalities, and (ii) the Money Fund and the Government Money
Fund may lend portfolio securities in an amount not exceeding 30% of their total
assets;
8. Invest in bank obligations having remaining maturities in excess
of one year, except that securities subject to repurchase agreements may bear
longer maturities;
9. Invest in companies for the purpose of exercising management or
control;
10. Invest more than 5% of a Funds's total assets in securities
issued by companies which, together with any predecessor, have been in
continuous operation for fewer than three years;
11. Purchase foreign securities; except the Money Fund may purchase
certificates of deposit, bankers' acceptances, or other similar obligations
issued by domestic branches of foreign banks and foreign branches of U.S. banks
in an amount not to exceed 20% of its total net assets;
12. Acquire any other investment company or investment company
security, except in connection with a merger, consolidation, reorganization, or
acquisition of assets or where otherwise permitted by the Investment Company Act
of 1940;
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13. Invest in obligations of foreign branches of financial
institutions or in domestic branches of foreign banks, if immediately after such
purchase (i) more than 5% of the value of a Fund's total assets would be
invested in obligations of any one foreign branch of the financial institution
or domestic branch of a foreign bank; or (ii) more than 20% of its total assets
would be invested in foreign branches of financial institutions or in domestic
branches of foreign banks;
14. Purchase any securities which would cause more than 25% of the
value of a Fund's total assets at the time of purchase to be invested in the
securities of one or more issuers conducting their principal business activities
in the same industry, provided that (a) there is no limitation with respect to
securities issued or guaranteed by the U.S. Government or domestic bank
obligations, and (b) neither all finance companies, as a group, nor all utility
companies, as a group, are considered a single industry for purposes of this
policy; and
15. Knowingly invest more than 10% of the value of a Fund's total
assets in illiquid securities, including repurchase agreements with remaining
maturities in excess of seven days, restricted securities, and other securities
for which market quotations are not readily available.
In addition, the Short-Term Fund may not:
16. Make loans, except that the Fund may purchase or hold debt
obligations in accordance with its investment objective, policies, and
limitations; and
17. Invest in industrial revenue bonds where the payment of principal
and interest are the responsibility of a company (including its predecessors)
with less than three years of continuous operation;
18. Knowingly invest more than 10% of the value of its total assets
in securities which may be illiquid in light of legal or contractual
restrictions on resale or the absence of readily available market quotations;
19. Purchase any securities which would cause more than 25% of the
value of its total assets at the time of purchase to be invested in the
securities of one or more issuers conducting their principal business activities
in the same industry, provided that there is no limitation with respect to
domestic bank obligations or securities issued or guaranteed by the United
States; any state or territory; any possession of the U.S. Government; the
District of Columbia; or any of their authorities, agencies, instrumentalities,
or political subdivisions; and
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20. Purchase securities of other investment companies (except as part
of a merger, consolidation or reorganization or purchase of assets approved by
the Fund's shareholders), provided that the Fund may purchase shares of any
registered, open-end investment company, if immediately after any such purchase,
the Fund does not (a) own more than 3% of the outstanding voting stock of any
one investment company, (b) invest more than 5% of the value of its total assets
in the securities of any one investment company, or (c) invest more than 10% of
the value of its total assets in the aggregate in securities of investment
companies.
* * *
If a percentage limitation is satisfied at the time of investment, a
later increase or decrease in such percentage resulting from a change in value
of a Fund's portfolio securities will not constitute a violation of such
limitation.
For the purpose of Investment Limitation No. 3, the prohibition of
purchases of real estate includes acquisition of limited partnership interests
in partnerships formed with a view toward investing in real estate, but does not
prohibit purchases of shares in real estate investment trusts.
Notwithstanding Investment Limitations Nos. 15 and 18 above, the
Companies intend to limit the Funds' investments in illiquid securities to 10%
of each Fund's net (rather than total) assets.
Notwithstanding the proviso in Investment Limitation No. 19, to the
extent that the Short-Term Fund has invested more than 20% of the value of its
assets in taxable securities on a temporary defensive basis, the industry
diversification limitation in Investment Limitation No. 19 shall apply to
taxable securities issued or guaranteed by any state, territory, or possession
of the U.S. Government; the District of Columbia; or any of their authorities,
agencies, instrumentalities, or political subdivisions.
In order to permit the sale of Shares in certain states, the Companies
may make other commitments more restrictive than the investment policies and
limitations described above and in the Funds' Prospectus. Should the Companies
determine that any such commitment is no longer in the Funds' best interests,
they will revoke the commitment by terminating sales of the Shares to investors
residing in the state involved.
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NET ASSET VALUE AND NET INCOME
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The Companies use the amortized cost method of valuation to value
Shares in the Funds. Pursuant to this method, a security is valued at its cost
initially, and thereafter a constant amortization to maturity of any discount or
premium is assumed, regardless of the impact of fluctuating interest rates on
the market value of the security. This method may result in periods during which
value, as determined by amortized cost, is higher or lower than the price the
Fund involved would receive if it sold the security. The market value of
portfolio securities held by the Funds can be expected to vary inversely with
changes in prevailing interest rates.
The Funds invest only in high-quality instruments and maintain a
dollar-weighted average portfolio maturity appropriate to their objective of
maintaining a constant net asset value per Share. The Funds will not purchase
any security deemed to have a remaining maturity of more than 13 months within
the meaning of the 1940 Act or maintain a dollar-weighted average portfolio
maturity which exceeds 90 days. The Companies' Boards of Directors have
established procedures that are intended to stabilize the net asset value per
Share of each Fund for purposes of sales and redemptions at $1.00. These
procedures include the determination, at such intervals as the Boards deem
appropriate, of the extent, if any, to which the net asset value per Share of a
Fund calculated by using available market quotations deviates from $1.00 per
Share. In the event such deviation exceeds one half of one percent, the Boards
of Directors will promptly consider what action, if any, should be initiated.
If the Boards of Directors believe that the extent of any deviation from a
Fund's $1.00 amortized cost price per Share may result in material dilution or
other unfair results to new or existing investors, they will take appropriate
steps to eliminate or reduce, to the extent reasonably practicable, any such
dilution or unfair results. These steps may include selling portfolio
instruments prior to maturity; shortening the average portfolio maturity;
withholding or reducing dividends; redeeming Shares in kind; reducing the number
of the Fund's outstanding Shares without monetary consideration; or utilizing a
net asset value per share determined by using available market quotations.
Net income of each of the Funds for dividend purposes consists of (i)
interest accrued and discount earned on a Fund's assets, less (ii) amortization
of market premium on such assets, accrued expenses directly attributable to the
Fund, and the general expenses or the expenses common to more than one portfolio
of a Company (e.g., administrative, legal, accounting, and directors' fees)
prorated to each portfolio of the Company on the basis of their relative net
assets.
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ADDITIONAL PURCHASE AND REDEMPTION INFORMATION
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Shares are continuously offered for sale by Edgewood Services, Inc.
(the "Distributor"), a wholly-owned subsidiary of Federated Investors, and the
Distributor has agreed to use appropriate efforts to solicit all purchase
orders. As described in the Prospectus, Shares may be sold to customers
("Customers") of the Investment Adviser, its affiliates and correspondent banks,
and qualified banks, savings and loan associations, broker/dealers and other
institutions ("Shareholder Organizations") that have entered into servicing
agreements with one of the Companies. Shares are also offered for sale to
institutional investors ("Institutional Investors") and to members of the
general public ("Direct Investors", and collectively with Institutional
Investors, "Investors"). Different types of Customer accounts at Shareholder
Organizations may be used to purchase Shares, including eligible agency and
trust accounts. In addition, Shareholder Organizations may automatically
"sweep" a Customer's account not less frequently than weekly and invest amounts
in excess of a minimum balance agreed to by the Shareholder Organization and its
Customer in Shares of the Fund selected by the Customer. Investors purchasing
Shares may include officers, directors, or employees of the particular
Shareholder Organization.
As stated in the Prospectus, no sales charge is imposed by the
Companies on purchases of Shares. In addition, no sales load is charged on the
reinvestment of dividends or distributions or in connection with certain Share
exchanges as described in the Prospectus under "Investor Programs--Exchange
Privilege."
As described in the Prospectus, Direct Investors may redeem Shares by
writing a check. Checks to redeem Shares are drawn on the Companies' accounts
at United States Trust Company of New York. Direct Investors will be subject to
the same rules and regulations that U.S. Trust applies to checking accounts and
will have the same rights and duties with respect to stop-payment orders,
"stale" checks, unauthorized signatures, collection of deposits, alterations and
unauthorized endorsements as bank checking account customers do under the New
York Uniform Commercial Code. When a check is presented to U.S. Trust for
payment, U.S. Trust, as the shareholder's agent, will cause the Fund from which
the redemption is requested to redeem sufficient Shares in the shareholder's
account to cover the amount of the check.
The Companies may suspend the right of redemption or postpone the date
of payment for Shares for more than 7 days during any period when (a) trading on
the New York Stock Exchange (the "Exchange") is restricted by applicable rules
and regulations of the Securities and Exchange Commission; (b) the
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Exchange is closed for other than customary weekend and holiday closings; (c)
the Securities and Exchange Commission has by order permitted such suspension;
or (d) an emergency exists as determined by the Securities and Exchange
Commission.
In the event that Shares are redeemed in cash at their net asset
value, a shareholder may receive in payment for such Shares an amount that is
more or less than his original investment due to changes in the market prices of
that Fund's portfolio securities.
Under limited circumstances, the Companies may accept securities as
payment for Shares. Securities acquired in this manner will be limited to
securities issued in transactions involving a bona fide reorganization or
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statutory merger, or will be limited to other securities (except for municipal
debt securities issued by state political subdivisions or their agencies or
instrumentalities) that: (a) meet the investment objective and policies of any
Fund acquiring such securities; (b) are acquired for investment and not for
resale; (c) are liquid securities that are not restricted as to transfer either
by law or liquidity of market; and (d) have a value that is readily
ascertainable (and not established only by evaluation procedures) as evidenced
by a listing on the American Stock Exchange, New York Stock Exchange or NASDAQ,
or as evidenced by their status as U.S. Government securities, bank certificates
of deposit, banker's acceptances, corporate and other debt securities that are
actively traded, money market securities and other similar securities with a
readily ascertainable value.
INVESTOR PROGRAMS
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Systematic Withdrawal Plan
--------------------------
An Investor who owns Shares with a value of $10,000 or more may begin
a Systematic Withdrawal Plan. The withdrawal can be on a monthly, quarterly,
semiannual or annual basis. There are four options for such systematic
withdrawals. The Investor may request:
(1) A fixed-dollar withdrawal;
(2) A fixed-share withdrawal;
(3) A fixed-percentage withdrawal (based on the current value of the
account); or
(4) A declining-balance withdrawal.
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Prior to participating in a Systematic Withdrawal Plan, the Investor must
deposit any outstanding certificates for Shares with Mutual Funds Service
Company, the Funds' sub-transfer agent. Under this Plan, dividends and
distributions are automatically reinvested in additional Shares. Amounts paid
to Investors under this Plan should not be considered as income. Withdrawal
payments represent proceeds from the sale of Shares, and there will be a
reduction of the shareholder's equity in the Fund involved if the amount of the
withdrawal payments exceeds the dividends paid on the Shares. This in turn may
result in a complete depletion of the shareholder's investment. An Investor may
not participate in a program of systematic investing in a Fund while at the same
time participating in the Systematic Withdrawal Plan with respect to an account
in that Fund.
Exchange Privilege
------------------
Investors and Customers of Shareholder Organizations may exchange
Shares having a value of at least $500 for Shares of any other portfolio of the
Companies. Shares may be exchanged by wire, telephone or mail and must be made
to accounts of identical registration. There is no exchange fee imposed by the
Companies. In order to prevent abuse of this privilege to the disadvantage of
other shareholders, the Companies reserve the right to limit the number of
exchange requests of Investors and Customers of Shareholder Organizations to no
more than six per year. The Companies may modify or terminate the exchange
program at any time upon 60 days' written notice to shareholders, and may reject
any exchange request.
For Federal income tax purposes, exchanges are treated as sales on
which the shareholder will realize a gain or loss, depending upon whether the
value of the Shares to be given up in exchange is more or less than the basis in
such Shares at the time of the exchange. Generally, a shareholder may include
sales loads incurred upon the purchase of Shares in his or her tax basis for
such Shares for the purpose of determining gain or loss on a redemption,
transfer or exchange of such Shares. However, if the shareholder effects an
exchange of Shares for shares of another portfolio of the Companies within 90
days of the purchase and is able to reduce the sales load applicable to the new
shares (by virtue of the Companies' exchange privilege), the amount equal to
such reduction may not be included in the tax basis of the shareholder's
exchanged Shares but may be included (subject to the limitation) in the tax
basis of the new shares.
Other Investor Programs
-----------------------
As discussed in the Prospectus, Shares of the Funds may be purchased
in connection with the Automatic Investment Program. Shares of the Money,
Government Money and Treasury Money Funds
-13-
<PAGE>
may also be purchased in connection with certain Retirement Programs.
DESCRIPTION OF CAPITAL STOCK
----------------------------
Master Fund's Charter authorizes its Board of Directors to issue up to
35 billion full and fractional shares of capital stock; and Master Tax-Exempt
Fund's Charter authorizes its Board of Directors to issue up to 14 billion full
and fractional shares of capital stock. Both Charters authorize the respective
Boards of Directors to classify or reclassify any unissued shares of the
respective Companies into one or more additional classes or series by setting or
changing in any one or more respects their respective preferences, conversion or
other rights, voting powers, restrictions, limitations as to dividends,
qualifications, and terms and conditions of redemption. The Prospectus
describes the classes of shares into which the Companies' authorized capital is
currently classified.
Shares have no preemptive rights and only such conversion or exchange
rights as the Boards of Directors may grant in their discretion. When issued
for payment as described in the Prospectus, Shares will be fully paid and non-
assessable. In the event of a liquidation or dissolution of a Fund,
shareholders of that Fund are entitled to receive the assets available for
distribution belonging to that Fund and a proportionate distribution, based upon
the relative asset values of the portfolios of the Company involved, of any
general assets of that Company not belonging to any particular portfolio of that
Company which are available for distribution. In the event of a liquidation or
dissolution of either Company, shareholders of such Company will be entitled to
the same distribution process.
Shareholders of the Companies are entitled to one vote for each full
share held, and fractional votes for fractional shares held, and will vote in
the aggregate and not by class, except as otherwise required by the 1940 Act or
other applicable law or when the matter to be voted upon affects only the
interests of the shareholders of a particular class. Voting rights are not
cumulative and, accordingly, the holders of more than 50% of a Company's
aggregate outstanding shares may elect all of that Company's directors,
regardless of the votes of other shareholders.
Rule 18f-2 under the 1940 Act provides that any matter required to be
submitted to the holders of the outstanding voting securities of an investment
company such as each Company shall not be deemed to have been effectively acted
upon unless approved by the holders of a majority of the outstanding shares of
each portfolio affected by the matter. A portfolio is affected by a
-14-
<PAGE>
matter unless it is clear that the interests of each portfolio in the matter are
substantially identical or that the matter does not affect any interest of the
portfolio. Under the Rule, the approval of an investment advisory agreement or
any change in a fundamental investment policy would be effectively acted upon
with respect to a portfolio only if approved by a majority of the outstanding
shares of such portfolio. However, the Rule also provides that the ratification
of the appointment of independent public accountants, the approval of principal
underwriting contracts, and the election of directors may be effectively acted
upon by shareholders of each Company voting without regard to class.
The Companies' Charters authorize the Boards of Directors, without
shareholder approval (unless otherwise required by applicable law), to (a) sell
and convey the assets of a Fund to another management investment company for
consideration which may include securities issued by the purchaser and, in
connection therewith, to cause all outstanding Shares of the Fund involved to be
redeemed at a price which is equal to their net asset value and which may be
paid in cash or by distribution of the securities or other consideration
received from the sale and conveyance; (b) sell and convert a Fund's assets into
money and, in connection therewith, to cause all outstanding Shares to be
redeemed at their net asset value; or (c) combine the assets belonging to a Fund
with the assets belonging to another portfolio of the Company involved, if the
Board of Directors reasonably determines that such combination will not have a
material adverse effect on shareholders of any portfolio participating in such
combination, and, in connection therewith, to cause all outstanding shares of
any portfolio to be redeemed at their net asset value or converted into shares
of another class of the Company's capital stock at net asset value. The
exercise of such authority by the Boards of Directors will be subject to the
provisions of the 1940 Act, and the Boards of Directors will not take any action
described in this paragraph unless the proposed action has been disclosed in
writing to the particular Fund's shareholders at least 30 days prior thereto.
Notwithstanding any provision of Maryland law requiring a greater vote
of a Company's Common Stock (or of the Shares of a Fund voting separately as a
class) in connection with any corporate action, unless otherwise provided by law
(for example, by Rule 18f-2, discussed above) or by the Company's Charter, each
Company may take or authorize such action upon the favorable vote of the holders
of more than 50% of its outstanding Common Stock voting without regard to class.
-15-
<PAGE>
MANAGEMENT OF THE FUNDS
-----------------------
Directors and Officers
----------------------
The directors and executive officers of the Companies, their
addresses, ages, principal occupations during the past five years, and other
affiliations are as follows (the listed positions apply to both):
<TABLE>
<CAPTION>
Position Principal Occupation
with the During Past 5 Years and
Name and Address Companies Other Affiliations
---------------- --------- ------------------------
<S> <C> <C>
Alfred C. Tannachion/1/ Chairman of the Retired.
1135 Hyde Park Court Board, President
Mahwah, NJ 07430 and Treasurer
Age 69
Donald L. Campbell Director Retired; Senior Vice
333 East 69th Street President, Royal
Apt. 10-H Insurance Company, Inc.,
New York, NY 10021 until August, 1989;
Age 69 Director, Royal Life
Insurance Co. of N.Y.
Joseph H. Dugan Director Retired; President, CEO
913 Franklin Lake Road and Director, L.B. Foster
Franklin Lakes, NJ 07417 Company (tubular products),
Age 70 from September, 1987 until
May, 1990; Executive Vice
President and COO, L.B.
Foster Company, from
September, 1986 until
September, 1987; Senior
Vice President -- Finance,
Chief Financial Officer and
Director, Todd Shipyards
Corporation, prior to
January 3, 1986.
Wolfe J. Frankl Director Retired; Director; Deutsche
40 Gooseneck Lane Bank Financial, Inc.;
Charlottesville, VA 22903 Director The Harbus
Age 74 Corporation; Trustee,
Mariner Funds Trust.
Robert A. Robinson Director President Emeritus, The
Church Pension Fund Church Pension Fund and its
800 Second Avenue affiliated companies, since
New York, NY 10017 1968; Trustee, Mariner
Age 69 Funds Trust; Trustee, H.B.
</TABLE>
----------------------
/1/ This director is considered to be an "interested person" of the Companies as
defined in the 1940 Act.
-16-
<PAGE>
<TABLE>
<CAPTION>
Position Principal Occupation
with the During Past 5 Years and
Name and Address Companies Other Affiliations
---------------- --------- -----------------------
<S> <C> <C>
and F.H. Bugher Foundation
and Director of its wholly
owned subsidiaries --
Rosiclear Lead and
Flourspar Mining Co. and
The Pigmy Corporation;
Director, Morehouse
Publishing Co.
W. Bruce McConnel, III Secretary Partner of the law firm
Philadelphia National of Drinker Biddle & Reath.
Bank Building
1345 Chestnut Street
Philadelphia, PA 19107
Age 52
Frank M. Deutchki Assistant Vice President, Mutual
Mutual Funds Service Co. Secretary Funds Service Company
73 Tremont Street since February, 1989;
Boston, MA 02108-3913 Senior Vice President --
Age 41 Risk Analysis and Avoid-
ance, Putnam Investor
Services (mutual fund group),
from October, 1987 to
January, 1989.
John M. Corcoran Assistant Assistant Vice President,
Mutual Funds Service Co. Treasurer Manager of Administration,
73 Tremont Street Mutual Funds Service
Boston, MA 02108-3913 Company, since October
Age 30 1993; Audit Manager, Ernst &
Young, from August, 1987 to
September, 1993.
</TABLE>
Each director receives an annual fee of $9,000 with respect to each
Company plus a per-Company meeting fee of $1,500 for each meeting attended and
is reimbursed for expenses incurred in attending meetings. The Chairman of the
Board is entitled to receive an additional $5,000 per annum with respect to each
Company for services in such capacity. Drinker Biddle & Reath, of which Mr.
McConnel is a partner, receives legal fees as counsel to the Companies. The
employees of Mutual Funds Service Company do not receive any compensation from
the Companies for acting as officers of the Companies. No person who is
currently an officer, director or employee of the Investment Adviser serves as
an officer, director or employee of the Companies. The directors and officers
of the Companies as a group own less than 1% of the Shares of each Fund.
-17-
<PAGE>
The following chart provides certain information about the fees
received by the Companies' directors in the most recently completed fiscal year.
<TABLE>
<CAPTION>
Pension or
Retirement Total
Benefits Compensation
Accrued as from the Companies
Aggregate Part of and Fund
Name of Compensation from Fund Complex/*/ Paid
Person/Position each Companies Expenses to Directors
--------------- ----------------- ---------- ------------------
<S> <C> <C> <C>
Alfred C. Tannachion $20,000 None $40,000
Chairman of the Board,
President and Treasurer
Donald L. Campbell $15,000 None $30,000
Director
Joseph H. Dugan $15,000 None $30,000
Director
Wolfe J. Frankl $15,000 None $30,000
Director
Robert A. Robinson
Director $15,000 None $30,000
</TABLE>
---------------------------
/*/ The "Fund Complex" consists of UST Master Funds, Inc., UST Master Tax-
Exempt Funds, Inc. and UST Master Variable Series, Inc. For the fiscal
year ended March 31, 1995, UST Master Variable Series, Inc. did not pay any
directors' fees.
Investment Advisory and Administration Agreements
-------------------------------------------------
United States Trust Company of New York serves as Investment Adviser
to the Funds. In the Investment Advisory Agreements, U.S. Trust has agreed to
provide the services described in the Prospectus. The Investment Adviser has
also agreed to pay all expenses incurred by it in connection with its activities
under the respective agreements other than the cost of securities, including
brokerage commissions, if any, purchased for the Funds. See "Expenses" in the
Prospectus.
For the fiscal year ended March 31, 1993, Master Fund paid the
Investment Adviser $1,776,065, $2,102,373 and $610,108 with respect to the
Money, Government Money and Treasury Money Funds, respectively. For the same
period, Master Tax-Exempt Fund paid the Investment Adviser $1,629,056 with
respect to the Short-Term Fund.
-18-
<PAGE>
For the fiscal year ended March 31, 1994, Master Fund paid the
Investment Adviser $2,183,204, $1,897,581 and $702,230 with respect to the
Money, Government Money and Treasury Money Funds, respectively. For the same
period, Master Tax-Exempt Fund paid the Investment Adviser $1,697,812 with
respect to the Short-Term Fund. For the fiscal year ended March 31, 1994, the
Investment Adviser waived fees totalling $14,775, $20,874, $1,704 and $20,732
with respect to the Money, Government Money, Treasury Money and Short-Term
Funds, respectively.
For the fiscal year ended March 31, 1995, Master Fund paid the
Investment Adviser $1,781,897, $1,665,344 and $674,259 with respect to the
Money, Government Money and Treasury Money Funds, respectively. For the same
period, Master Tax-Exempt Fund paid the Investment Adviser $1,698,879 with
respect to the Short-Term Fund. For the fiscal year ended March 31, 1995, the
Investment Adviser waived fees totalling $204,060, $173,321, $45,366 and
$236,867 with respect to the Money, Government Money, Treasury Money and Short-
Term Funds, respectively.
The Investment Advisory Agreements provide that the Investment Adviser
shall not be liable for any error of judgment or mistake of law or for any loss
suffered by the Funds in connection with the performance of such agreements,
except a loss resulting from a breach of fiduciary duty with respect to the
receipt of compensation for advisory services or a loss resulting from willful
misfeasance, bad faith or gross negligence on the part of the Investment Adviser
in the performance of its duties or from reckless disregard by it of its duties
and obligations thereunder. In addition, the Investment Adviser has undertaken
in the Investment Advisory Agreements to maintain its policy and practice of
conducting its Asset Management Group independently of its Banking Group.
Mutual Funds Service Company ("MFSC") and Federated Administrative
Services, an affiliate of the Distributor, jointly serve as the Funds'
administrators. Under the Administration Agreements, the administrators have
agreed to maintain office facilities for the Funds, furnish the Funds with
statistical and research data, clerical, accounting and bookkeeping services,
and certain other services required by the Funds, and to compute the net asset
value, net income, "exempt-interest dividends," and realized capital gains or
losses, if any, of the respective Funds. The administrators prepare semiannual
reports to the Securities and Exchange Commission, prepare Federal and state tax
returns, prepare filings with state securities commissions, arrange for and bear
the cost of processing Share purchase and redemption orders, maintain the Funds'
financial accounts and records, and generally assist in the Funds' operations.
-19-
<PAGE>
Prior to August 1, 1995, administrative services were provided to the
Funds by MFSC and Concord Holding Corporation (collectively, the
"Administrators") under administration agreements having substantially the same
terms as the Administration Agreements currently in effect.
For the fiscal year ended March 31, 1993, Master Fund paid the
Administrators $1,100,322, $1,301,645 and $315,026 in the aggregate with respect
to the Money, Government Money and Treasury Money Funds, respectively. For the
same period, Master Tax-Exempt Fund paid the Administrators $1,009,414 in the
aggregate with respect to the Short-Term Fund.
For the fiscal year ended March 31, 1994, Master Fund paid the
Administrators $1,362,669, $1,183,297 and $360,869 in the aggregate with respect
to the Money, Government Money and Treasury Money Funds, respectively. For the
same period, Master Tax-Exempt Fund paid the Administrators $1,060,325 in the
aggregate with respect to the Short-Term Tax-Exempt Fund. For the fiscal year
ended March 31, 1994, the Administrators waived fees totalling $384 and $358
with respect to the Government Money and Treasury Money Funds, respectively.
For the fiscal year ended March 31, 1995, Master Fund paid the
Administrators $1,223,349, $1,131,530 and $369,056 in the aggregate with respect
to the Money Fund, Government Money Fund and Treasury Money Fund, respectively.
For the same period, Master Tax-Exempt Fund paid the Administrators $1,193,896
in the aggregate with respect to the Short-Term Fund. For the fiscal year ended
March 31, 1995, the Administrators waived fees totalling $1,087 and $351 with
respect to the Government Money and Treasury Money Funds, respectively.
Service Organizations
---------------------
As stated in the Prospectus, the Companies will enter into agreements
with Service Organizations. Such shareholder servicing agreements will require
the Service Organizations to provide shareholder administrative services to
their Customers who beneficially own Shares in consideration for a Fund's
payment (on an annualized basis) of up to .40% of the average daily net assets
of the Fund's Shares beneficially owned by Customers of the Service
Organization. Such services with respect to a Fund may include: (a) assisting
Customers in designating and changing dividend options, account designations and
addresses; (b) providing necessary personnel and facilities to establish and
maintain certain shareholder accounts and records, as may reasonably be
requested from time to time by the Companies; (c) assisting in processing
purchases, exchange and redemption transactions; (d) arranging for the wiring
of funds; (e) transmitting and receiving funds in connection with Customer
-20-
<PAGE>
orders to purchase, exchange or redeem Shares; (f) verifying and guaranteeing
Customer signatures in connection with redemption orders, transfers among and
changes in Customer-designated accounts; (g) providing periodic statements
showing a Customer's account balances and, to the extent practicable,
integrating of such information with information concerning other client
transactions otherwise effected with or through the Service Organization; (h)
furnishing on behalf of the Companies' distributor (either separately or on an
integrated basis with other reports sent to a Customer by the Service
Organization) periodic statements and confirmations of all purchases, exchanges
and redemptions of Shares in a Customer's account required by applicable federal
or state law; (i) transmitting proxy statements, annual reports, updating
prospectuses and other communications from the Companies to Customers; (j)
receiving, tabulating and transmitting to the Companies proxies executed by
Customers with respect to annual and special meetings of shareholders of the
Companies; (k) providing reports (at least monthly, but more frequently if so
requested by the Companies' distributor) containing state-by-state listings of
the principal residences of the beneficial owners of the Shares; and (l)
providing or arranging for the provision of such other related services as the
Companies or a Customer may reasonably request.
The Companies' agreements with Service Organizations are governed by
Administrative Services Plans (the "Plans") adopted by the Companies. Pursuant
to the Plans, each Company's Board of Directors will review, at least quarterly,
a written report of the amounts expended under the Company's agreements with
Service Organizations and the purposes for which the expenditures were made. In
addition, the arrangements with Service Organizations will be approved annually
by a majority of each Company's directors, including a majority of the directors
who are not "interested persons" of the Company as defined in the 1940 Act and
have no direct or indirect financial interest in such arrangements (the
"Disinterested Directors").
Any material amendment to a Company's arrangements with Service
Organizations must be approved by a majority of the Company's Board of Directors
(including a majority of the Disinterested Directors). So long as the
Companies' arrangements with Service Organizations are in effect, the selection
and nomination of the members of the Companies' Boards of Directors who are not
"interested persons" (as defined in the 1940 Act) of the Companies will be
committed to the discretion of such non-interested Directors.
For the fiscal years ended March 31, 1995 and 1994, payments to
Service Organizations totalled $204,060 and $14,775, $174,408 and $21,258,
$45,717 and $2,062, and $236,867 and $20,732 with respect to the Money,
Government Money, Treasury
-21-
<PAGE>
Money and Short-Term Tax-Exempt Funds, respectively. Of these respective
amounts, $203,572 and $14,775, $171,257 and $20,233, $44,596 and $1,075, and
$236,399 and $20,732 were paid to affiliates of U.S. Trust with respect to the
Money, Government Money, Treasury Money and Short-Term Tax-Exempt Funds.
Expenses
--------
Except as otherwise noted, the Investment Adviser and the
Administrators bear all expenses in connection with the performance of their
services. The Funds bear the expenses incurred in their operations. Expenses of
the Funds include taxes; interest; fees (including fees paid to the Companies'
Directors and officers who are not affiliated with the Distributor or the
Administrators); Securities and Exchange Commission fees; state securities
qualification fees, costs of preparing and printing prospectuses for regulatory
purposes and for distribution to shareholders; advisory, administration and
administrative servicing fees, charges of the custodian, transfer agent, and
dividend disbursing agent; certain insurance premiums; outside auditing and
legal expenses; costs of shareholder reports and meetings; and any extraordinary
expenses. The Funds also pay any brokerage fees and commissions in connection
with the purchase of portfolio securities.
If the expenses borne by a Fund in any fiscal year exceed expense
limitations imposed by applicable state securities regulations, the Investment
Adviser and the Administrators will reimburse such Fund for a portion of any
such excess to the extent required by such regulations in proportion to the fees
received by them in such year up to the amount of the fees payable to them,
provided, however, to the extent required by such state regulations, the
Investment Adviser and the Administrators have agreed to effect such
reimbursement regardless of the fees payable to them. The amounts of the above
reimbursements, if any, will be estimated, reconciled and paid on a monthly
basis. To the Companies' knowledge, of the applicable expense limitations in
effect on the date of this Statement of Additional Information, none is more
restrictive than the following: 2 1/2% of the first $30 million of average
annual net assets, 2% of the next $70 million of average annual net assets and 1
1/2% of average annual net assets in excess of $100 million.
Custodian and Transfer Agent
----------------------------
United States Trust Company of New York also serves as custodian of
the Funds' assets. Under the custodian agreement, U.S. Trust has agreed to (i)
maintain a separate account or accounts in the name of the Funds; (ii) make
receipts and disbursements of money on behalf of the Funds; (iii) collect
-22-
<PAGE>
and receive all income and other payments and distributions on account of the
Funds' portfolio securities; (iv) respond to correspondence from securities
brokers and others relating to its duties; (v) maintain certain financial
accounts and records; and (vi) make periodic reports to the Companies' Boards of
Directors concerning the Funds' operations. U.S. Trust is entitled to monthly
fees for furnishing custodial services according to the following fee schedule:
on the face value of debt securities and the market value of equity securities,
a fee at the annual rate of .05%; on issues held, $50.00 for each physical issue
held, $25.00 for each book-entry issue held and 1/4 of 1% of market value for
each foreign issue held; on transactions, $25.00 for each physical transaction,
$15.00 for each book-entry transaction and $50.00 for each foreign security
transaction. In addition, U.S. Trust is entitled to reimbursement for its out-
of-pocket expenses in connection with the above services.
U.S. Trust also serves as the Funds' transfer agent and dividend
disbursing agent. In such capacity, U.S. Trust has agreed to (i) issue and
redeem Shares; (ii) address and mail all communications by the Funds to their
shareholders, including reports to shareholders, dividend and distribution
notices, and proxy materials for its meetings of shareholders; (iii) respond to
correspondence by shareholders and others relating to its duties; (iv) maintain
shareholder accounts; and (v) make periodic reports to the Companies concerning
each Fund's operations. For its transfer agency, dividend disbursing, and
subaccounting services, U.S. Trust is entitled to receive $15.00 per annum per
account and subaccount. In addition, U.S. Trust is entitled to be reimbursed
for its out-of-pocket expenses for the cost of forms, postage, processing
purchase and redemption orders, handling of proxies, and other similar expenses
in connection with the above services.
U.S. Trust may, at its own expense, open and maintain custody accounts
with respect to the Funds with other banks or trust companies, and may delegate
its transfer agency obligations to another transfer agent registered or
qualified under applicable law, provided that U.S. Trust shall remain liable for
the performance of all of its custodial and transfer agency duties under the
Custodian and Transfer Agency Agreement, notwithstanding any delegation.
Pursuant to this provision in the agreement, U.S. Trust has entered into a sub-
transfer agency arrangement with MFSC, an affiliate of U.S. Trust, with respect
to accounts of shareholders who are not Customers of U.S. Trust. For the
services provided by MFSC, U.S. Trust has agreed to pay MFSC $15.00 per annum
per account or subaccount plus out-of-pocket expenses. MFSC receives no fee
directly from the Companies for any of its sub-transfer agency services.
-23-
<PAGE>
PORTFOLIO TRANSACTIONS
----------------------
Subject to the general control of the Companies' Boards of Directors,
the Investment Adviser is responsible for, makes decisions with respect to, and
places orders for all purchases and sales of all portfolio securities of each of
the Funds.
The Funds do not intend to seek profits from short-term trading.
Their annual portfolio turnover will be relatively high, but brokerage
commissions are not normally paid on money market instruments, and portfolio
turnover is not expected to have a material effect on the net income of the
Funds.
Securities purchased and sold by the Funds are generally traded in the
over-the-counter market on a net basis (i.e., without commission) through
dealers, or otherwise involve transactions directly with the issuer of an
instrument. The cost of securities purchased from underwriters includes an
underwriting commission or concession, and the prices at which securities are
purchased from and sold to dealers include a dealer's mark-up or mark-down.
With respect to over-the-counter transactions, the Funds, where possible, 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.
The Investment Advisory Agreements between the Companies and the
Investment Adviser provide that, in executing portfolio transactions and
selecting brokers or dealers, the Investment Adviser will seek to obtain the
best net price and the most favorable execution. The Investment Adviser shall
consider factors it deems relevant, including the breadth of the market in the
security, the price of the security, the financial condition and execution
capability of the broker or dealer and whether such broker or dealer is selling
shares of the Companies, and the reasonableness of the commission, if any, for
the specific transaction and on a continuing basis.
In addition, the Investment Advisory Agreements authorize the
Investment Adviser, to the extent permitted by law and subject to the review of
the Companies' Boards of Directors from time to time with respect to the extent
and continuation of the policy, to cause the Funds to pay a broker which
furnishes brokerage and research services a higher commission than that which
might be charged by another broker for effecting the same transaction, provided
that the Investment Adviser determines in good faith that such commission is
reasonable in relation to the value of the brokerage and research services
provided by such broker, viewed in terms of either that particular transaction
or the overall responsibilities of the Investment Adviser to the
-24-
<PAGE>
accounts as to which it exercises investment discretion. Such brokerage and
research services might consist of reports and statistics on specific companies
or industries, general summaries of groups of stocks and their comparative
earnings, or broad overviews of the stock market and the economy.
Supplementary research information so received is in addition to and
not in lieu of services required to be performed by the Investment Adviser and
does not reduce the investment advisory fees payable by the Funds. Such
information may be useful to the Investment Adviser in serving the Funds and
other clients and, conversely, supplemental information obtained by the
placement of business of other clients may be useful to the Investment Adviser
in carrying out its obligations to the Funds.
Portfolio securities will not be purchased from or sold to the
Investment Adviser, the Distributor, or any affiliated person of either of them
(as such term is defined in the 1940 Act) acting as principal, except to the
extent permitted by the Securities and Exchange Commission.
Investment decisions for the Funds are made independently from those
for other investment companies, common trust funds and other types of funds
managed by the Investment Adviser. Such other investment companies and funds
may also invest in the same securities as the Funds. When a purchase or sale of
the same security is made at substantially the same time on behalf of the Funds
and another investment company or common trust fund, the transaction will be
averaged as to price, and available investments allocated as to amount, in a
manner which the Investment Adviser believes to be equitable to the Funds and
such other investment company or common trust fund. In some instances, this
investment procedure may adversely affect the price paid or received by the
Funds or the size of the position obtained by the Funds. To the extent
permitted by law, the Investment Adviser may aggregate the securities to be sold
or purchased for the Funds with those to be sold or purchased for other
investment companies or common trust funds in order to obtain best execution.
The Companies are required to identify any securities of their regular
brokers or dealers (as defined in Rule 10b-1 under the 1940 Act) or their
parents held by the Companies as of the close of their most recent fiscal year.
As of March 31, 1995, the following Funds held the following securities of
Master Fund's regular brokers or dealers or their parents: (a) the Money Fund
held the following securities: repurchase agreement with Nomura Securities,
Inc. in the principal amount of $19,685,063, repurchase agreement with Fuji
Securities, Inc. in the principal amount of $20,000,000, commercial paper of
Merrill Lynch & Co., Inc. in the principal amount of $35,000,000 and
-25-
<PAGE>
commercial paper of UBS Finance in the principal amount of $30,000,000; and (b)
the Government Money Fund held the following securities: repurchase agreement
with Nomura Securities, Inc. in the principal amount of $20,216,462 and
repurchase agreement with Fuji Securities, Inc. in the principal amount of
$20,000,000. Nomura Securities International, Inc., Fuji Bank & Trust, Merrill
Lynch, Pierce, Fenner & Smith, Inc. and UBS Securities are considered to be
regular brokers and dealers of Master Fund. As of March 31, 1995, Master Tax-
Exempt Fund held no securities of Master Tax-Exempt Fund's regular brokers or
dealers or their parents.
INDEPENDENT AUDITORS
--------------------
Ernst & Young LLP, independent auditors, 200 Clarendon Street, Boston,
MA 02116, serve as auditors of the Companies. The Funds' Financial Highlights
included in the Prospectus and the financial statements for the period ended
March 31, 1995 incorporated by reference in this Statement of Additional
Information have been audited by Ernst & Young LLP for the periods included in
their reports thereon which appear therein.
COUNSEL
-------
Drinker Biddle & Reath (of which Mr. McConnel, Secretary of the
Companies, is a partner), located at 1345 Chestnut Street, Philadelphia,
Pennsylvania 19107, is counsel to the Companies, and will pass upon the legality
of the Shares offered by the Prospectus.
ADDITIONAL INFORMATION CONCERNING TAXES
---------------------------------------
Generally
---------
The following supplements the tax information contained in the
Prospectus.
Each of the Funds is treated as a separate corporate entity under the
Internal Revenue Code of 1986, as amended (the "Code"), and intends to qualify
as a regulated investment company. If, for any reason, a Fund does not qualify
for a taxable year for the special Federal tax treatment afforded regulated
investment companies, such Fund would be subject to Federal tax on all of its
taxable income at regular corporate rates, without any deduction for
distributions to shareholders. In such event, dividend distributions (whether
or not derived from interest on Municipal Securities) would be taxable as
ordinary income to shareholders to the extent of the Fund's current and
accumulated earnings and profits and would be
-26-
<PAGE>
eligible for the dividends received deduction in the case of corporate
shareholders.
A 4% non-deductible excise tax is imposed on regulated investment
companies that fail to currently distribute an amount equal to specified
percentages of their ordinary taxable income and capital gain net income (excess
of capital gains over capital losses). The Funds intend to make sufficient
distributions or deemed distributions of their ordinary taxable income and any
capital gain net income prior to the end of each calendar year to avoid
liability for this excise tax.
Each Fund will be required in certain cases to withhold and remit to
the U.S. Treasury 31% of taxable dividends paid to shareholders who have failed
to provide a correct tax identification number in the manner required, who are
subject to withholding by the Internal Revenue Service for failure properly to
include on their return payments of taxable interest or dividends, or who have
failed to certify to the Fund when required to do so either that they are not
subject to backup withholding or that they are "exempt recipients."
Short-Term Fund
---------------
The Short-Term Fund is not intended to constitute a balanced
investment program and is not designed for investors seeking capital
appreciation or maximum tax-exempt income irrespective of fluctuations in
principal. Shares of the Short-Term Fund would not be suitable for tax-exempt
institutions and may not be suitable for retirement plans qualified under
Section 401 of the Code, H.R. 10 plans and individual retirement accounts
because such plans and accounts are generally tax-exempt and, therefore, not
only would not gain any additional benefit from the Short-Term Fund dividends
being tax-exempt, but such dividends would be ultimately taxable to the
beneficiaries when distributed to them. In addition, the Short-Term Fund may not
be an appropriate investment for entities which are "substantial users" of
facilities financed by private activity bonds or "related persons" thereof.
"Substantial user" is defined under the Treasury Regulations to include a non-
exempt person who regularly uses a part of such facilities in his trade or
business and whose gross revenues derived with respect to the facilities
financed by the issuance of bonds are more than 5% of the total revenues derived
by all users of such facilities, who occupies more than 5% of the usable area of
such facilities or for whom such facilities or a part thereof were specifically
constructed, reconstructed or acquired. "Related persons" include certain
related natural persons, affiliated corporations, a partnership and its partners
and an S Corporation and its shareholders.
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<PAGE>
In order for the Short-Term Fund to pay exempt-interest dividends for
any taxable year, at least 50% of the aggregate value of the Fund's portfolio
must consist of exempt-interest obligations at the close of each quarter of its
taxable year. Within 60 days after the close of the taxable year, the Short-
Term Fund will notify its shareholders of the portion of the dividends paid by
the Fund which constitutes an exempt-interest dividend with respect to such
taxable year. However, the aggregate amount of dividends so designated by the
Short-Term Fund cannot exceed the excess of the amount of interest exempt from
tax under Section 103 of the Code received by the Short-Term Fund during the
taxable year over any amounts disallowed as deductions under Sections 265 and
171(a)(2) of the Code. The percentage of total dividends paid by the Short-Term
Fund with respect to any taxable year which qualifies as exempt-interest
dividends will be the same for all shareholders receiving dividends from the
Short-Term Fund for such year.
A percentage of the interest on indebtedness incurred by a shareholder
to purchase or carry the Short-Term Fund's Shares, equal to the percentage of
the total non-capital gain dividends distributed during the shareholders taxable
year that is exempt-interest dividends, is not deductible for Federal income tax
purposes.
Master Tax-Exempt Fund intends to distribute to shareholders of the
Short-Term Fund any investment company taxable income earned by the Short-Term
Fund for each taxable year. In general, the Short-Term Fund's investment
company taxable income will be its taxable income (such as taxable interest and
short-term capital gains) subject to certain adjustments and excluding the
excess of any net long-term capital gain for the taxable year over the net
short-term capital loss, if any, for such year. Such distributions will be
taxable to the shareholders as ordinary income (whether paid in cash or
additional Shares).
* * *
The foregoing discussion is based on Federal tax laws and regulations
which are in effect on the date of this Statement of Additional Information;
such laws and regulations may be changed by legislative or administrative
action. Shareholders are advised to consult their tax advisers concerning their
specific situations and the application of state and local taxes.
YIELD INFORMATION
-----------------
The standardized annualized seven-day yields for the Shares of the
Funds are computed separately by determining the net change, exclusive of
capital changes, in the value of a
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<PAGE>
hypothetical pre-existing account in the Fund involved, having a balance of one
Share at the beginning of the period, dividing the net change in account value
by the value of the account at the beginning of the period to obtain the base
period return, and multiplying the base period return by (365/7). The net
change in the value of an account in each of the Funds includes the value of
additional Shares purchased with dividends from the original Share and dividends
declared on both the original Share and any such additional Shares, net of all
fees that are charged to all shareholder accounts and to the particular series
of Shares in proportion to the length of the base period, other than
nonrecurring account or any sales charges. For any account fees that vary with
the size of the account, the amount of fees charged is computed with respect to
the Fund's mean (or median) account size. The capital changes to be excluded
from the calculation of the net change in account value are realized gains and
losses from the sale of securities and unrealized appreciation and depreciation.
In addition, each Fund may use effective compound yield quotations for its
Shares computed by adding 1 to the unannualized base period return (calculated
as described above), raising the sums to a power equal to 365 divided by 7, and
subtracting 1 from the results.
From time to time, in advertisements, sales literature or in reports
to shareholders, the yields of each Money Market Fund's Shares may be quoted and
compared to those of other mutual funds with similar investment objectives and
to stock or other relevant indices. For example, the yield of such a Fund's
Shares may be compared to the Donoghue's Money Fund average, which is an average
compiled by Donoghue's MONEY FUND REPORT of Holliston, MA 01746, a widely
recognized independent publication that monitors the performance of money market
funds, or to the data prepared by Lipper Analytical Services, Inc., a widely
recognized independent service that monitors the performance of mutual funds.
Advertisements, sales literature or reports to shareholders may from time to
time also include a discussion and analysis of each Fund's performance,
including without limitation, those factors, strategies and techniques that,
together with market conditions and events, materially affected each Fund's
performance.
The current yields for the Funds' Shares may be obtained by calling
(800) 233-9180. For the seven-day period ended March 31, 1995, the annualized
yields for Shares of the Money Fund, Government Money Fund, Treasury Money Fund
and Short-Term Fund were 5.69%, 5.62%, 5.30% and 3.64%, respectively, and the
effective yields for Shares of such respective Funds were 5.85%, 5.78%, 5.44%
and 3.71%.
The "tax-equivalent" yield of the Short-Term Fund is computed by: (a)
dividing the portion of the yield (calculated as above) that is exempt from
Federal income tax by one minus a
-29-
<PAGE>
stated Federal income tax rate and (b) adding that figure to that portion, if
any of the yield that is not exempt from Federal income tax. Tax-equivalent
yields assume the payment of Federal income taxes at a rate of 31%.
Based on the foregoing calculation, the annualized tax-equivalent
yield of the Short-Term Fund for the seven-day period ended March 31, 1995 was
5.28%.
MISCELLANEOUS
-------------
As used in the Prospectus, "assets belonging to a Fund" means the
consideration received upon the issuance of Shares in the Fund, together with
all income, earnings, profits, and proceeds derived from the investment thereof,
including any proceeds from the sale of such investments, any funds or payments
derived from any reinvestment of such proceeds, and a portion of any general
assets of the Company involved not belonging to a particular portfolio of that
Company. In determining the net asset value of a Fund's Shares, assets
belonging to the Fund are charged with the direct liabilities in respect of that
Fund and with a share of the general liabilities of the Company involved which
are normally allocated in proportion to the relative asset values of the
Company's portfolios at the time of allocation. Subject to the provisions of
the Companies' Charters, determinations by the Boards of Directors as to the
direct and allocable liabilities, and the allocable portion of any general
assets with respect to a particular Fund, are conclusive.
As of July 11, 1995, U.S. Trust held of record substantially all of
the outstanding Shares in the Funds, but did not own such Shares beneficially
because it did not have discretion to vote or invest such Shares.
As of July 11, 1995, the name, address and percentage ownership of
each person, in addition to U.S. Trust, that beneficially owned 5% or more of
the outstanding shares of a Fund
-30-
<PAGE>
were as follows: (i) Government Money Fund: NCNB Corp. Retirement Plan, c/o
---------------------
United States Trust Company of New York, 114 West 47th Street, New York, New
York 10036, 6.9%; American Ent. Holdings, Inc., c/o United States Trust Company
of New York, 114 West 47th Street, New York, New York 10036, 5.7%; and White
River Corp. c/o United States Trust Company of New York, 114 West 47th Street,
New York, New York 10036, 5.7%; and (ii) Treasury Money Fund: W. H. Reaves Co.
-------------------
Inc., c/o United States Trust Company of New York, 114 West 47th Street, New
York, New York 10036, 5.8%.
FINANCIAL STATEMENTS
--------------------
The Companies' Annual Reports to Shareholders for the fiscal year
ended March 31, 1995 (the "Annual Reports") for the fixed income and tax-exempt
fixed income portfolios accompany this Statement of Additional Information. The
financial statements in the Annual Reports for the Money, Government Money,
Treasury Money and Short-Term Tax-Exempt Funds (the "Financial Statements") are
incorporated in this Statement of Additional Information by reference. The
Financial Statements included in the Annual Reports for the fiscal year ended
March 31, 1995 have been audited by the Companies' independent auditors, Ernst &
Young LLP, whose reports thereon also appear in such Annual Reports and are
incorporated herein by reference. The Financial Statements in such Annual
Reports have been incorporated herein in reliance upon such reports given upon
the authority of such firm as experts in accounting and auditing. Additional
copies of the Annual Reports may be obtained at no charge by telephoning MFSC at
the telephone number appearing on the front page of this Statement of Additional
Information.
-31-
<PAGE>
APPENDIX A
----------
Commercial Paper Ratings
------------------------
A Standard & Poor's commercial paper rating is a current assessment of
the likelihood of timely payment of debt considered short-term in the relevant
market. The following summarizes the rating categories used by Standard and
Poor's for commercial paper:
"A-1" - Issue's degree of safety regarding timely payment is strong.
Those issues determined to possess extremely strong safety characteristics are
denoted "A-1+."
"A-2" - Issue's capacity for timely payment is satisfactory. However,
the relative degree of safety is not as high as for issues designated "A-1."
"A-3" - Issue has an adequate capacity for timely payment. It is,
however, somewhat more vulnerable to the adverse effects of changes and
circumstances than an obligation carrying a higher designation.
"B" - Issue has only a speculative capacity for timely payment.
"C" - Issue has a doubtful capacity for payment.
"D" - Issue is in payment default.
Moody's commercial paper ratings are opinions of the ability of
issuers to repay punctually promissory obligations not having an original
maturity in excess of 9 months. The following summarizes the rating categories
used by Moody's for commercial paper:
"Prime-1" - Issuer or related supporting institutions are considered
to have a superior capacity for repayment of short-term promissory obligations.
Prime-1 repayment capacity will normally be evidenced by the following
characteristics: leading market positions in well established industries; high
rates of return on funds employed; conservative capitalization structures with
moderate reliance on debt and ample asset protection; broad margins in earning
coverage of fixed financial charges and high internal cash generation; and well
established access to a range of financial markets and assured sources of
alternate liquidity.
A-1
<PAGE>
"Prime-2" - Issuer or related supporting institutions are considered
to have a strong capacity for repayment of short-term promissory obligations.
This will normally be evidenced by many of the characteristics cited above but
to a lesser degree. Earnings trends and coverage ratios, while sound, will be
more subject to variation. Capitalization characteristics, while still
appropriate, may be more affected by external conditions. Ample alternative
liquidity is maintained.
"Prime-3" - Issuer or related supporting institutions have an
acceptable capacity for repayment of short-term promissory obligations. The
effects of industry characteristics and market composition may be more
pronounced. Variability in earnings and profitability may result in changes in
the level of debt protection measurements and the requirement for relatively
high financial leverage. Adequate alternate liquidity is maintained.
"Not Prime" - Issuer does not fall within any of the Prime rating
categories.
The three rating categories of Duff & Phelps for investment grade
commercial paper and short-term debt are "D-1," "D-2" and "D-3." Duff & Phelps
employs three designations, "D-1+," "D-1" and "D-1-," within the highest rating
category. The following summarizes the rating categories used by Duff & Phelps
for commercial paper:
"D-1+" - Debt possesses highest certainty of timely payment. Short-
term liquidity, including internal operating factors and/or access to
alternative sources of funds, is outstanding, and safety is just below risk-free
U.S. Treasury short-term obligations.
"D-1" - Debt possesses very high certainty of timely payment.
Liquidity factors are excellent and supported by good fundamental protection
factors. Risk factors are minor.
"D-1-" - Debt possesses high certainty of timely payment. Liquidity
factors are strong and supported by good fundamental protection factors. Risk
factors are very small.
"D-2" - Debt possesses good certainty of timely payment. Liquidity
factors and company fundamentals are sound. Although ongoing funding needs may
enlarge total financing requirements, access to capital markets is good. Risk
factors are small.
"D-3" - Debt possesses satisfactory liquidity, and other protection
factors qualify issue as investment grade. Risk factors are larger and subject
to more variation. Nevertheless, timely payment is expected.
A-2
<PAGE>
"D-4" - Debt possesses speculative investment characteristics.
Liquidity is not sufficient to ensure against disruption in debt service.
Operating factors and market access may be subject to a high degree of
variation.
"D-5" - Issuer has failed to meet scheduled principal and/or interest
payments.
Fitch short-term ratings apply to debt obligations that are payable on
demand or have original maturities of up to three years. The following
summarizes the rating categories used by Fitch for short-term obligations:
"F-1+" - Securities possess exceptionally strong credit quality.
Issues assigned this rating are regarded as having the strongest degree of
assurance for timely payment.
"F-1" - Securities possess very strong credit quality. Issues
assigned this rating reflect an assurance of timely payment only slightly less
in degree than issues rated "F-1+."
"F-2" - Securities possess good credit quality. Issues assigned this
rating have a satisfactory degree of assurance for timely payment, but the
margin of safety is not as great as the "F-1+" and "F-1" categories.
"F-3" - Securities possess fair credit quality. Issues assigned this
rating have characteristics suggesting that the degree of assurance for timely
payment is adequate; however, near-term adverse changes could cause these
securities to be rated below investment grade.
"F-S" - Securities possess weak credit quality. Issues assigned this
rating have characteristics suggesting a minimal degree of assurance for timely
payment and are vulnerable to near-term adverse changes in financial and
economic conditions.
"D" - Securities are in actual or imminent payment default.
Fitch may also use the symbol "LOC" with its short-term ratings to
indicate that the rating is based upon a letter of credit issued by a commercial
bank.
Thomson BankWatch short-term ratings assess the likelihood of an
untimely or incomplete payment of principal or interest of unsubordinated
instruments having a maturity of one year or less which is issued by United
States commercial banks, thrifts and non-bank banks; non-United States banks;
and broker-
A-3
<PAGE>
dealers. The following summarizes the ratings used by Thomson BankWatch:
"TBW-1" - This designation represents Thomson BankWatch's highest
rating category and indicates a very high degree of likelihood that principal
and interest will be paid on a timely basis.
"TBW-2" - This designation indicates that while the degree of safety
regarding timely payment of principal and interest is strong, the relative
degree of safety is not as high as for issues rated "TBW-1."
"TBW-3" - This designation represents the lowest investment grade
category and indicates that while the debt is more susceptible to adverse
developments (both internal and external) than obligations with higher ratings,
capacity to service principal and interest in a timely fashion is considered
adequate.
"TBW-4" - This designation indicates that the debt is regarded as non-
investment grade and therefore speculative.
IBCA assesses the investment quality of unsecured debt with an
original maturity of less than one year which is issued by bank holding
companies and their principal bank subsidiaries. The following summarizes the
rating categories used by IBCA for short-term debt ratings:
"A1" - Obligations are supported by the highest capacity for timely
repayment. Where issues possess a particularly strong credit feature, a rating
of A1+ is assigned.
"A2" - Obligations are supported by a good capacity for timely
repayment.
"A3" - Obligations are supported by a satisfactory capacity for timely
repayment.
"B" - Obligations for which there is an uncertainty as to the capacity
to ensure timely repayment.
"C" - Obligations for which there is a high risk of default or which
are currently in default.
A-4
<PAGE>
Corporate and Municipal Long-Term Debt Ratings
----------------------------------------------
The following summarizes the ratings used by Standard & Poor's for
corporate and municipal debt:
"AAA" - This designation represents the highest rating assigned by
Standard & Poor's to a debt obligation and indicates an extremely strong
capacity to pay interest and repay principal.
"AA" - Debt is considered to have a very strong capacity to pay
interest and repay principal and differs from AAA issues only in small degree.
"A" - Debt is considered to have a strong capacity to pay interest and
repay principal although such issues are somewhat more susceptible to the
adverse effects of changes in circumstances and economic conditions than debt in
higher-rated categories.
"BBB" - Debt is regarded as having an adequate capacity to pay
interest and repay principal. Whereas such issues normally exhibit adequate
protection parameters, adverse economic conditions or changing circumstances are
more likely to lead to a weakened capacity to pay interest and repay principal
for debt in this category than in higher-rated categories.
"BB," "B," "CCC," "CC" and "C" - Debt is regarded, on balance, as
predominantly speculative with respect to capacity to pay interest and repay
principal in accordance with the terms of the obligation. "BB" indicates the
lowest degree of speculation and "C" the highest degree of speculation. While
such debt will likely have some quality and protective characteristics, these
are outweighed by large uncertainties or major risk exposures to adverse
conditions.
"BB" - Debt has less near-term vulnerability to default than other
speculative issues. However, it faces major ongoing uncertainties or exposure
to adverse business, financial or economic conditions which could lead to
inadequate capacity to meet timely interest and principal payments. The "BB"
rating category is also used for debt subordinated to senior debt that is
assigned an actual or implied "BBB-" rating.
"B" - Debt has a greater vulnerability to default but currently has
the capacity to meet interest payments and principal repayments. Adverse
business, financial or economic conditions will likely impair capacity or
willingness to pay interest and repay principal. The "B" rating category is
also used for debt subordinated to senior debt that is assigned an actual or
implied "BB" or "BB-" rating.
A-5
<PAGE>
"CCC" - Debt has a currently identifiable vulnerability to default,
and is dependent upon favorable business, financial and economic conditions to
meet timely payment of interest and repayment of principal. In the event of
adverse business, financial or economic conditions, it is not likely to have the
capacity to pay interest and repay principal. The "CCC" rating category is also
used for debt subordinated to senior debt that is assigned an actual or implied
"B" or "B-" rating.
"CC" - This rating is typically applied to debt subordinated to senior
debt that is assigned an actual or implied "CCC" rating.
"C" - This rating is typically applied to debt subordinated to senior
debt which is assigned an actual or implied "CCC-" debt rating. The "C" rating
may be used to cover a situation where a bankruptcy petition has been filed, but
debt service payments are continued.
"CI" - This rating is reserved for income bonds on which no interest
is being paid.
"D" - Debt is in payment default. This rating is used when interest
payments or principal payments are not made on the date due, even if the
applicable grace period has not expired, unless S & P believes such payments
will be made during such grace period. "D" rating is also used upon the filing
of a bankruptcy petition if debt service payments are jeopardized.
PLUS (+) OR MINUS (-) - The ratings from "AA" through "CCC" may be
modified by the addition of a plus or minus sign to show relative standing
within the major rating categories.
"r" - This rating is attached to highlight derivative, hybrid, and
certain other obligations that S & P believes may experience high volatility or
high variability in expected returns due to non-credit risks. Examples of such
obligations are: securities whose principal or interest return is indexed to
equities, commodities, or currencies; certain swaps and options; and interest
only and principal only mortgage securities.
The following summarizes the ratings used by Moody's for corporate and
municipal long-term debt:
"Aaa" - Bonds are judged to be of the best quality. They carry the
smallest degree of investment risk and are generally referred to as "gilt
edged." Interest payments are protected by a large or by an exceptionally
stable margin and principal is secure. While the various protective elements
are likely to change, such changes as can be visualized are most unlikely to
impair the fundamentally strong position of such issues.
A-6
<PAGE>
"Aa" - Bonds are judged to be of high quality by all standards.
Together with the "Aaa" group they comprise what are generally known as high
grade bonds. They are rated lower than the best bonds because margins of
protection may not be as large as in "Aaa" securities or fluctuation of
protective elements may be of greater amplitude or there may be other elements
present which make the long-term risks appear somewhat larger than in "Aaa"
securities.
"A" - Bonds possess many favorable investment attributes and are to be
considered as upper medium grade obligations. Factors giving security to
principal and interest are considered adequate but elements may be present which
suggest a susceptibility to impairment sometime in the future.
"Baa" - Bonds considered medium-grade obligations, i.e., they are
neither highly protected nor poorly secured. Interest payments and principal
security appear adequate for the present but certain protective elements may be
lacking or may be characteristically unreliable over any great length of time.
Such bonds lack outstanding investment characteristics and in fact have
speculative characteristics as well.
"Ba," "B," "Caa," "Ca," and "C" - Bonds that possess one of these
ratings provide questionable protection of interest and principal ("Ba"
indicates some speculative elements; "B" indicates a general lack of
characteristics of desirable investment; "Caa" represents a poor standing; "Ca"
represents obligations which are speculative in a high degree; and "C"
represents the lowest rated class of bonds). "Caa," "Ca" and "C" bonds may be in
default.
Con. (---) - Bonds for which the security depends upon the completion
of some act or the fulfillment of some condition are rated conditionally. These
are bonds secured by (a) earnings of projects under construction, (b) earnings
of projects unseasoned in operation experience, (c) rentals which begin when
facilities are completed, or (d) payments to which some other limiting condition
attaches. Parenthetical rating denotes probable credit stature upon completion
of construction or elimination of basis of condition.
Moody's applies numerical modifiers 1, 2 and 3 in each generic
classification from "Aa" to "B" in its bond rating system. The modifier 1
indicates that the issuer ranks in the higher end of its generic rating
category; the modifier 2 indicates a mid-range ranking; and the modifier 3
indicates that the issuer ranks at the lower end of its generic rating category.
A-7
<PAGE>
The following summarizes the long-term debt ratings used by Duff &
Phelps for corporate and municipal long-term debt:
"AAA" - Debt is considered to be of the highest credit quality. The
risk factors are negligible, being only slightly more than for risk-free U.S.
Treasury debt.
"AA" - Debt is considered of high credit quality. Protection factors
are strong. Risk is modest but may vary slightly from time to time because of
economic conditions.
"A" - Debt possesses protection factors which are average but
adequate. However, risk factors are more variable and greater in periods of
economic stress.
"BBB" - Debt possesses below average protection factors but such
protection factors are still considered sufficient for prudent investment.
Considerable variability in risk is present during economic cycles.
"BB," "B," "CCC," "DD," and "DP" - Debt that possesses one of these
ratings is considered to be below investment grade. Although below investment
grade, debt rated "BB" is deemed likely to meet obligations when due. Debt
rated "B" possesses the risk that obligations will not be met when due. Debt
rated "CCC" is well below investment grade and has considerable uncertainty as
to timely payment of principal, interest or preferred dividends. Debt rated
"DD" is a defaulted debt obligation, and the rating "DP" represents preferred
stock with dividend arrearages.
To provide more detailed indications of credit quality, the "AA," "A,"
"BBB," "BB" and "B" ratings may be modified by the addition of a plus (+) or
minus (-) sign to show relative standing within these major categories.
The following summarizes the highest four ratings used by Fitch for
corporate and municipal bonds:
"AAA" - Bonds considered to be investment grade and of the highest
credit quality. The obligor has an exceptionally strong ability to pay interest
and repay principal, which is unlikely to be affected by reasonably foreseeable
events.
"AA" - Bonds considered to be investment grade and of very high credit
quality. The obligor's ability to pay interest and repay principal is very
strong, although not quite as strong as bonds rated "AAA." Because bonds rated
in the "AAA" and "AA" categories are not significantly vulnerable to foreseeable
future developments, short-term debt of these issuers is generally rated "F-1+."
A-8
<PAGE>
"A" - Bonds considered to be investment grade and of high credit
quality. The obligor's ability to pay interest and repay principal is
considered to be strong, but may be more vulnerable to adverse changes in
economic conditions and circumstances than bonds with higher ratings.
"BBB" - Bonds considered to be investment grade and of satisfactory
credit quality. The obligor's ability to pay interest and repay principal is
considered to be adequate. Adverse changes in economic conditions and
circumstances, however, are more likely to have an adverse impact on these
bonds, and therefore, impair timely payment. The likelihood that the ratings of
these bonds will fall below investment grade is higher than for bonds with
higher ratings.
"BB," "B," "CCC," "CC," "C," "DDD," "DD," and "D" -Bonds that possess
one of these ratings are considered by Fitch to be speculative investments. The
ratings "BB" to "C" represent Fitch's assessment of the likelihood of timely
payment of principal and interest in accordance with the terms of obligation for
bond issues not in default. For defaulted bonds, the rating "DDD" to "D" is an
assessment of the ultimate recovery value through reorganization or liquidation.
To provide more detailed indications of credit quality, the Fitch
ratings from and including "AA" to "C" may be modified by the addition of a plus
(+) or minus (-) sign to show relative standing within these major rating
categories.
IBCA assesses the investment quality of unsecured debt with an
original maturity of more than one year which is issued by bank holding
companies and their principal bank subsidiaries. The following summarizes the
rating categories used by IBCA for long-term debt ratings:
"AAA" - Obligations for which there is the lowest expectation of
investment risk. Capacity for timely repayment of principal and interest is
substantial such that adverse changes in business, economic or financial
conditions are unlikely to increase investment risk substantially.
"AA" - Obligations for which there is a very low expectation of
investment risk. Capacity for timely repayment of principal and interest is
substantial. Adverse changes in business, economic or financial conditions may
increase investment risk albeit not very significantly.
"A" - Obligations for which there is a low expectation of investment
risk. Capacity for timely repayment of principal and interest is strong,
although adverse changes in business,
A-9
<PAGE>
economic or financial conditions may lead to increased investment risk.
"BBB" - Obligations for which there is currently a low expectation of
investment risk. Capacity for timely repayment of principal and interest is
adequate, although adverse changes in business, economic or financial conditions
are more likely to lead to increased investment risk than for obligations in
higher categories.
"BB," "B," "CCC," "CC," and "C" - Obligations are assigned one of
these ratings where it is considered that speculative characteristics are
present. "BB" represents the lowest degree of speculation and indicates a
possibility of investment risk developing. "C" represents the highest degree of
speculation and indicates that the obligations are currently in default.
IBCA may append a rating of plus (+) or minus (-) to a rating to
denote relative status within major rating categories.
Thomson BankWatch assesses the likelihood of an untimely repayment of
principal or interest over the term to maturity of long term debt and preferred
stock which are issued by United States commercial banks, thrifts and non-bank
banks; non-United States banks; and broker-dealers. The following summarizes
the rating categories used by Thomson BankWatch for long-term debt ratings:
"AAA" - This designation represents the highest category assigned by
Thomson BankWatch to long-term debt and indicates that the ability to repay
principal and interest on a timely basis is very high.
"AA" - This designation indicates a superior ability to repay
principal and interest on a timely basis with limited incremental risk versus
issues rated in the highest category.
"A" - This designation indicates that the ability to repay principal
and interest is strong. Issues rated "A" could be more vulnerable to adverse
developments (both internal and external) than obligations with higher ratings.
"BBB" - This designation represents Thomson BankWatch's lowest
investment grade category and indicates an acceptable capacity to repay
principal and interest. Issues rated "BBB" are, however, more vulnerable to
adverse developments (both internal and external) than obligations with higher
ratings.
"BB," "B," "CCC," and "CC," - These designations are assigned by
Thomson BankWatch to non-investment grade long-term
A-10
<PAGE>
debt. Such issues are regarded as having speculative characteristics regarding
the likelihood of timely payment of principal and interest. "BB" indicates the
lowest degree of speculation and "CC" the highest degree of speculation.
"D" - This designation indicates that the long-term debt is in
default.
PLUS (+) OR MINUS (-) - The ratings from "AAA" through "CC" may
include a plus or minus sign designation which indicates where within the
respective category the issue is placed.
Municipal Note Ratings
----------------------
A Standard and Poor's rating reflects the liquidity concerns and
market access risks unique to notes due in three years or less. The following
summarizes the ratings used by Standard & Poor's Ratings Group for municipal
notes:
"SP-1" - The issuers of these municipal notes exhibit very strong or
strong capacity to pay principal and interest. Those issues determined to
possess overwhelming safety characteristics are given a plus (+) designation.
"SP-2" - The issuers of these municipal note exhibit satisfactory
capacity to pay principal and interest.
"SP-3" - The issuers of these municipal notes exhibit speculative
capacity to pay principal and interest.
Moody's ratings for state and municipal notes and other short-term
loans are designated Moody's Investment Grade ("MIG") and variable rate demand
obligations are designated Variable Moody's Investment Grade ("VMIG"). Such
ratings recognize the differences between short-term credit risk and long-term
risk. The following summarizes the ratings by Moody's Investors Service, Inc.
for short-term notes:
"MIG-1"/"VMIG-1" - Loans bearing this designation are of the best
quality, enjoying strong protection by established cash flows, superior
liquidity support or demonstrated broad-based access to the market for
refinancing.
"MIG-2"/"VMIG-2" - Loans bearing this designation are of high quality,
with margins of protection ample although not so large as in the preceding
group.
"MIG-3"/"VMIG-3" - Loans bearing this designation are of favorable
quality, with all security elements accounted for but lacking the undeniable
strength of the preceding grades.
A-11
<PAGE>
Liquidity and cash flow protection may be narrow and market access for
refinancing is likely to be less well established.
"MIG-4"/"VMIG-4" - Loans bearing this designation are of adequate
quality, carrying specific risk but having protection commonly regarded as
required of an investment security and not distinctly or predominantly
speculative.
"SG" - Loans bearing this designation are of speculative quality and
lack margins of protection.
Fitch and Duff & Phelps use the short-term ratings described under
Commercial Paper Ratings for municipal notes.
A-12
<PAGE>
UST MASTER FUNDS, INC.
Short-Term Government Securities Fund
Intermediate-Term Managed Income Fund
Managed Income Fund
UST MASTER TAX-EXEMPT FUNDS, INC.
Short-Term Tax-Exempt Securities Fund
Intermediate-Term Tax-Exempt Fund
Long-Term Tax-Exempt Fund
STATEMENT OF ADDITIONAL INFORMATION
August 1, 1995
This Statement of Additional Information is not a prospectus but should be read
in conjunction with the current prospectuses for the Short-Term Government
Securities Fund, Intermediate-Term Managed Income Fund and Managed Income Fund
of UST Master Funds, Inc. ("Master Fund") and Short-Term Tax-Exempt Securities
Fund, Intermediate-Term Tax-Exempt Fund and Long-Term Tax-Exempt Fund of UST
Master Tax-Exempt Funds, Inc. ("Master Tax-Exempt Fund") dated August 1, 1995,
respectively (the "Fixed-Income Funds Prospectus" and the "Tax-Exempt Funds
Prospectus", respectively; together, the "Prospectuses"). Much of the
information contained in this Statement of Additional Information expands upon
the subjects discussed in the Prospectuses. No investment in shares of the
portfolios described herein ("Shares") should be made without reading the
Prospectuses. A copy of each Prospectus may be obtained by writing UST Master
Funds c/o Mutual Funds Service Company, 73 Tremont Street, Boston, MA 02108-
3913 or by calling (800) 446-1012.
<PAGE>
TABLE OF CONTENTS
-----------------
<TABLE>
<CAPTION>
Page
----
<S> <C>
INVESTMENT OBJECTIVES AND POLICIES...................... 1
Additional Information on Portfolio Instruments.... 1
Additional Investment Limitations.................. 8
ADDITIONAL PURCHASE AND REDEMPTION INFORMATION.......... 12
INVESTOR PROGRAMS....................................... 15
Systematic Withdrawal Plan......................... 15
Exchange Privilege................................. 16
Other Investor Programs............................ 16
DESCRIPTION OF CAPITAL STOCK............................ 16
MANAGEMENT OF THE FUNDS................................. 18
Directors and Officers............................. 18
Investment Advisory and Administration Agreements.. 21
Service Organizations.............................. 23
Expenses 25
Custodian and Transfer Agent....................... 26
PORTFOLIO TRANSACTIONS.................................. 27
INDEPENDENT AUDITORS.................................... 29
COUNSEL................................................. 29
ADDITIONAL INFORMATION CONCERNING TAXES................. 29
Generally.......................................... 29
Tax-Exempt Funds................................... 30
Taxation of Certain Financial Instruments.......... 31
PERFORMANCE AND YIELD INFORMATION....................... 33
Yields and Performance............................. 33
MISCELLANEOUS........................................... 38
FINANCIAL STATEMENTS.................................... 39
APPENDIX A.............................................. A-1
</TABLE>
-i-
<PAGE>
INVESTMENT OBJECTIVES AND POLICIES
----------------------------------
This Statement of Additional Information contains additional
information with respect to the Short-Term Tax-Exempt Securities Fund,
Intermediate-Term Tax-Exempt Fund and Long-Term Tax-Exempt Fund (collectively,
the "Tax-Exempt Funds") of Master Tax-Exempt Fund and the Short-Term Government
Securities Fund, Intermediate-Term Managed Income Fund and Managed Income Fund
of Master Fund (collectively, the "Fixed-Income Funds"). The portfolios are
referred to individually as a "Fund" and collectively as the "Funds"; Master
Tax-Exempt Fund and Master Fund are referred to individually as a "Company" and
collectively as the "Companies".
For ease of reference, the various Funds are referred to as follows:
Short-Term Tax-Exempt Securities Fund as "Short-Term Tax-Exempt Fund";
Intermediate-Term Tax-Exempt Fund as "IT Tax-Exempt Fund"; Long-Term Tax-Exempt
Fund as "LT Tax-Exempt Fund", Short-Term Government Securities Fund as "ST
Government Fund", and Intermediate-Term Managed Income Fund as "IT Income Fund".
The following policies and disclosures supplement the Funds'
investment objectives and policies as set forth in the Prospectuses.
Additional Information on Portfolio Instruments
-----------------------------------------------
Municipal Obligations
---------------------
The Tax-Exempt Funds invest substantially all of their assets in
Municipal Obligations as defined in the Prospectus. Municipal Obligations
include debt obligations issued by governmental entities to obtain funds for
various public purposes, including the construction of a wide range of public
facilities, the refunding of outstanding obligations, the payment of general
operating expenses, and the extension of loans to public institutions and
facilities. Private activity bonds that are issued by or on behalf of public
authorities to finance various privately operated facilities are included within
the term "Municipal Obligations" only if the interest paid thereon is exempt
from regular Federal income tax and not treated as a specific tax preference
item under the Federal alternative minimum tax.
The two principal classifications of Municipal Obligations are
"general obligation" and "revenue" issues, but the Tax-Exempt Funds' portfolios
may include "moral obligation" issues, which are normally issued by special-
purpose authorities. There are, of course, variations in the quality of
Municipal Obligations, both within a particular classification and between
<PAGE>
classifications, and the yields on Municipal Obligations depend upon a variety
of factors, including general money market conditions, the financial condition
of the issuer, general conditions of the municipal bond market, the size of a
particular offering, the maturity of the obligation, and the rating of the
issue. The ratings of Moody's Investors Service, Inc. ("Moody's") and Standard
& Poor's Ratings Group ("S&P") described in the Prospectus and Appendix A hereto
represent their opinion as to the quality of Municipal Obligations. It should
be emphasized that these ratings are general and are not absolute standards of
quality, and Municipal Obligations with the same maturity, interest rate, and
rating may have different yields while Municipal Obligations of the same
maturity and interest rate with different ratings may have the same yield.
Subsequent to its purchase by a Fund, an issue of Municipal Obligations may
cease to be rated, or its rating may be reduced below the minimum rating
required for purchase by that Fund. United States Trust Company of New York,
the Funds' investment adviser ("Investment Adviser" or "U.S. Trust"), will
consider such an event in determining whether a Fund should continue to hold the
obligation.
The payment of principal and interest on most securities purchased by
the Tax-Exempt Funds will depend upon the ability of the issuers to meet their
obligations. Each state, the District of Columbia, each of their political
subdivisions, agencies, instrumentalities and authorities, and each multistate
agency of which a state is a member, is a separate "issuer" as that term is used
in this Statement of Additional Information and the Prospectus. The non-
governmental user of facilities financed by private activity bonds is also
considered to be an "issuer." An issuer's obligations under its Municipal
Obligations are subject to the provisions of bankruptcy, insolvency, and other
laws affecting the rights and remedies of creditors, such as the Federal
Bankruptcy Code, and laws, if any, which may be enacted by Federal or state
legislatures extending the time for payment of principal or interest, or both,
or imposing other constraints upon enforcement of such obligations or upon the
ability of municipalities to levy taxes. The power or ability of an issuer to
meet its obligations for the payment of interest on and principal of its
Municipal Obligations may be materially adversely affected by litigation or
other conditions.
Private activity bonds are or have been issued to obtain funds to
provide, among other things, privately operated housing facilities, pollution
control facilities, convention or trade show facilities, mass transit, airport,
port or parking facilities and certain local facilities for water supply, gas,
electricity or sewage or solid waste disposal. Private activity bonds are also
issued to privately held or publicly owned corporations in the financing of
commercial or industrial facilities. State and local governments are authorized
in most
-2-
<PAGE>
states to issue private activity bonds for such purposes in order to encourage
corporations to locate within their communities. The principal and interest on
these obligations may be payable from the general revenues of the users of such
facilities.
Among other instruments, the Tax-Exempt Funds may purchase short-term
General Obligation Notes, Tax Anticipation Notes, Bond Anticipation Notes,
Revenue Anticipation Notes, Tax-Exempt Commercial Paper, Construction Loan Notes
and other forms of short-term loans. Such instruments are issued with a short-
term maturity in anticipation of the receipt of tax funds, the proceeds of bond
placements or other revenues. In addition, each Fund may invest in long-term
tax-exempt instruments, such as municipal bonds and private activity bonds, to
the extent consistent with the maturity restrictions applicable to it.
From time to time, proposals have been introduced before Congress for
the purpose of restricting or eliminating the Federal income tax exemption for
interest on Municipal Obligations. For example, under the Tax Reform Act of
1986, as amended, interest on certain private activity bonds must be included in
an investor's alternative minimum taxable income, and corporate investors must
treat all tax-exempt interest as an item of tax preference. Master Tax-Exempt
Fund cannot, of course, predict what legislation may be proposed in the future
regarding the income tax status of interest on Municipal Obligations, or which
proposals, if any, might be enacted. Such proposals, while pending or if
enacted, might materially adversely affect the availability of Municipal
Obligations for investment by the Tax-Exempt Funds and the liquidity and value
of their portfolios. In such an event, Master Tax-Exempt Fund would reevaluate
the Funds' investment objectives and policies and consider possible changes in
their structure or possible dissolution.
Opinions relating to the validity of Municipal Obligations and to the
exemption of interest thereon from Federal income tax are rendered by bond
counsel to the respective issuers at the time of issuance. Neither Master Tax-
Exempt Fund nor the Investment Adviser will review the proceedings relating to
the issuance of Municipal Obligations or the basis for such opinions.
The IT Income and Managed Income Funds may, when deemed appropriate by
the Investment Adviser in light of the Funds' investment objective, also invest
in Municipal Obligations. Although yields on municipal obligations can
generally be expected under normal market conditions to be lower than yields on
corporate and U.S. Government obligations, from time to time municipal
securities have outperformed, on a total return basis, comparable corporate and
Federal debt obligations as a result of prevailing economic, regulatory or other
circumstances. Dividends paid by the IT Income and Managed Income Funds that
are
-3-
<PAGE>
derived from interest on municipal securities would be taxable to the Funds'
shareholders for Federal income tax purposes.
Insured Municipal Obligations
-----------------------------
The Tax-Exempt Funds may purchase Municipal Obligations which are
insured as to timely payment of principal and interest at the time of purchase.
The insurance policies will usually be obtained by the issuer of the bond at the
time of its original issuance. Bonds of this type will be acquired only if at
the time of purchase they satisfy quality requirements generally applicable to
Municipal Obligations as described in the Prospectus. Although insurance
coverage for the Municipal Obligations held by the Tax-Exempt Funds reduces
credit risk by insuring that the Funds will receive timely payment of principal
and interest, it does not protect against market fluctuations caused by changes
in interest rates and other factors. Each Tax-Exempt Fund may invest more than
25% of its net assets in Municipal Obligations covered by insurance policies.
Repurchase Agreements
---------------------
The repurchase price under the repurchase agreements described in the
Prospectus generally equals the price paid by a Fund plus interest negotiated on
the basis of current short-term rates (which may be more or less than the rate
on the securities underlying the repurchase agreement). Securities subject to
repurchase agreements are held by the Funds' custodian (or sub-custodian) or in
the Federal Reserve/Treasury book-entry system. Repurchase agreements are
considered loans by a Fund under the Investment Company Act of 1940 (the "1940
Act").
Securities Lending
------------------
When the ST Government Fund, IT Income Fund and Managed Income Fund
lend their portfolio securities, they continue to receive interest or dividends
on the securities lent and may simultaneously earn interest on the investment of
the cash loan collateral, which will be invested in readily marketable, high-
quality, short-term obligations. Although voting rights, or rights to consent,
attendant to securities lent pass to the borrower, such loans may be called at
any time and will be called so that the securities may be voted by the pertinent
Fund if a material event affecting the investment is to occur.
Government Obligations
----------------------
Examples of the types of U.S. Government obligations that may be held
by the Funds include, in addition to U.S. Treasury Bills, the obligations of
Federal Home Loan Banks, Federal Farm Credit Banks, Federal Land Banks, the
Federal Housing Administration, Farmers Home Administration, Export-
-4-
<PAGE>
Import Bank of the United States, Small Business Administration, Government
National Mortgage Association, Federal National Mortgage Association, General
Services Administration, Student Loan Marketing Association, Central Bank for
Cooperatives, Federal Home Loan Mortgage Corporation, Federal Intermediate
Credit Banks and Maritime Administration.
When-Issued and Forward Transactions
------------------------------------
When a Fund agrees to purchase securities on a "when-issued" or
forward commitment basis, the custodian will set aside cash or liquid portfolio
securities equal to the amount of the commitment in a separate account.
Normally, the custodian will set aside portfolio securities to satisfy a
purchase commitment and, in such case, the Fund may be required subsequently to
place additional assets in the separate account in order to ensure that the
value of the account remains equal to the amount of the Fund's commitment. It
may be expected that a Fund's net assets will fluctuate to a greater degree when
it sets aside portfolio securities to cover such purchase commitments than when
it sets aside cash. Because a Fund will set aside cash or liquid assets to
satisfy its purchase commitments in the manner described, its liquidity and
ability to manage its portfolio might be affected in the event its forward
commitments or commitments to purchase "when-issued" securities ever exceeded
25% of the value of its assets.
A Fund will purchase securities on a "when-issued" or forward
commitment basis only with the intention of completing the transaction. If
deemed advisable as a matter of investment strategy, however, a Fund may dispose
of or renegotiate a commitment after it is entered into, and may sell securities
it has committed to purchase before those securities are delivered to the Fund
on the settlement date. In these cases, the Fund may realize a taxable capital
gain or loss.
When a Fund engages in "when-issued" or forward commitment
transactions, it relies on the other party to consummate the trade. Failure of
such other party to do so may result in the Fund incurring a loss or missing an
opportunity to obtain a price considered to be advantageous.
The market value of the securities underlying a "when-issued" purchase
or a forward commitment to purchase securities and any subsequent fluctuations
in their market value are taken into account when determining the market value
of a Fund starting on the day the Fund agrees to purchase the securities. The
Fund does not earn interest on the securities it has committed to purchase until
they are paid for and delivered on the settlement date.
-5-
<PAGE>
Stand-By Commitments
--------------------
The Managed Income and IT Income Funds and the Tax-Exempt Funds may
acquire "stand-by commitments" with respect to Municipal Obligations held by
them. Under a "stand-by commitment," a dealer or bank agrees to purchase from a
Fund, at the Fund's option, specified Municipal Obligations at a specified
price. The amount payable to a Fund upon its exercise of a "stand-by
commitment" is normally (i) the Fund's acquisition cost of the Municipal
Obligations (excluding any accrued interest which the Fund paid on their
acquisition), less any amortized market premium or plus any amortized market or
original issue discount during the period the Fund owned the securities, plus
(ii) all interest accrued on the securities since the last interest payment date
during that period. "Stand-by commitments" are exercisable by a Fund at any
time before the maturity of the underlying Municipal Obligations, and may be
sold, transferred or assigned by the Fund only with the underlying instruments.
The Managed Income and IT Income Funds and the Tax-Exempt Funds expect
that "stand-by commitments" will generally be available without the payment of
any direct or indirect consideration. However, if necessary or advisable, a
Fund may pay for a "stand-by commitment" either separately in cash or by paying
a higher price for securities which are acquired subject to the commitment (thus
reducing the yield to maturity otherwise available for the same securities).
Where a Fund has paid any consideration directly or indirectly for a "stand-by
commitment," its cost will be reflected as unrealized depreciation for the
period during which the commitment was held by the Fund.
The Managed Income and IT Income Funds and the Tax-Exempt Funds intend
to enter into "stand-by commitments" only with banks and broker/dealers which,
in the Investment Adviser's opinion, present minimal credit risks. In evaluating
the creditworthiness of the issuer of a "stand-by commitment," the Investment
Adviser will review periodically the issuer's assets, liabilities, contingent
claims and other relevant financial information.
Commercial Paper
----------------
Investments by the Funds in commercial paper will consist of issues
that are rated "A-2" or better by S&P or "Prime-2" or better by Moody's. In
addition, each Fund may acquire unrated commercial paper that is determined by
the Investment Adviser at the time of purchase to be of comparable quality to
rated instruments that may be acquired by the particular Fund. Each Fund will
generally limit its investments in such unrated commercial paper to 5% of its
total assets.
-6-
<PAGE>
Futures Contracts
-----------------
Each Fund may invest in futures contracts (interest rate futures
contracts or municipal bond index futures contracts, as applicable). Futures
contracts will not be entered into for speculative purposes, but to hedge risks
associated with a Fund's securities investments. Positions in futures contracts
may be closed out only on an exchange which provides a secondary market for such
futures. However, there can be no assurance that a liquid secondary market will
exist for any particular futures contract at any specific time. Thus, it may
not be possible to close a futures position. In the event of adverse price
movements, a Fund would continue to be required to make daily cash payments to
maintain its required margin. In such situations, if a Fund has insufficient
cash, it may have to sell portfolio securities to meet daily margin requirements
at a time when it may be disadvantageous to do so. In addition, a Fund may be
required to make delivery of the instruments underlying futures contracts it
holds. The inability to close options and futures positions also could have an
adverse impact on a Fund's ability to effectively hedge.
Successful use of futures by a Fund is also subject to the Investment
Adviser's ability to correctly predict movements in the direction of the market.
For example, if a Fund has hedged against the possibility of a decline in the
market adversely affecting securities held by it and securities prices increase
instead, the Fund will lose part or all of the benefit to the increased value of
its securities which it has hedged because it will have approximately equal
offsetting losses in its futures positions. In addition, in some situations, if
a Fund has insufficient cash, it may have to sell securities to meet daily
variation margin requirements. Such sales of securities may be, but will not
necessarily be, at increased prices which reflect the rising market. A Fund may
have to sell securities at a time when it may be disadvantageous to do so.
The risk of loss in trading futures contracts in some strategies can
be substantial, due both to the low margin deposits required, and the extremely
high degree of leverage involved in futures pricing. As a result, a relatively
small price movement in a futures contract may result in immediate and
substantial loss (as well as gain) to the investor. For example, if at the time
of purchase, 10% of the value of the futures contract is deposited as margin, a
subsequent 10% decrease in the value of the futures contract would result in a
total loss of the margin deposit, before any deduction for the transaction
costs, if the account were then closed out. A 15% decrease would result in a
loss equal to 150% of the original margin deposit, before any deduction for the
transaction costs, if the contract were closed out. Thus, a purchase or sale of
a futures contract may
-7-
<PAGE>
result in losses in excess of the amount invested in the contract.
Utilization of futures transactions by a Fund involves the risk of
loss by a Fund of margin deposits in the event of bankruptcy of a broker with
whom the Fund has an open position in a futures contract or related option.
Most futures exchanges limit the amount of fluctuation permitted in
futures contract prices during a single trading day. The daily limit
establishes the maximum amount that the price of a futures contract may vary
either up or down from the previous day's settlement price at the end of a
trading session. Once the daily limit has been reached in a particular type of
contract, no trades may be made on that day at a price beyond that limit. The
daily limit governs only price movement during a particular trading day and
therefore does not limit potential losses, because the limit may prevent the
liquidation of unfavorable positions. Futures contract prices have occasionally
moved to the daily limit for several consecutive trading days with little or no
trading, thereby preventing prompt liquidation of futures positions and
subjecting some futures traders to substantial losses.
The trading of futures contracts is also subject to the risk of
trading halts, suspensions, exchange or clearing house equipment failures,
government intervention, insolvency of a brokerage firm or clearing house or
other disruptions of normal trading activity, which could at times make it
difficult or impossible to liquidate existing positions or to recover excess
variation margin payments.
Additional Investment Limitations
---------------------------------
In addition to the investment limitations disclosed in the Prospectus,
the Funds are subject to the investment limitations enumerated below.
Fundamental investment limitations may be changed with respect to a Fund only by
a vote of the holders of a majority of such Fund's outstanding Shares (as
defined under "Miscellaneous" in the Prospectuses). However, investment
limitations which are "operating policies" with respect to a Fund may be changed
by Master Fund's or Master Tax-Exempt Fund's Board of Directors upon reasonable
notice to investors.
The following investment limitations are fundamental with respect to
each Fund. No Fund may:
1. Act as an underwriter of securities within the meaning of the
Securities Act of 1933, except to the extent that the purchase of Municipal
Obligations or other securities directly from the issuer thereof in accordance
with the Tax-
-8-
<PAGE>
Exempt Funds' investment objectives, policies, and limitations may be deemed to
be underwriting; and except insofar as the Managed Income Fund might be deemed
to be an underwriter upon disposition of certain portfolio securities acquired
within the limitation on purchases of restricted securities;
2. Purchase or sell real estate, except that each Tax-Exempt Fund may
invest in Municipal Obligations secured by real estate or interests therein, and
the Managed Income and Intermediate-Term Managed Income Funds may purchase
securities of issuers which deal in real estate and may purchase securities
which are secured by interests in real estate; and
3. Issue any senior securities, except insofar as any borrowing by
each Fund in accordance with its investment limitations might be considered to
be the issuance of a senior security; provided that each Fund may enter into
futures contracts and futures options.
The following investment limitations are fundamental with respect to
the IT Tax-Exempt, LT Tax-Exempt and Managed Income Funds, but are operating
policies with respect to the Short-Term Tax-Exempt, ST Government and IT Income
Funds. The Funds may not:
4. Purchase securities on margin, make short sales of securities, or
maintain a short position; provided that each Fund may enter into futures
contracts and futures options; and
5. Write or sell puts, calls, straddles, spreads, or combinations
thereof; provided that each Fund may enter into futures contracts and futures
options.
The following investment limitation is fundamental with respect to
each Tax-Exempt Fund. A Tax-Exempt Fund may not:
6. Make loans, except that each Tax-Exempt Fund may purchase or hold
debt obligations in accordance with its investment objective, policies, and
limitations.
The following investment limitations are fundamental with respect to
the IT Tax-Exempt and LT Tax-Exempt Funds, but are operating policies with
respect to the Short-Term Tax-Exempt Fund. A Tax-Exempt Fund may not:
7. Invest in industrial revenue bonds where the payment of principal
and interest are the responsibility of a company (including its predecessors)
with less than three years of continuous operation; and
8. Purchase securities of other investment companies (except as part
of a merger, consolidation or reorganization or
-9-
<PAGE>
purchase of assets approved by the Fund's shareholders), provided that a Fund
may purchase shares of any registered, open-end investment company, if
immediately after any such purchase, the Fund does not (a) own more than 3% of
the outstanding voting stock of any one investment company, (b) invest more than
5% of the value of its total assets in the securities of any one investment
company, or (c) invest more than 10% of the value of its total assets in the
aggregate in securities of investment companies.
The following investment limitations are fundamental with respect to
the Managed Income Fund, but are operating policies with respect to the IT
Income and ST Government Funds. A Fixed-Income Fund may not:
9. Invest in companies for the purpose of exercising management or
control;
10. Invest more than 5% of its total assets in securities issued by
companies which, together with any predecessor, have been in continuous
operation for fewer than three years;
11. Purchase foreign securities; provided that subject to the limit
described below, the IT Income and Managed Income Funds may purchase (a) dollar-
denominated debt obligations issued by foreign issuers, including foreign
corporations and governments, by U.S. corporations outside the United States in
an amount not to exceed 25% of its total assets at time of purchase; and (b)
certificates of deposit, bankers' acceptances, or other similar obligations
issued by domestic branches of foreign banks, or foreign branches of U.S. banks,
in an amount not to exceed 20% of its total net assets; and
12. Acquire any other investment company or investment company
security, except in connection with a merger, consolidation, reorganization, or
acquisition of assets or where otherwise permitted by the 1940 Act.
The following investment limitation is fundamental with respect to the
IT Tax-Exempt, LT Tax-Exempt and Managed Income Funds. The IT Tax-Exempt, LT
Tax-Exempt and Managed Income Funds may not:
13. Purchase or sell commodity futures contracts, or invest in oil,
gas, or mineral exploration or development programs; provided that the Funds may
enter into futures contracts and futures options.
The following investment limitation is fundamental with respect to the
Short-Term Tax-Exempt, ST Government and IT Income
-10-
<PAGE>
Funds. The Short-Term Tax-Exempt, ST Government and IT Income Funds may not:
14. Purchase or sell commodities or commodity futures contracts, or
invest in oil, gas, or mineral exploration or development programs; provided
that the Funds may enter into futures contracts and futures options.
* * *
For the purpose of Investment Limitation No. 2, the prohibition of
purchases of real estate includes acquisition of limited partnership interests
in partnerships formed with a view toward investing in real estate, but does not
prohibit purchases of shares in real estate investment trusts. The Funds do not
currently intend to invest in real estate investment trusts.
In addition to the above investment limitations, Master Fund currently
intends to limit the IT Income and Managed Income Funds' investments in warrants
so that, valued at the lower of cost or market value, they do not exceed 5% of a
Fund's net assets. Included within that amount, but not to exceed 2% of the
value of the IT Income or Managed Income Fund's net assets, may be warrants
which are not listed on the New York or American Stock Exchange. For the
purpose of this limitation, warrants acquired by the IT Income or Managed Income
Fund in units or attached to securities will be deemed to be without value.
The IT Tax-Exempt, LT Tax-Exempt and Managed Income Funds may not
purchase or sell commodities.
The Funds' transactions in futures contracts and futures options
(including the margin posted by the Funds in connection with such transactions)
are excluded from the Funds' prohibitions: against the purchase of securities
on margin, short sales of securities and the maintenance of a short position;
the issuance of senior securities; writing or selling puts, calls, straddles,
spreads, or combinations thereof; and the mortgage, pledge or hypothecation of
the Funds' assets.
If a percentage limitation is satisfied at the time of investment, a
later increase or decrease in such percentage resulting from a change in value
of a Fund's portfolio securities will not constitute a violation of such
limitation.
In order to permit the sale of Shares in certain states, Master Fund
may make other commitments more restrictive than the investment policies and
limitations described above and in the Prospectus. Should the Companies
determine that any such commitment is no longer in the Funds' best interests,
they will revoke the commitment by terminating sales of the Shares to investors
residing in the state involved.
-11-
<PAGE>
ADDITIONAL PURCHASE AND REDEMPTION INFORMATION
----------------------------------------------
Shares are continuously offered for sale by Edgewood Services, Inc.
(the "Distributor"), a wholly-owned subsidiary of Federated Investors, and the
Distributor has agreed to use appropriate efforts to solicit all purchase
orders. As described in the Prospectus, Shares may be sold to customers
("Customers") of the Investment Adviser, its affiliates and correspondent banks,
and qualified banks, savings and loan associations, broker/dealers and other
institutions ("Shareholder Organizations") that have entered into servicing
agreements with one of the Companies. Shares are also offered for sale to
institutional investors ("Institutional Investors") and to members of the
general public ("Direct Investors", and collectively with "Institutional
Investors", "Investors"). Different types of Customer accounts at the
Shareholder Organizations may be used to purchase Shares, including eligible
agency and trust accounts. In addition, Shareholder Organizations may
automatically "sweep" a Customer's account not less frequently than weekly and
invest amounts in excess of a minimum balance agreed to by the Shareholder
Organization and its Customer in Shares of the Fund selected by the Customer.
Investors purchasing Shares may include officers, directors, or employees of the
particular Shareholder Organization.
Shares of the Funds are offered for sale with a maximum sales charge
of 4.50%. An illustration of the computation of the offering price per share of
the Funds, using the value of each Fund's net assets and number of outstanding
securities at the close of business on March 31, 1995, is as follows:
<TABLE>
<CAPTION>
Short-Term LT Tax-
Tax-Exempt IT Tax-Exempt Exempt
Fund Fund Fund
------------ ------------- -----------
<S> <C> <C> <C>
Net Assets.............. $48,187,543 $234,990,220 $78,880,450
Outstanding Shares...... 6,927,683 26,690,412 8,511,184
Net Asset Value Per
Share................... $ 6.96 $ 8.80 $ 9.27
Sales Charge (4.50% of
the offering price)..... $ .33 $ .41 $ .44
Offering to Public...... $ 7.29 $ 9.21 $ 9.71
</TABLE>
-12-
<PAGE>
<TABLE>
<CAPTION>
Managed IT Income ST Government
Income Fund Fund Fund
----------- ----------- -------------
<S> <C> <C> <C>
Net Assets.............. $86,024,245 $47,928,448 $25,215,627
Outstanding Shares...... 10,251,319 7,095,338 3,657,258
Net Asset Value Per
Share................... $ 8.39 $ 6.75 $ 6.89
Sales Charge (4.50% of
the offering price)..... $ .40 $ .32 $ .32
Offering to Public...... $ 8.79 $ 7.07 $ 7.21
</TABLE>
As stated in the Prospectus, the sales load described above will not
be applicable to: (a) purchases of Shares by customers of the Investment Adviser
or its affiliates; (b) trust, agency or custodial accounts opened through the
trust department of a bank, trust company or thrift institution, provided that
appropriate notification of such status is given at the time of investment; (c)
companies, corporations and partnerships (excluding full service broker/dealers
and financial planners, registered investment advisers and depository
institutions not covered by the exemptions in (d) and (e) below); (d) financial
planners and registered investment advisers not affiliated with or clearing
purchases through full service broker/dealers; (e) purchases of Shares by
depository institutions for their own account as principal; (f) exchange
transactions (described below under "Investor Programs -- Exchange Privilege")
where the Shares being exchanged were acquired in connection with the
distribution of assets held in trust, agency or custodial accounts maintained
with the trust department of a bank; (g) corporate/business retirement plans
(such as 401(k), 403(b)(7), 457 and Keogh accounts) sponsored by the Distributor
and IRA accounts sponsored by the Investment Adviser; (h) company-sponsored
employee pension or retirement plans making direct investments in the Funds; (i)
purchases of Shares by officers, trustees, directors, employees, former
employees and retirees of the Companies, the Investment Adviser, the Distributor
or of any direct or indirect affiliate of any of them; (j) purchases of Shares
by all beneficial shareholders of the Companies as of May 22, 1989; (k)
purchases of Shares by investment advisers registered under the Investment
Advisers Act of 1940 for their customers through an omnibus account established
with United States Trust Company of New York; (l) purchases of Shares by
directors, officers and employees of brokers and dealers selling shares pursuant
to a selling agreement with the Companies; (m) purchase of Shares by investors
who are members of groups services by USAffinity Investment Limited Partnership;
and (n) customers of certain financial institutions who purchase Shares through
a registered representative of UST Financial Services Corp. on the premises of
their financial institutions. In addition, no sales load is charged on the
reinvestment of dividends or distributions or in connection with certain share
exchange transactions. Investors who have previously redeemed shares in a
portfolio of Master Fund or Master Tax-Exempt Fund on which a sales load has
been paid
-13-
<PAGE>
also have a one-time privilege of purchasing shares of another portfolio of
either Company at net asset value without a sales charge, provided that such
--------
privilege will apply only to purchases made within 30 calendar days from the
date of redemption and only with respect to the amount of the redemption.
For the fiscal years ended March 31, 1995, 1994 and 1993, total sales
charges paid by shareholders: for the IT Tax-Exempt Fund were $17,776, $8,588
and $15,256, respectively; for the LT Tax-Exempt Fund were $4,088, $16,720 and
$22,984, respectively; for the Managed Income Fund were $973, $17,120 and
$24,570, respectively. Of these respective amounts, UST Distributors, Inc., the
Funds' former distributor, retained $431, $6,693 and $13,214 with respect to the
IT Tax-Exempt Fund; $3,188, $9,491 and $11,296 with respect to the LT Tax-Exempt
Fund; and $973, $14,297 and $16,204 with respect to the Managed Income Fund.
Total sales charges paid by shareholders of the Short-Term Tax-Exempt, ST
Government and IT Income Funds for the fiscal years ended March 31, 1995 and
1994 were $20 and $42,285; $1 and $11,744; and $815 and $741, respectively. Of
these respective amounts, UST Distributors, Inc., the Funds' former distributor,
retained $20 and $27,165 with respect to the Short-Term Tax-Exempt Fund; $1 and
$9,788 with respect to the ST Government Fund; and $815 and $660 with respect to
the IT Income Fund. The balance was paid to selling dealers. Shareholders of
the Short-Term Tax-Exempt, ST Government and IT Income Funds paid no sales
charges for the period from December 31, 1992 (commencement of operations) to
March 31, 1993.
The Companies may suspend the right of redemption or postpone the date
of payment for Shares for more than seven days during any period when (a)
trading on the New York Stock Exchange (the "Exchange") is restricted by
applicable rules and regulations of the Securities and Exchange Commission; (b)
the Exchange is closed for other than customary weekend and holiday closings;
(c) the Securities and Exchange Commission has by order permitted such
suspension; or (d) an emergency exists as determined by the Securities and
Exchange Commission.
In the event that Shares are redeemed in cash at their net asset
value, a shareholder may receive in payment for such Shares an amount that is
more or less than his original investment due to changes in the market prices of
that Fund's portfolio securities.
Under limited circumstances, the Companies may accept securities as
payment for Shares. Securities acquired in this manner will be limited to
securities issued in transactions involving a bona fide reorganization or
---------
statutory merger, or will be limited to other securities (except for municipal
debt securities issued by state political subdivisions or their agencies or
instrumentalities) that: (a) meet the investment
-14-
<PAGE>
objective and policies of any Fund acquiring such securities; (b) are acquired
for investment and not for resale; (c) are liquid securities that are not
restricted as to transfer either by law or liquidity of market; and (d) have a
value that is readily ascertainable (and not established only by evaluation
procedures) as evidenced by a listing on the American Stock Exchange, New York
Stock Exchange or NASDAQ, or as evidenced by their status as U.S. Government
securities, bank certificates of deposit, banker's acceptances, corporate and
other debt securities that are actively traded, money market securities and
other similar securities with a readily ascertainable value.
INVESTOR PROGRAMS
-----------------
Systematic Withdrawal Plan
--------------------------
An Investor who owns Shares with a value of $10,000 or more may begin
a Systematic Withdrawal Plan. The withdrawal can be on a monthly, quarterly,
semiannual or annual basis. There are four options for such systematic
withdrawals. The Investor may request:
(1) A fixed-dollar withdrawal;
(2) A fixed-share withdrawal;
(3) A fixed-percentage withdrawal (based on the current value of the
account); or
(4) A declining-balance withdrawal.
Prior to participating in a Systematic Withdrawal Plan, the Investor must
deposit any outstanding certificates for Shares with Mutual Funds Service
Company, the Funds' sub-transfer agent. Under this Plan, dividends and
distributions are automatically reinvested in additional Shares. Amounts paid
to Investors under this Plan should not be considered as income. Withdrawal
payments represent proceeds from the sale of Shares, and there will be a
reduction of the shareholder's equity in the Fund involved if the amount of the
withdrawal payments exceeds the dividends and distributions paid on the Shares
and the appreciation of the Investor's investment in the Fund. This in turn may
result in a complete depletion of the shareholder's investment. An Investor may
not participate in a program of systematic investing in a Fund while at the same
time participating in the Systematic Withdrawal Plan with respect to an account
in that Fund.
-15-
<PAGE>
Exchange Privilege
------------------
Investors and Customers of Shareholder Organizations may exchange
Shares having a value of at least $500 for Shares of any other portfolio of the
Companies. Shares may be exchanged by wire, telephone or mail and must be made
to accounts of identical registration. There is no exchange fee imposed by the
Companies. The Companies may modify or terminate the exchange program at any
time upon 60 days' written notice to shareholders, and may reject any exchange
request. In order to prevent abuse of this privilege to the disadvantage of
other shareholders, the Companies reserve the right to limit the number of
exchange requests of Investors and Customers of Shareholder Organizations to no
more than six per year.
For Federal income tax purposes, exchanges are treated as sales on
which the shareholder will realize a gain or loss, depending upon whether the
value of the Shares to be given up in exchange is more or less than the basis in
such Shares at the time of the exchange. Generally, a shareholder may include
sales loads incurred upon the purchase of Shares in his or her tax basis for
such Shares for the purpose of determining gain or loss on a redemption,
transfer or exchange of such Shares. However, if the shareholder effects an
exchange of Shares for shares of another portfolio of the Companies within 90
days of the purchase and is able to reduce the sales load applicable to the new
shares (by virtue of the Companies' exchange privilege), the amount equal to
such reduction may not be included in the tax basis of the shareholder's
exchanged Shares but may be included (subject to the limitation) in the tax
basis of the new shares.
Other Investor Programs
-----------------------
As described in the Prospectus, Shares of the Funds may be purchased
in connection with the Automatic Investment Program. Shares of the Managed
Income, IT Income and ST Government Funds may also be purchased in connection
with certain Retirement Programs.
DESCRIPTION OF CAPITAL STOCK
----------------------------
Master Fund's Charter authorizes its Board of Directors to issue up to
thirty-five billion full and fractional shares of capital stock; Master Tax-
Exempt Fund's Charter authorizes its Board of Directors to issue up to fourteen
billion full and fractional shares of capital stock. Both Charters authorize
the respective Boards of Directors to classify or reclassify any unissued shares
of the respective Companies into one or more additional classes or series by
setting or changing in any one or more respects their respective preferences,
conversion or other rights, voting powers, restrictions, limitations as to
dividends,
-16-
<PAGE>
qualifications, and terms and conditions of redemption. The Prospectus
describes the classes of shares into which the Companies' authorized capital is
currently classified.
Shares have no preemptive rights and only such conversion or exchange
rights as the Boards of Directors may grant in their discretion. When issued
for payment as described in the Prospectus, Shares will be fully paid and non-
assessable. In the event of a liquidation or dissolution of a Fund,
shareholders of that Fund are entitled to receive the assets available for
distribution belonging to that Fund and a proportionate distribution, based upon
the relative asset values of the portfolios of the Company involved, of any
general assets of that Company not belonging to any particular portfolio of that
Company which are available for distribution. In the event of a liquidation or
dissolution of either Company, shareholders of such Company will be entitled to
the same distribution process.
Shareholders of the Companies are entitled to one vote for each full
share held, and fractional votes for fractional shares held, and will vote in
the aggregate and not by class, except as otherwise required by the 1940 Act or
other applicable law or when the matter to be voted upon affects only the
interests of the shareholders of a particular class. Voting rights are not
cumulative and, accordingly, the holders of more than 50% of the aggregate of a
Company's outstanding shares may elect all of that Company's directors,
regardless of the votes of other shareholders.
Rule 18f-2 under the 1940 Act provides that any matter required to be
submitted to the holders of the outstanding voting securities of an investment
company such as each Company shall not be deemed to have been effectively acted
upon unless approved by the holders of a majority of the outstanding shares of
each portfolio affected by the matter. A portfolio is affected by a matter
unless it is clear that the interests of each portfolio in the matter are
substantially identical or that the matter does not affect any interest of the
portfolio. Under the Rule, the approval of an investment advisory agreement or
any change in a fundamental investment policy would be effectively acted upon
with respect to a portfolio only if approved by a majority of the outstanding
shares of such portfolio. However, the Rule also provides that the ratification
of the appointment of independent public accountants, the approval of principal
underwriting contracts, and the election of directors may be effectively acted
upon by shareholders of each Company voting without regard to class.
The Companies' Charters authorize the Boards of Directors, without
shareholder approval (unless otherwise required by applicable law), to (a) sell
and convey the assets of a Fund to another management investment company for
consideration
-17-
<PAGE>
which may include securities issued by the purchaser and, in connection
therewith, to cause all outstanding Shares of the Fund involved to be redeemed
at a price which is equal to their net asset value and which may be paid in cash
or by distribution of the securities or other consideration received from the
sale and conveyance; (b) sell and convert a Fund's assets into money and, in
connection therewith, to cause all outstanding Shares to be redeemed at their
net asset value; or (c) combine the assets belonging to a Fund with the assets
belonging to another portfolio of the Company involved, if the Board of
Directors reasonably determines that such combination will not have a material
adverse effect on shareholders of any portfolio participating in such
combination, and, in connection therewith, to cause all outstanding shares of
any portfolio to be redeemed at their net asset value or converted into shares
of another class of the Company's capital stock at net asset value. The
exercise of such authority by the Boards of Directors will be subject to the
provisions of the 1940 Act, and the Boards of Directors will not take any action
described in this paragraph unless the proposed action has been disclosed in
writing to the particular Fund's shareholders at least 30 days prior thereto.
Notwithstanding any provision of Maryland law requiring a greater vote
of the Companies' Common Stock (or of the Shares of a Fund voting separately as
a class) in connection with any corporate action, unless otherwise provided by
law (for example, by Rule 18f-2, discussed above) or by the Companies' Charters,
the Companies may take or authorize such action upon the favorable vote of the
holders of more than 50% of the outstanding Common Stock of the particular
Company voting without regard to class.
MANAGEMENT OF THE FUNDS
-----------------------
Directors and Officers
----------------------
The directors and executive officers of the Companies, their
addresses, ages, principal occupations during the past five years, and other
affiliations are as follows (the listed positions apply to both Companies):
-18-
<PAGE>
<TABLE>
<CAPTION>
Principal Occupation
Position with During Past 5 Years
Name and Address the Companies and Other Affiliations
---------------- ------------- ----------------------
<S> <C> <C>
Alfred C. Tannachion/1/ Chairman of the Retired.
1135 Hyde Park Court Board, President
Mahwah, NJ 07430 and Treasurer
Age 69
Donald L. Campbell Director Retired; Senior Vice
333 East 69th Street President, Royal
Apt. 10-H Insurance Company, Inc.,
New York, NY 10021 until August, 1989;
Age 69 Director, Royal Life
Insurance Co. of N.Y.
Joseph H. Dugan Director Retired; President, CEO
913 Franklin Lake Road and Director, L.B.
Franklin Lakes, NJ 07417 Foster Company, (tubular
Age 70 products), from September,
1987 until May, 1990;
Executive Vice President and
COO, L.B. Foster Company,
from September, 1986 until
September, 1987; Senior Vice
President--Finance, Chief
Financial Officer and
Director, Todd Shipyards
Corporation, prior to
January 3, 1986.
Wolfe J. Frankl Director Retired; Director, Deutsche
40 Gooseneck Lane Bank Financial, Inc.;
Charlottesville, VA 22903 Director, The Harbus
Age 74 Corporation; Trustee,
Mariner Funds Trust.
Robert A. Robinson Director President Emeritus,
Church Pension Fund The Church Pension Fund
800 Second Avenue and its affiliated
New York, New York 10017 companies since 1968;
Age 69 Trustee, Mariner Funds
Trust; Trustee, H.B. and
F.H. Bugher Foundation and
Director of its wholly owned
subsidiaries -- Rosiclear
Lead and Flourspar Mining
Co. and The Pigmy
Corporation; Director,
Morehouse Publishing Co.
W. Bruce McConnel, III Secretary Partner of the law
Philadelphia National firm of Drinker
Bank Building Biddle & Reath.
1345 Chestnut Street
Philadelphia, PA 19107-3496
Age 52
</TABLE>
------------------
/1/ This director is considered to be an "interested person" of the Companies
as defined in the 1940 Act.
-19-
<PAGE>
<TABLE>
<CAPTION>
Principal Occupation
Position with During Past 5 Years
Name and Address the Companies and Other Affiliations
---------------- ------------- ----------------------
<S> <C> <C>
Frank M. Deutchki Assistant Vice President
Mutual Funds Service Co. Secretary Mutual Funds Service
73 Tremont Street Company. Since February,
Boston, MA 02108-3913 1989; Senior Vice President
Age 41 -- Risk Analysis and
Avoidance, Putnam Investor
Services (mutual fund
group), from October, 1987
to January, 1989.
John M. Corcoran Assistant Assistant Vice President,
Mutual Funds Service Co. Treasurer Manager of Administration,
73 Tremont Street Mutual Funds Service
Boston, MA 02108-3913 Company, since October, 1993;
Age 30 Audit Manager, Ernst & Young,
from August, 1987 to
September, 1993.
</TABLE>
Each director receives an annual fee of $9,000 with respect to each
Company plus a per-Company meeting fee of $1,500 for each meeting attended and
is reimbursed for expenses incurred in attending meetings. The Chairman of the
Board is entitled to receive an additional $5,000 per annum with respect to each
Company for services in such capacity. Drinker Biddle & Reath, of which Mr.
McConnel is a partner, receives legal fees as counsel to the Companies. The
employees of Mutual Funds Service Company do not receive any compensation from
the Companies for acting as officers of the Companies. No person who is
currently an officer, director or employee of the Investment Adviser serves as
an officer, director or employee of the Companies. The directors and officers
of the Companies as a group own less than 1% of the Shares of each Fund.
The following chart provides certain information about the fees
received by the Companies' directors in the most recently completed fiscal year.
-20-
<PAGE>
<TABLE>
<CAPTION>
Pension or
Retirement Total
Benefits Compensation
Accrued as from the Companies
Aggregate Part of and Fund
Name of Compensation from Fund Complex/*/ Paid
Person/Position each Company Expenses to Directors
--------------- ----------------- ---------- ------------------
<S> <C> <C> <C>
Alfred C. Tannachion $20,000 None $40,000
Chairman of the Board,
President and Treasurer
Donald L. Campbell $15,000 None $30,000
Director
Joseph H. Dugan $15,000 None $30,000
Director
Wolfe J. Frankl $15,000 None $30,000
Director
Robert A. Robinson $15,000 None $30,000
Director
</TABLE>
---------------------------
/*/ The "Fund Complex" consists of UST Master Funds, Inc., UST Master Tax-
Exempt Funds, Inc. and UST Master Variable Series, Inc. For the fiscal
year ended March 31, 1995, UST Master Variable Series, Inc. did not pay any
directors' fees.
Investment Advisory and Administration Agreements
-------------------------------------------------
United States Trust Company of New York serves as Investment Adviser
to the Funds. In the Investment Advisory Agreements, U.S. Trust has agreed to
provide the services described in the Prospectus. The Investment Adviser has
also agreed to pay all expenses incurred by it in connection with its activities
under the respective agreements other than the cost of securities, including
brokerage commissions, if any, purchased for the Funds.
For the fiscal year ended March 31, 1993, Master Tax-Exempt Fund paid
the Investment Adviser $908,764 with respect to the IT Tax-Exempt Fund and
$381,604 with respect to the LT Tax-Exempt Fund. For the same period, Master
Fund paid the Investment Adviser $679,262 with respect to the Managed Income
Fund and the Investment Adviser waived fees totalling $174,339 with respect to
such Fund. For the period from December 31, 1992 (commencement of operations)
to March 31, 1993, Master Tax-Exempt Fund paid the Investment Adviser $2,424
with respect to the Short-Term Tax-Exempt Fund and the Investment Adviser waived
fees totalling $10,372 with respect to such Fund. For the same
-21-
<PAGE>
period, Master Fund paid the Investment Adviser $2,504 and $1,945 with respect
to the ST Government and IT Income Funds, respectively, and the Investment
Adviser waived fees totalling $4,865 and $7,000 with respect to such respective
Funds.
For the fiscal year ended March 31, 1994, the particular Company paid
the Investment Adviser advisory fees of $54,640, $137,367, $654,944, $143,413,
$1,052,739 and $426,183 with respect to the ST Government, IT Income, Managed
Income, Short-Term Tax-Exempt, IT Tax-Exempt and LT Tax-Exempt Funds,
respectively, and the Investment Adviser waived advisory fees of $5,489, $439,
$177,587, $1,948, $6,157 and $1,779 with respect to such respective Funds.
For the fiscal year ended March 31, 1995, the particular Company paid
the Investment Adviser adivsory fees of $62,036, $142,883, $634,922, $149,283,
$801,081 and $374,134 with respect to the ST Goverment, IT Income, Managed
Income, Short-Term Tax-Exempt, IT Tax-Exempt and LT Tax-Exempt Funds,
respectively. For the same period, the Investment Adviser waived fees totalling
$14,308, $8,255, $121,999, $12,322, $84,360 and $26,819 with respect to the ST
Government, IT Income, Managed Income, Short-Term Tax-Exempt, IT Tax-Exempt and
LT Tax-Exempt Funds, respectively.
The Investment Advisory Agreements provide that the Investment Adviser
shall not be liable for any error of judgment or mistake of law or for any loss
suffered by the Funds in connection with the performance of such agreements,
except a loss resulting from a breach of fiduciary duty with respect to the
receipt of compensation for advisory services or a loss resulting from willful
misfeasance, bad faith or gross negligence on the part of the Investment Adviser
in the performance of its duties or from reckless disregard by it of its duties
and obligations thereunder.
Mutual Funds Service Company ("MFSC") and Federated Administrative
Services, an affiliate of the Distributor, jointly serve as the Funds'
administrators. Under the Administration Agreements, the administrators have
agreed to maintain office facilities for the Funds, furnish the Funds with
statistical and research data, clerical, accounting and bookkeeping services,
and certain other services required by the Funds, and to compute the net asset
value, net income, "exempt interest dividends" and realized capital gains or
losses, if any, of the respective Funds. The administrators prepare semiannual
reports to the Securities and Exchange Commission, prepare Federal and state tax
returns, prepare filings with state securities commissions, arrange for and bear
the cost of processing Share purchase and redemption orders, maintain the Funds'
financial accounts and records, and generally assist in all aspects of the
Funds' operations.
-22-
<PAGE>
Prior to August 1, 1995, administrative services were provided to the
Funds by MFSC and Concord Holding Corporation (collectively, the
"Administrators") under administration agreements having substantially the same
terms as the Administration Agreements currently in effect.
For the fiscal year ended March 31, 1993, Master Tax-Exempt Fund paid
the Administrators $405,828 and $119,289 in the aggregate with respect to the IT
Tax-Exempt Fund and the LT Tax-Exempt Fund, respectively. For the same period,
Master Fund paid the Administrators $177,890 in the aggregate with respect to
the Managed Income Fund. For the period from December 31, 1992 (commencement of
operations) to March 31, 1993, Master Tax-Exempt Fund paid the Administrators
$7,169 in the aggregate with respect to the Short-Term Tax-Exempt Fund. For the
same period, Master Fund paid the Administrators $4,663 and $5,277 in the
aggregate with respect to the ST Government Fund and the IT Income Fund,
respectively.
For the fiscal year ended March 31, 1994, Master Tax-Exempt Fund paid
the Administrators $74,732, $466,189 and $131,739 in the aggregate with respect
to the Short-Term Tax-Exempt Fund, IT Tax-Exempt Fund and LT Tax-Exempt Fund,
respectively, and the Administrators waived fees totalling $519 with respect to
the IT Tax-Exempt Fund. For the same period Master Fund paid the Administrators
in the aggregate $31,686, $58,869 and $171,157 with respect to the ST
Government, IT Income and Managed Income Funds, respectively, and the
Administrators waived fees totalling $95 with respect to the Managed Income
Fund.
For the fiscal year ended March 31, 1995, Master Tax-Exempt Fund paid
the Administrators $82,797, $386,614 and $123,173 in the aggregate with respect
to the Short-Term Tax-Exempt Fund, IT Tax-Exempt Fund and the LT Tax-Exempt Fund
respectively. For the same period, Master Fund paid the Administrators $39,116,
$66,481 and $154,370 in the aggregate with respect to the ST Government, IT
Income and Managed Income Funds, respectively. For the same period, the
Administrators waived fees totalling $2,634, $19, $1,051, $356, $3,455 and $321
with respect to the ST Government, IT Income, Managed Income, Short-Term Tax-
Exempt, IT Tax-Exempt and LT Tax-Exempt Funds, respectively.
Service Organizations
---------------------
As stated in the Prospectus, a Company will enter into agreements with
Service Organizations. Such shareholder servicing agreements will require the
Service Organizations to provide shareholder administrative services to their
Customers who beneficially own Shares in consideration for a Fund's payment (on
an annualized basis) of up to .40% of the average daily net
-23-
<PAGE>
assets of the Fund's Shares beneficially owned by Customers of the Service
Organization. Such services may include: (a) assisting Customers in
designating and changing dividend options, account designations and addresses;
(b) providing necessary personnel and facilities to establish and maintain
certain shareholder accounts and records, as may reasonably be requested from
time to time by the Companies; (c) assisting in processing purchases, exchange
and redemption transactions; (d) arranging for the wiring of funds; (e)
transmitting and receiving funds in connection with Customer orders to purchase,
exchange or redeem Shares; (f) verifying and guaranteeing Customer signatures in
connection with redemption orders, transfers among and changes in Customer-
designated accounts; (g) providing periodic statements showing a Customer's
account balances and, to the extent practicable, integrating such information
with information concerning other client transactions otherwise effected with or
through the Service Organization; (h) furnishing on behalf of the Companies'
distributor (either separately or on an integrated basis with other reports sent
to a Customer by the Service Organization) periodic statements and confirmations
of all purchases, exchanges and redemptions of Shares in a Customer's account
required by applicable federal or state law; (i) transmitting proxy statements,
annual reports, updating prospectuses and other communications from the
Companies to Customers; (j) receiving, tabulating and transmitting to the
Companies proxies executed by Customers with respect to annual and special
meetings of shareholders of the Companies; (k) providing reports (at least
monthly, but more frequently if so requested by the Companies' distributor)
containing state-by-state listings of the principal residences of the beneficial
owners of the Shares; and (l) providing or arranging for the provision of such
other related services as the Companies or a Customer may reasonably request.
The Companies' agreements with Service Organizations are governed by
Administrative Services Plans (the "Plans") adopted by the Companies. Pursuant
to the Plans, each Company's Board of Directors will review, at least quarterly,
a written report of the amounts expended under the Company's agreements with
Service Organizations and the purposes for which the expenditures were made. In
addition, the arrangements with Service Organizations will be approved annually
by a majority of each Company's directors, including a majority of the directors
who are not "interested persons" of the Company as defined in the 1940 Act and
have no direct or indirect financial interest in such arrangements (the
"Disinterested Directors").
Any material amendment to a Company's arrangements with Service
Organizations must be approved by a majority of the Company's Board of Directors
(including a majority of the Disinterested Directors). So long as the
Companies' arrangements with Service Organizations are in effect, the selection
and
-24-
<PAGE>
nomination of the members of the Companies' Boards of Directors who are not
"interested persons" (as defined in the 1940 Act) of the Companies will be
committed to the discretion of such non-interested Directors.
For the fiscal years ended March 31, 1995 and 1994, payments to
Service Organizations under the Plans totalled $12,678 and $615, $87,815 and
$6,676, $27,140 and $1,779, $4,466 and $119, $8,274 and $439, and $28,171 and
$1,537 with respect to the Short-Term Tax-Exempt, IT Tax-Exempt, LT Tax-Exempt,
ST Government, IT Income and Managed Income Funds, respectively. Of these
respective amounts, $11,475 and $615, $74,979 and $4,947, $25,075 and $1,779,
$3,649 and $119, $8,041 and $439, and $20,247 and $965 were paid to affiliates
of U.S. Trust with respect to the Short-Term Tax-Exempt, IT Tax-Exempt, LT Tax-
Exempt, ST Government, IT Income and Managed Income Funds, respectively.
Expenses
--------
Except as otherwise noted, the Investment Adviser and the
Administrators bear all expenses in connection with the performance of their
advisory and administrative services. The Funds bear the expenses incurred in
their operations. Expenses of the Funds include: taxes; interest; fees
(including fees paid to the Companies' Directors and officers who are not
affiliated with the Distributor or the Administrators); SEC fees; state
securities qualification fees; costs of preparing and printing prospectuses for
regulatory purposes and for distribution to shareholders; advisory,
administration and administrative servicing fees; charges of the custodian,
transfer agent and dividend disbursing agent; certain insurance premiums;
outside auditing and legal expenses; cost of independent pricing service; costs
of shareholder reports and meetings; and any extraordinary expenses. The Funds
also pay for any brokerage fees and commissions in connection with the purchase
of portfolio securities.
If the expenses borne by a Fund in any fiscal year exceed expense
limitations imposed by applicable state securities regulations, the Investment
Adviser and the Administrators will reimburse such Fund for a portion of any
such excess to the extent required by such regulations in proportion to the fees
received by them in such year up to the amount of fees payable to them,
provided, however, to the extent required by such state regulations, the
Investment Adviser and the Administrators have agreed to effect such
reimbursement regardless of the fees payable to them. The amounts of the above
reimbursements, if any, will be estimated, reconciled and paid on a monthly
basis. To the Companies' knowledge, of the applicable expense limitations in
effect on the date of this Statement of Additional Information, none is more
restrictive than the following: 2 1/2% of the first $30 million of average
annual net assets, 2% of the
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next $70 million of average annual net assets and l 1/2% of average annual net
assets in excess of $100 million.
Custodian and Transfer Agent
----------------------------
United States Trust Company of New York also serves as custodian of
the Funds' assets. Under the custodian agreements, U.S. Trust has agreed to (i)
maintain a separate account or accounts for each of the Funds; (ii) make
receipts and disbursements of money on behalf of the Funds; (iii) collect and
receive income and other payments and distributions on account of the Funds'
portfolio securities; (iv) respond to correspondence from securities brokers and
others relating to its duties; (v) maintain certain financial accounts and
records; and (vi) make periodic reports to the Companies concerning the Funds'
operations. U.S. Trust is entitled to monthly fees for furnishing custodial
services according to the following fee schedule: on the face value of debt
securities and the market value of equities, a fee at the annual rate of .05%;
on issues held, $50.00 for each physical issue held, $25.00 for each book-entry
issue held, and 1/4 of 1% of market value for each foreign issue held; on
transactions, $25.00 for each physical transaction, $15.00 for each book-entry
transaction, and $50.00 for each foreign security transaction. In addition,
U.S. Trust is entitled to reimbursement for its out-of-pocket expenses in
connection with the above services.
U.S. Trust also serves as the Funds' transfer agent and dividend
disbursing agent. In such capacity, U.S. Trust has agreed to (i) issue and
redeem Shares; (ii) address and mail all communications by the Funds to their
shareholders, including reports to shareholders, dividend and distribution
notices, and proxy materials for their meetings of shareholders; (iii) respond
to correspondence by shareholders and others relating to its duties; (iv)
maintain shareholder accounts; and (v) make periodic reports to the Companies
concerning the Funds' operations. For its transfer agency, dividend disbursing,
and subaccounting services, U.S. Trust is entitled to receive $15.00 per annum
per account and subaccount. In addition, U.S. Trust is entitled to be
reimbursed for its out-of-pocket expenses for the cost of forms, postage,
processing purchase and redemption orders, handling of proxies, and other
similar expenses in connection with the above services.
U.S. Trust may, at its own expense, open and maintain custody accounts
with respect to the Funds with other banks or trust companies, and may delegate
its transfer agency obligations to another transfer agent registered or
qualified under applicable law, provided that U.S. Trust shall remain liable for
the performance of all of its custodial and transfer agency duties under the
Custodian and Transfer Agency Agreements, notwithstanding any delegation.
Pursuant to this provision in
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<PAGE>
the agreements, U.S. Trust has entered into a sub-transfer agency arrangement
with MFSC, an affiliate of U.S. Trust, with respect to accounts of shareholders
who are not Customers of U.S. Trust. For the services provided by MFSC, U.S.
Trust has agreed to pay MFSC $15.00 per annum per account or subaccount plus
out-of-pocket expenses. MFSC receives no fee directly from the Companies for
any of its sub-transfer agency services.
PORTFOLIO TRANSACTIONS
----------------------
Subject to the general control of the Companies' Boards of Directors,
the Investment Adviser is responsible for, makes decisions with respect to and
places orders for all purchases and sales of portfolio securities of each of the
Funds. Purchases and sales of portfolio securities will usually be principal
transactions without brokerage commissions.
The Funds may engage in short-term trading to achieve their investment
objectives. Portfolio turnover may vary greatly from year to year as well as
within a particular year. It is expected that the Funds' turnover rates may
remain higher than those of many other investment companies with similar
investment objectives and policies. However, since brokerage commissions are
not normally paid on instruments purchased by the Funds, portfolio turnover is
not expected to have a material effect on the net income of any of the Funds.
The Funds' portfolio turnover rate may also be affected by cash requirements for
redemptions of Shares and by regulatory provisions which enable the Funds to
receive certain favorable tax treatment. Portfolio turnover will not be a
limiting factor in making portfolio decisions. See "Financial Highlights" in
the Funds' prospectuses for the Funds' portfolio turnover rates.
Securities purchased and sold by the Funds are generally traded in the
over-the-counter market on a net basis (i.e., without commission) through
dealers, or otherwise involve transactions directly with the issuer of an
instrument. The cost of securities purchased from underwriters includes an
underwriting commission or concession, and the prices at which securities are
purchased from and sold to dealers include a dealer's mark-up or markdown. With
respect to over-the-counter transactions, the Funds, where possible, will deal
directly with dealers who make a market in the securities involved, except in
those situations where better prices and execution are available elsewhere.
The Investment Advisory Agreements between the Companies and the
Investment Adviser provide that, in executing portfolio transactions and
selecting brokers or dealers, the Investment Adviser will seek to obtain the
best net price and the most favorable execution. The Investment Adviser shall
consider
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factors it deems relevant, including the breadth of the market in the security,
the price of the security, the financial condition and execution capability of
the broker or dealer and whether such broker or dealer is selling shares of the
Companies, and the reasonableness of the commission, if any, for the specific
transaction and on a continuing basis.
In addition, the Investment Advisory Agreements authorize the
Investment Adviser, to the extent permitted by law and subject to the review of
the Companies' Boards of Directors from time to time with respect to the extent
and continuation of the policy, to cause the Funds to pay a broker which
furnishes brokerage and research services a higher commission than that which
might be charged by another broker for effecting the same transaction, provided
that the Investment Adviser determines in good faith that such commission is
reasonable in relation to the value of the brokerage and research services
provided by such broker, viewed in terms of either that particular transaction
or the overall responsibilities of the Investment Adviser to the accounts as to
which it exercises investment discretion. Such brokerage and research services
might consist of reports and statistics on specific companies or industries,
general summaries of groups of stocks and their comparative earnings, or broad
overviews of the stock market and the economy.
Supplementary research information so received is in addition to and
not in lieu of services required to be performed by the Investment Adviser and
does not reduce the investment advisory fee payable by the Funds. Such
information may be useful to the Investment Adviser in serving the Funds and
other clients and, conversely, supplemental information obtained by the
placement of business of other clients may be useful to the Investment Adviser
in carrying out its obligations to the Funds.
Portfolio securities will not be purchased from or sold to the
Investment Adviser, the Distributor, or any affiliated person of either of them
(as such term is defined in the 1940 Act) acting as principal, except to the
extent permitted by the Securities and Exchange Commission.
Investment decisions for the Funds are made independently from those
for other investment companies, common trust funds and other types of funds
managed by the Investment Adviser. Such other investment companies and funds
may also invest in the same securities as the Funds. When a purchase or sale of
the same security is made at substantially the same time on behalf of the Funds
and another investment company or common trust fund, the transaction will be
averaged as to price, and available investments allocated as to amount, in a
manner which the Investment Adviser believes to be equitable to the Funds and
such other investment company or common trust fund. In some instances, this
investment procedure may adversely affect the
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<PAGE>
price paid or received by the Funds or the size of the position obtained by the
Funds. To the extent permitted by law, the Investment Adviser may aggregate the
securities to be sold or purchased for the Funds with those to be sold or
purchased for other investment companies or common trust funds in order to
obtain best execution.
The Companies are required to identify any securities of their regular
brokers or dealers (as defined in Rule 10b-1 under the 1940 Act) or their
parents held by the Companies as of the close of their most recent fiscal year.
As of March 31, 1995 none of the Funds held any securities of Master Fund's or
Master Tax-Exempt Fund's regular brokers or dealers or their parents.
INDEPENDENT AUDITORS
--------------------
Ernst & Young LLP, independent auditors, 200 Clarendon Street, Boston,
MA 02116, serve as auditors of the Companies. The Funds' Financial Highlights
included in the Prospectus and the financial statements for the period ended
March 31, 1995 incorporated by reference in this Statement of Additional
Information have been audited by Ernst & Young LLP for the periods included in
their reports thereon which appear therein.
COUNSEL
-------
Drinker Biddle & Reath (of which Mr. McConnel, Secretary of the
Companies, is a partner), Philadelphia National Bank Building, 1345 Chestnut
Street, Philadelphia, Pennsylvania 19107-3496, is counsel to the Companies and
will pass upon the legality of the Shares offered by the Prospectuses.
ADDITIONAL INFORMATION CONCERNING TAXES
---------------------------------------
Generally
---------
The following supplements the tax information contained in the
Prospectus.
Each of the Funds is treated as a separate corporate entity under the
Internal Revenue Code of 1986, as amended (the "Code"), and intends to qualify
as a regulated investment company. If, for any reason, a Fund does not qualify
for a taxable year for the special Federal tax treatment afforded regulated
investment companies, such Fund would be subject to Federal tax on all of its
taxable income at regular corporate rates, without any deduction for
distributions to shareholders. In such event, dividend distributions (whether or
not derived from interest on Municipal Securities) would be taxable as
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<PAGE>
ordinary income to shareholders to the extent of the Fund's current and
accumulated earnings and profits and would be eligible for the dividends
received deduction in the case of corporate shareholders.
A Fund will designate any distribution of the excess of net long-term
capital gain over net short-term capital loss as a capital gain dividend in a
written notice mailed to shareholders within 60 days after the close of the
Fund's taxable year. Shareholders should note that, upon the sale or exchange
of Shares, if the shareholder has not held such Shares for at least six months,
any loss on the sale or exchange of those Shares will be treated as long-term
capital loss to the extent of the capital gain dividends received with respect
to the Shares.
A 4% non-deductible excise tax is imposed on regulated investment
companies that fail to currently distribute an amount equal to specified
percentages of their ordinary taxable income and capital gain net income (excess
of capital gains over capital losses). Each Fund intends to make sufficient
distributions or deemed distributions of their ordinary taxable income and any
capital gain net income prior to the end of each calendar year to avoid
liability for this excise tax.
Each Fund will be required in certain cases to withhold and remit to
the U.S. Treasury 31% of taxable dividends or gross proceeds realized upon sale
paid to shareholders who have failed to provide a correct tax identification
number in the manner required, who are subject to withholding by the Internal
Revenue Service for failure properly to include on their return payments of
taxable interest or dividends, or who have failed to certify to the Fund when
required to do so either that they are not subject to backup withholding or that
they are "exempt recipients."
Tax-Exempt Funds
----------------
As stated in their Prospectus, the Tax-Exempt Funds are not intended
to constitute a balanced investment program and are not designed for investors
seeking capital appreciation or maximum tax-exempt income irrespective of
fluctuations in principal. Shares of the Tax-Exempt Funds would not be suitable
for tax-exempt institutions and may not be suitable for retirement plans
qualified under Section 401 of the Code, H.R. 10 plans and individual retirement
accounts because such plans and accounts are generally tax-exempt and,
therefore, not only would not gain any additional benefit from the Tax-Exempt
Funds' dividends being tax-exempt, but such dividends would be ultimately
taxable to the beneficiaries when distributed to them. In addition, the Tax-
Exempt Funds may not be an appropriate investment for entities which are
"substantial users" of
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<PAGE>
facilities financed by private activity bonds or "related persons" thereof.
"Substantial user" is defined under the Treasury Regulations to include a non-
exempt person who regularly uses a part of such facilities in his trade or
business and whose gross revenues derived with respect to the facilities
financed by the issuance of bonds are more than 5% of the total revenues derived
by all users of such facilities, who occupies more than 5% of the usable area of
such facilities or for whom such facilities or a part thereof were specifically
constructed, reconstructed or acquired. "Related persons" include certain
related natural persons, affiliated corporations, a partnership and its partners
and an S Corporation and its shareholders.
In order for a Tax-Exempt Fund to pay exempt-interest dividends for
any taxable year, at least 50% of the aggregate value of such Fund's portfolio
must consist of exempt-interest obligations at the close of each quarter of its
taxable year. Within 60 days after the close of the taxable year, each of the
Tax-Exempt Funds will notify its shareholders of the portion of the dividends
paid by that Fund which constitutes an exempt-interest dividend with respect to
such taxable year. However, the aggregate amount of dividends so designated by
that Fund cannot exceed the excess of the amount of interest exempt from tax
under Section 103 of the Code received by that Fund during the taxable year over
any amounts disallowed as deductions under Sections 265 and 171(a)(2) of the
Code. The percentage of total dividends paid by each of the Tax-Exempt Funds
with respect to any taxable year which qualifies as exempt-interest dividends
will be the same for all shareholders receiving dividends from that Tax-Exempt
Fund for such year.
A percentage of the interest on indebtedness incurred by a shareholder
to purchase or carry a Tax-Exempt Fund's Shares, equal to the percentage of the
total non-capital gain dividends distributed during the shareholder's taxable
year that is exempt - interest dividends, is not deductible for Federal income
tax purposes. In addition, if a shareholder holds Tax-Exempt Fund Shares for
six months or less, any loss on the sale or exchange of those Shares will be
disallowed to the extent of the amount of exempt-interest dividends received
with respect to the Shares. The Treasury Department, however, is authorized to
issue regulations reducing the six-month holding requirement to a period of not
less than the greater of 31 days or the period between regular dividend
distributions where the investment company regularly distributes at least 90% of
its net tax-exempt interest. No such regulations had been issued as of the date
of this Statement of Additional Information.
Taxation of Certain Financial Instruments
-----------------------------------------
Generally, futures contracts held by the Funds at the close of their
taxable year will be treated for Federal income
-31-
<PAGE>
tax purposes as sold for their fair market value on the last business day of
such year, a process known as "marking-to-market." Forty percent of any gain or
loss resulting from such constructive sale will be treated as short-term capital
gain or loss and 60% of such gain or loss will be treated as long-term capital
gain or loss, without regard to the length of time a Fund has held the futures
contract (the "40%-60% rule"). The amount of any capital gain or loss actually
realized by a Fund in a subsequent sale or other disposition of those futures
contracts will be adjusted to reflect any capital gain or loss taken into
account by the Fund in a prior year as a result of the constructive sale of the
contracts. With respect to futures contracts to sell, which will be regarded as
parts of a "mixed straddle" because their values fluctuate inversely to the
values of specific securities held by a Fund, losses as to such contracts to
sell will be subject to certain loss deferral rules which limit the amount of
loss currently deductible on either part of the straddle to the amount thereof
which exceeds the unrecognized gain (if any) with respect to the other part of
the straddle, and to certain wash sales regulations. Under short sales rules,
which also are applicable, the holding period of the securities forming part of
the straddle will (if they have not been held for the long-term holding period)
be deemed not to begin prior to termination of the straddle. With respect to
certain futures contracts, deductions for interest and carrying charges will not
be allowed. Notwithstanding the rules described above, with respect to futures
contracts to sell which are properly identified as such, a Fund may make an
election which will exempt (in whole or in part) those identified futures
contracts from being treated for Federal income tax purposes as sold on the last
business day of the Fund's taxable year, but gains and losses will be subject to
such short sales, wash sales and loss deferral rules, and the requirement to
capitalize interest and carrying charges. Under temporary regulations, the Fund
would be allowed (in lieu of the foregoing) to elect either (1) to offset gains
or losses from positions which are part of a mixed straddle by separately
identifying each mixed straddle to which such treatment applies, or (2) to
establish a mixed straddle account for which gains and losses would be
recognized and offset on a periodic basis during the taxable year. Under either
election, the 40%-60% rule will apply to the net gain or loss attributable to
the futures contracts, but in the case of a mixed straddle account election, not
more than 50 percent of any net gain may be treated as long term and no more
than 40 percent of any net loss may be treated as short term. Options on
futures contracts generally receive Federal tax treatment similar to that
described above.
A Fund will not be treated as a regulated investment company under the
Code if 30% or more of the Fund's gross income for a taxable year is derived
from gains realized on the sale or other disposition of the following
investments held for less than
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<PAGE>
three months (the "30% test"): (1) stock and securities (as defined in section
2(a)(36) of the 1940 Act); (2) options, futures and forward contracts other than
those on foreign currencies; and (3) foreign currencies (and options, futures
and forward contracts on foreign currencies) that are not directly related to
the Fund's principal business of investing in stock and securities (and options
and futures with respect to stocks and securities). Interest (including
original issue discount and accrued market discount) received by the Fund upon
maturity or disposition of a security held for less than three months will not
be treated as gross income derived from the sale or other disposition of such
security within the meaning of this requirement. However, any other income
which is attributable to realized market appreciation will be treated as gross
income from the sale or other disposition of securities for this purpose. With
respect to forward contracts, futures contracts, options on futures contracts,
and other financial instruments subject to the marking-to-market rules described
above, the Internal Revenue Service has ruled in private letter rulings that a
gain realized from such a contract, option or financial instrument will be
treated as being derived from a security held for three months or more
(regardless of the actual period for which the contract, option or instrument is
held) if the gain arises as a result of a constructive sale under the marking-
to-market rules, and will be treated as being derived from a security held for
less than three months only if the contract, option or instrument is terminated
(or transferred) during the taxable year (other than by reason of marking-to-
market) and less than three months have elapsed between the date the contract,
option or instrument is acquired and the termination date. Increases and
decreases in the value of a Fund's futures contracts and other investments that
qualify as part of a "designated hedge," as defined in Section 851(g) of the
Code, may be netted for purposes of determining whether the 30% test is met.
* * *
The foregoing discussion is based on Federal tax laws and regulations
which are in effect on the date of this Statement of Additional Information;
such laws and regulations may be changed by legislative or administrative
action. Shareholders are advised to consult their tax advisers concerning their
specific situations and the application of state and local taxes.
PERFORMANCE AND YIELD INFORMATION
---------------------------------
Yields and Performance
----------------------
The Funds may advertise the standardized effective 30-day (or one
month) yields calculated in accordance with the method prescribed by the
Securities and Exchange Commission for
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<PAGE>
mutual funds. Such yield will be calculated separately for each Fund according
to the following formula:
a-b
Yield = 2 [(-------- + 1)/6/ - 1]
cd
Where: a = dividends and interest earned during the period.
b = expenses accrued for the period (net of
reimbursements).
c = average daily number of Shares outstanding that were
entitled to receive dividends.
d = maximum offering price per Share on the last day of the
period.
For the purpose of determining interest earned during the period
(variable "a" in the formula), each of the Funds computes the yield to maturity
of any debt obligation held by it based on the market value of the obligation
(including actual accrued interest) at the close of business on the last
business day of each month, or, with respect to obligations purchased during the
month, the purchase price (plus actual accrued interest). Such yield is then
divided by 360, and the quotient is multiplied by the market value of the
obligation (including actual accrued interest) in order to determine the
interest income on the obligation for each day of the subsequent month that the
obligation is in the portfolio. It is assumed in the above calculation that
each month contains 30 days. Also, the maturity of a debt obligation with a
call provision is deemed to be the next call date on which the obligation
reasonably may be expected to be called or, if none, the maturity date. Each of
the Funds calculates interest gained on tax-exempt obligations issued without
original issue discount and having a current market discount by using the coupon
rate of interest instead of the yield to maturity. In the case of tax-exempt
obligations with original issue discount, where the discount based on the
current market value exceeds the then-remaining portion of original issue
discount, the yield to maturity is the imputed rate based on the original issue
discount calculation. Conversely, where the discount based on the current
market value is less than the remaining portion of the original issue discount,
the yield to maturity is based on the market value.
Expenses accrued for the period (variable "b" in the formula) include
all recurring fees charged by each of the Funds to all shareholder accounts and
to the particular series of
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<PAGE>
Shares in proportion to the length of the base period and that Fund's mean (or
median) account size. Undeclared earned income will be subtracted from the
maximum offering price per Share (variable "d" in the formula). The Funds'
maximum offering price per Share for purposes of the formula will include the
maximum sales load imposed by the Funds -- currently 4.50% of the per share
offering price. Based on the foregoing calculations, the effective yields for
Shares of the IT Tax-Exempt, LT Tax-Exempt, Managed Income, Short-Term Tax-
Exempt, IT Income and ST Government Funds for the 30-day period ended March 31,
1995 were 4.43%, 5.48%, 6.44%, 3.95%, 6.38% and 5.88%, respectively.
The "tax-equivalent" yield of the Short-Term Tax-Exempt, IT Tax-Exempt
and LT Tax-Exempt Funds is computed by: (a) dividing the portion of the yield
(calculated as above) that is exempt from Federal income tax by one minus a
stated Federal income tax rate and (b) adding that figure to that portion, if
any, of the yield that is not exempt from Federal income tax. Tax-equivalent
yields assume the payment of Federal income taxes at a rate of 31%. Based on
the foregoing calculations, the tax-equivalent yield of the Short-Term Tax-
Exempt, IT Tax-Exempt and LT Tax-Exempt Funds for the 30-day period ended March
31, 1995 were 5.72%, 6.42% and 7.94%, respectively.
Each Fund's "average annual total return" is computed by determining
the average annual compounded rate of return during specified periods that
equates the initial amount invested to the ending redeemable value of such
investment according to the following formula:
ERV /1/n/
T = [(-----) - 1]
P
Where: T = average annual total return.
ERV = ending redeemable value of a hypothetical $1,000
payment made at the beginning of the 1, 5 or 10
year (or other) periods at the end of the
applicable period (or a fractional portion
thereof).
P = hypothetical initial payment of $1,000.
n = period covered by the computation, expressed in
years.
Each Fund that advertises an "aggregate total return" computes such return
by determining the aggregate compounded
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<PAGE>
rates of return during specified periods that likewise equate the initial amount
invested to the ending redeemable value of such investment. The formula for
calculating aggregate total return is as follows:
ERV
Aggregate Total Return = [(------)] - 1
P
The above calculations are made assuming that (1) all dividends and
capital gain distributions are reinvested on the reinvestment dates at the price
per Share existing on the reinvestment date (reflecting any sales load charged
upon such reinvestment), (2) all recurring fees charged to all shareholder
accounts are included, and (3) for any account fees that vary with the size of
the account, a mean (or median) account size in the Fund during the periods is
reflected. The ending redeemable value (variable "ERV', in the formula) is
determined by assuming complete redemption of the hypothetical investment after
deduction of all nonrecurring charges at the end of the measuring period. In
addition, the Funds' average annual total return and aggregate total return
quotations will reflect the deduction of the maximum sales load charged in
connection with the purchase of Shares.
Based on the foregoing calculations, the average annual total returns
for Shares of the Short-Term Tax-Exempt Fund, IT Tax-Exempt Fund, LT Tax-Exempt
Fund, ST Government Fund, IT Income Fund and Managed Income Fund for the one
year period ended March 31, 1995 were (1.21)%, 1.52%, 5.99%, (0.44)%, 0.26% and
(0.58)%, respectively. The average annual total returns for the IT Tax-Exempt
Fund, LT Tax-Exempt Fund and Managed Income Fund for the five year period ended
March 31, 1995 were 6.40%, 8.69% and 7.91%, respectively. The average annual
total returns for the IT Tax-Exempt, LT Tax-Exempt and Managed Income Funds for
the periods from their commencement of operations (December 3, 1985, February 5,
1986, and January 9, 1986, respectively) to March 31, 1995 were 7.69%, 10.67%
and 10.10%, respectively. The average annual total returns for the Short-Term
Tax-Exempt, IT Income and ST Government Funds for the period from their
commencement of operations (December 31, 1992) to March 31, 1995 were 1.32%,
2.00% and 1.51%, respectively.
The Funds may also from time to time include in advertisements, sales
literature and communications to shareholders a total return figure that is not
calculated according to the formula set forth above in order to compare more
accurately a Fund's performance with other measures of investment return. For
example, in comparing a Fund's total return with data published by Lipper
Analytical Services, Inc., CDA Investment Technologies, Inc. or Weisenberger
Investment Company
-36-
<PAGE>
Service, or with the performance of an index, a Fund may calculate its aggregate
total return for the period of time specified in the advertisement, sales
literature or communication by assuming the investment of $10,000 in Shares and
assuming the reinvestment of each dividend or other distribution at net asset
value on the reinvestment date. Percentage increases are determined by
subtracting the initial value of the investment from the ending value and by
dividing the remainder by the beginning value. A Fund does not, for these
purposes, deduct from the initial value invested any amount representing sales
charges. A Fund will, however, disclose the maximum sales charge and will also
disclose that the performance data does not reflect sales charges and that
inclusion of sale charges would reduce the performance quoted.
The total return and yield of a Fund may be compared to those of other
mutual funds with similar investment objectives and to other relevant indices or
to ratings prepared by independent services or other financial or industry
publications that monitor the performance of mutual funds. For example, the
total return and/or yield of a Fund may be compared to data prepared by Lipper
Analytical Services, Inc., CDA Investment Technologies, Inc. and Weisenberger
Investment Company Service. Total return and yield data as reported in national
financial publications such as Money Magazine, Forbes, Barron's, The Wall Street
----- -------- ------ -------- --- ---- ------
Journal and The New York Times, or in publications of a local or regional
------- --- --- ---- -----
nature, may also be used in comparing the performance of a Fund.
Advertisements, sales literature or reports to shareholders may from time to
time also include a discussion and analysis of each Fund's performance,
including without limitation, those factors, strategies and technologies that
together with market conditions and events, materially affected each Fund's
performance.
The Funds may also from time to time include discussions or
illustrations of the effects of compounding in advertisements. "Compounding"
refers to the fact that, if dividends or other distributions of a Fund
investment are reinvested by being paid in additional Fund shares, any future
income or capital appreciations of a Fund would increase the value, not only of
the original Fund investment, but also of the additional Fund shares received
through reinvestment. As a result, the value of the Fund investment would
increase more quickly than if dividends or other distributions had been paid in
cash. The Funds may also include discussions or illustrations of the potential
investment goals of a prospective investor, investment management techniques,
policies or investment suitability of a Fund, economic conditions, the effects
of inflation and historical performance of various asset classes, including but
not limited to, stocks, bonds and Treasury bills. From time to time
advertisements, sales literature or communications to shareholders may summarize
the substance of information contained
-37-
<PAGE>
in shareholder reports (including the investment composition of a Fund), as well
as the views of the Investment Adviser as to current market, economy, trade and
interest rate trends, legislative, regulatory and monetary developments,
investment strategies and related matters believed to be of relevance to a Fund.
The Funds may also include in advertisements charts, graphs or drawings which
illustrate the potential risks and rewards of investment in various investment
vehicles, including but not limited to, stocks, bonds, treasury bills and shares
of a Fund. In addition, advertisement, sales literature or shareholder
communications may include a discussion of certain attributes or benefits to be
derived by an investment in a Fund. Such advertisements or communicators may
include symbols, headlines or other material which highlight or summarize the
information discussed in more detail therein.
MISCELLANEOUS
-------------
As used in the Prospectus, "assets belonging to a Fund" means the
consideration received upon the issuance of Shares in the Fund, together with
all income, earnings, profits, and proceeds derived from the investment thereof,
including any proceeds from the sale of such investments, any funds or payments
derived from any reinvestment of such proceeds, and a portion of any general
assets of the Company involved not belonging to a particular portfolio of that
Company. In determining the net asset value of a Fund's Shares, assets
belonging to the Fund are charged with the direct liabilities in respect of that
Fund and with a share of the general liabilities of the Company involved which
are normally allocated in proportion to the relative asset values of the
Company's portfolios at the time of allocation. Subject to the provisions of
the Companies' Charters, determinations by the Boards of Directors as to the
direct and allocable liabilities and the allocable portion of any general assets
with respect to a particular Fund are conclusive.
As of July 11, 1995 U.S. Trust held of record substantially all of the
outstanding Shares in all Funds other than the Managed Income Fund, where it
held a majority of the Shares, acting as agent or custodian for its customers,
but did not own such Shares beneficially because it did not have discretion to
vote or invest such Shares.
As of July 11, 1995, the name, address and percentage ownership of
each person, in addition to U.S. Trust, that beneficially owned 5% or more of
the outstanding Shares of the Short-Term Tax-Exempt Fund was as follows: G.L. &
J.E. Swenson, c/o United States Trust Company of New York, 114 West 47th Street,
New York, New York 10036, 7.2%.
-38-
<PAGE>
FINANCIAL STATEMENTS
--------------------
The Companies' Annual Reports to Shareholders for the fiscal year
ended March 31, 1995 (the "Annual Reports") for the fixed income and tax-exempt
fixed income portfolios accompany this Statement of Additional Information. The
financial statements in the Annual Reports for the ST Government, IT Income,
Managed Income, Short-Term Tax-Exempt, IT Tax-Exempt and LT Tax-Exempt Funds
(the "Financial Statements") are incorporated in this Statement of Additional
Information by reference. The Financial Statements included in the Annual
Reports for the fiscal year ended March 31, 1995 have been audited by the
Companies' independent auditors, Ernst & Young LLP, whose reports thereon also
appear in such Annual Reports and are incorporated herein by reference. The
Financial Statements in such Annual Reports have been incorporated herein in
reliance upon such reports given upon the authority of such firm as experts in
accounting and auditing. Additional copies of the Annual Reports may be
obtained at no charge by telephoning MFSC at the telephone number appearing on
the front page of this Statement of Additional Information.
-39-
<PAGE>
APPENDIX A
----------
Commercial Paper Ratings
------------------------
A Standard & Poor's commercial paper rating is a current assessment of
the likelihood of timely payment of debt considered short-term in the relevant
market. The following summarizes the rating categories used by Standard and
Poor's for commercial paper:
"A-1" - Issue's degree of safety regarding timely payment is strong.
Those issues determined to possess extremely strong safety characteristics are
denoted "A-1+."
"A-2" - Issue's capacity for timely payment is satisfactory. However,
the relative degree of safety is not as high as for issues designated "A-1."
"A-3" - Issue has an adequate capacity for timely payment. It is,
however, somewhat more vulnerable to the adverse effects of changes and
circumstances than an obligation carrying a higher designation.
"B" - Issue has only a speculative capacity for timely payment.
"C" - Issue has a doubtful capacity for payment.
"D" - Issue is in payment default.
Moody's commercial paper ratings are opinions of the ability of
issuers to repay punctually promissory obligations not having an original
maturity in excess of 9 months. The following summarizes the rating categories
used by Moody's for commercial paper:
"Prime-1" - Issuer or related supporting institutions are considered
to have a superior capacity for repayment of short-term promissory obligations.
Prime-1 repayment capacity will normally be evidenced by the following
characteristics: leading market positions in well established industries; high
rates of return on funds employed; conservative capitalization structures with
moderate reliance on debt and ample asset protection; broad margins in earning
coverage of fixed financial charges and high internal cash generation; and well
established access to a range of financial markets and assured sources of
alternate liquidity.
A-1
<PAGE>
"Prime-2" - Issuer or related supporting institutions are considered
to have a strong capacity for repayment of short-term promissory obligations.
This will normally be evidenced by many of the characteristics cited above but
to a lesser degree. Earnings trends and coverage ratios, while sound, will be
more subject to variation. Capitalization characteristics, while still
appropriate, may be more affected by external conditions. Ample alternative
liquidity is maintained.
"Prime-3" - Issuer or related supporting institutions have an
acceptable capacity for repayment of short-term promissory obligations. The
effects of industry characteristics and market composition may be more
pronounced. Variability in earnings and profitability may result in changes in
the level of debt protection measurements and the requirement for relatively
high financial leverage. Adequate alternate liquidity is maintained.
"Not Prime" - Issuer does not fall within any of the Prime rating
categories.
The three rating categories of Duff & Phelps for investment grade
commercial paper and short-term debt are "D-1," "D-2" and "D-3." Duff & Phelps
employs three designations, "D-1+," "D-1" and "D-1-," within the highest rating
category. The following summarizes the rating categories used by Duff & Phelps
for commercial paper:
"D-1+" - Debt possesses highest certainty of timely payment. Short-
term liquidity, including internal operating factors and/or access to
alternative sources of funds, is outstanding, and safety is just below risk-free
U.S. Treasury short-term obligations.
"D-1" - Debt possesses very high certainty of timely payment.
Liquidity factors are excellent and supported by good fundamental protection
factors. Risk factors are minor.
"D-1-" - Debt possesses high certainty of timely payment. Liquidity
factors are strong and supported by good fundamental protection factors. Risk
factors are very small.
"D-2" - Debt possesses good certainty of timely payment. Liquidity
factors and company fundamentals are sound. Although ongoing funding needs may
enlarge total financing requirements, access to capital markets is good. Risk
factors are small.
"D-3" - Debt possesses satisfactory liquidity, and other protection
factors qualify issue as investment grade. Risk
A-2
<PAGE>
factors are larger and subject to more variation. Nevertheless, timely payment
is expected.
"D-4" - Debt possesses speculative investment characteristics.
Liquidity is not sufficient to ensure against disruption in debt service.
Operating factors and market access may be subject to a high degree of
variation.
"D-5" - Issuer has failed to meet scheduled principal and/or interest
payments.
Fitch short-term ratings apply to debt obligations that are payable on
demand or have original maturities of up to three years. The following
summarizes the rating categories used by Fitch for short-term obligations:
"F-1+" - Securities possess exceptionally strong credit quality.
Issues assigned this rating are regarded as having the strongest degree of
assurance for timely payment.
"F-1" - Securities possess very strong credit quality. Issues
assigned this rating reflect an assurance of timely payment only slightly less
in degree than issues rated "F-1+."
"F-2" - Securities possess good credit quality. Issues assigned this
rating have a satisfactory degree of assurance for timely payment, but the
margin of safety is not as great as the "F-1+" and "F-1" categories.
"F-3" - Securities possess fair credit quality. Issues assigned this
rating have characteristics suggesting that the degree of assurance for timely
payment is adequate; however, near-term adverse changes could cause these
securities to be rated below investment grade.
"F-S" - Securities possess weak credit quality. Issues assigned this
rating have characteristics suggesting a minimal degree of assurance for timely
payment and are vulnerable to near-term adverse changes in financial and
economic conditions.
"D" - Securities are in actual or imminent payment default.
Fitch may also use the symbol "LOC" with its short-term ratings to
indicate that the rating is based upon a letter of credit issued by a commercial
bank.
Thomson BankWatch short-term ratings assess the likelihood of an
untimely or incomplete payment of principal or
A-3
<PAGE>
interest of unsubordinated instruments having a maturity of one year or less
which is issued by United States commercial banks, thrifts and non-bank banks;
non-United States banks; and broker-dealers. The following summarizes the
ratings used by Thomson BankWatch:
"TBW-1" - This designation represents Thomson BankWatch's highest
rating category and indicates a very high degree of likelihood that principal
and interest will be paid on a timely basis.
"TBW-2" - This designation indicates that while the degree of safety
regarding timely payment of principal and interest is strong, the relative
degree of safety is not as high as for issues rated "TBW-1."
"TBW-3" - This designation represents the lowest investment grade
category and indicates that while the debt is more susceptible to adverse
developments (both internal and external) than obligations with higher ratings,
capacity to service principal and interest in a timely fashion is considered
adequate.
"TBW-4" - This designation indicates that the debt is regarded as non-
investment grade and therefore speculative.
IBCA assesses the investment quality of unsecured debt with an
original maturity of less than one year which is issued by bank holding
companies and their principal bank subsidiaries. The following summarizes the
rating categories used by IBCA for short-term debt ratings:
"A1" - Obligations are supported by the highest capacity for timely
repayment. Where issues possess a particularly strong credit feature, a rating
of A1+ is assigned.
"A2" - Obligations are supported by a good capacity for timely
repayment.
"A3" - Obligations are supported by a satisfactory capacity for timely
repayment.
"B" - Obligations for which there is an uncertainty as to the capacity
to ensure timely repayment.
"C" - Obligations for which there is a high risk of default or which
are currently in default.
A-4
<PAGE>
Corporate and Municipal Long-Term Debt Ratings
----------------------------------------------
The following summarizes the ratings used by Standard & Poor's for
corporate and municipal debt:
"AAA" - This designation represents the highest rating assigned by
Standard & Poor's to a debt obligation and indicates an extremely strong
capacity to pay interest and repay principal.
"AA" - Debt is considered to have a very strong capacity to pay
interest and repay principal and differs from AAA issues only in small degree.
"A" - Debt is considered to have a strong capacity to pay interest and
repay principal although such issues are somewhat more susceptible to the
adverse effects of changes in circumstances and economic conditions than debt in
higher-rated categories.
"BBB" - Debt is regarded as having an adequate capacity to pay
interest and repay principal. Whereas such issues normally exhibit adequate
protection parameters, adverse economic conditions or changing circumstances are
more likely to lead to a weakened capacity to pay interest and repay principal
for debt in this category than in higher-rated categories.
"BB," "B," "CCC," "CC" and "C" - Debt is regarded, on balance, as
predominantly speculative with respect to capacity to pay interest and repay
principal in accordance with the terms of the obligation. "BB" indicates the
lowest degree of speculation and "C" the highest degree of speculation. While
such debt will likely have some quality and protective characteristics, these
are outweighed by large uncertainties or major risk exposures to adverse
conditions.
"BB" - Debt has less near-term vulnerability to default than other
speculative issues. However, it faces major ongoing uncertainties or exposure
to adverse business, financial or economic conditions which could lead to
inadequate capacity to meet timely interest and principal payments. The "BB"
rating category is also used for debt subordinated to senior debt that is
assigned an actual or implied "BBB-" rating.
"B" - Debt has a greater vulnerability to default but currently has
the capacity to meet interest payments and principal repayments. Adverse
business, financial or economic conditions will likely impair capacity or
willingness to pay interest and repay principal. The "B" rating category is
also used for debt subordinated to senior debt that is assigned an actual or
implied "BB" or "BB-" rating.
A-5
<PAGE>
"CCC" - Debt has a currently identifiable vulnerability to default,
and is dependent upon favorable business, financial and economic conditions to
meet timely payment of interest and repayment of principal. In the event of
adverse business, financial or economic conditions, it is not likely to have the
capacity to pay interest and repay principal. The "CCC" rating category is also
used for debt subordinated to senior debt that is assigned an actual or implied
"B" or "B-" rating.
"CC" - This rating is typically applied to debt subordinated to senior
debt that is assigned an actual or implied "CCC" rating.
"C" - This rating is typically applied to debt subordinated to senior
debt which is assigned an actual or implied "CCC-" debt rating. The "C" rating
may be used to cover a situation where a bankruptcy petition has been filed, but
debt service payments are continued.
"CI" - This rating is reserved for income bonds on which no interest
is being paid.
"D" - Debt is in payment default. This rating is used when interest
payments or principal payments are not made on the date due, even if the
applicable grace period has not expired, unless S & P believes such payments
will be made during such grace period. "D" rating is also used upon the filing
of a bankruptcy petition if debt service payments are jeopardized.
PLUS (+) OR MINUS (-) - The ratings from "AA" through "CCC" may be
modified by the addition of a plus or minus sign to show relative standing
within the major rating categories.
"r" - This rating is attached to highlight derivative, hybrid, and
certain other obligations that S & P believes may experience high volatility or
high variability in expected returns due to non-credit risks. Examples of such
obligations are: securities whose principal or interest return is indexed to
equities, commodities, or currencies; certain swaps and options; and interest
only and principal only mortgage securities.
The following summarizes the ratings used by Moody's for corporate and
municipal long-term debt:
"Aaa" - Bonds are judged to be of the best quality. They carry the
smallest degree of investment risk and are generally referred to as "gilt
edged." Interest payments are protected by a large or by an exceptionally
stable margin and principal is secure. While the various protective elements
are likely to change, such changes as can be visualized are most
A-6
<PAGE>
unlikely to impair the fundamentally strong position of such issues.
"Aa" - Bonds are judged to be of high quality by all standards.
Together with the "Aaa" group they comprise what are generally known as high
grade bonds. They are rated lower than the best bonds because margins of
protection may not be as large as in "Aaa" securities or fluctuation of
protective elements may be of greater amplitude or there may be other elements
present which make the long-term risks appear somewhat larger than in "Aaa"
securities.
"A" - Bonds possess many favorable investment attributes and are to be
considered as upper medium grade obligations. Factors giving security to
principal and interest are considered adequate but elements may be present which
suggest a susceptibility to impairment sometime in the future.
"Baa" - Bonds considered medium-grade obligations, i.e., they are
neither highly protected nor poorly secured. Interest payments and principal
security appear adequate for the present but certain protective elements may be
lacking or may be characteristically unreliable over any great length of time.
Such bonds lack outstanding investment characteristics and in fact have
speculative characteristics as well.
"Ba," "B," "Caa," "Ca," and "C" - Bonds that possess one of these
ratings provide questionable protection of interest and principal ("Ba"
indicates some speculative elements; "B" indicates a general lack of
characteristics of desirable investment; "Caa" represents a poor standing; "Ca"
represents obligations which are speculative in a high degree; and "C"
represents the lowest rated class of bonds). "Caa," "Ca" and "C" bonds may be in
default.
Con. (---) - Bonds for which the security depends upon the completion
of some act or the fulfillment of some condition are rated conditionally. These
are bonds secured by (a) earnings of projects under construction, (b) earnings
of projects unseasoned in operation experience, (c) rentals which begin when
facilities are completed, or (d) payments to which some other limiting condition
attaches. Parenthetical rating denotes probable credit stature upon completion
of construction or elimination of basis of condition.
Moody's applies numerical modifiers 1, 2 and 3 in each generic
classification from "Aa" to "B" in its bond rating system. The modifier 1
indicates that the issuer ranks in the higher end of its generic rating
category; the modifier 2 indicates a mid-range ranking; and the modifier 3
indicates that the issuer ranks at the lower end of its generic rating category.
A-7
<PAGE>
The following summarizes the long-term debt ratings used by Duff &
Phelps for corporate and municipal long-term debt:
"AAA" - Debt is considered to be of the highest credit quality. The
risk factors are negligible, being only slightly more than for risk-free U.S.
Treasury debt.
"AA" - Debt is considered of high credit quality. Protection factors
are strong. Risk is modest but may vary slightly from time to time because of
economic conditions.
"A" - Debt possesses protection factors which are average but
adequate. However, risk factors are more variable and greater in periods of
economic stress.
"BBB" - Debt possesses below average protection factors but such
protection factors are still considered sufficient for prudent investment.
Considerable variability in risk is present during economic cycles.
"BB," "B," "CCC," "DD," and "DP" - Debt that possesses one of these
ratings is considered to be below investment grade. Although below investment
grade, debt rated "BB" is deemed likely to meet obligations when due. Debt
rated "B" possesses the risk that obligations will not be met when due. Debt
rated "CCC" is well below investment grade and has considerable uncertainty as
to timely payment of principal, interest or preferred dividends. Debt rated
"DD" is a defaulted debt obligation, and the rating "DP" represents preferred
stock with dividend arrearages.
To provide more detailed indications of credit quality, the "AA," "A,"
"BBB," "BB" and "B" ratings may be modified by the addition of a plus (+) or
minus (-) sign to show relative standing within these major categories.
The following summarizes the highest four ratings used by Fitch for
corporate and municipal bonds:
"AAA" - Bonds considered to be investment grade and of the highest
credit quality. The obligor has an exceptionally strong ability to pay interest
and repay principal, which is unlikely to be affected by reasonably foreseeable
events.
"AA" - Bonds considered to be investment grade and of very high credit
quality. The obligor's ability to pay interest and repay principal is very
strong, although not quite as strong as bonds rated "AAA." Because bonds rated
in the "AAA" and "AA" categories are not significantly vulnerable to foreseeable
future developments, short-term debt of these issuers is generally rated "F-1+."
A-8
<PAGE>
"A" - Bonds considered to be investment grade and of high credit
quality. The obligor's ability to pay interest and repay principal is
considered to be strong, but may be more vulnerable to adverse changes in
economic conditions and circumstances than bonds with higher ratings.
"BBB" - Bonds considered to be investment grade and of satisfactory
credit quality. The obligor's ability to pay interest and repay principal is
considered to be adequate. Adverse changes in economic conditions and
circumstances, however, are more likely to have an adverse impact on these
bonds, and therefore, impair timely payment. The likelihood that the ratings of
these bonds will fall below investment grade is higher than for bonds with
higher ratings.
"BB," "B," "CCC," "CC," "C," "DDD," "DD," and "D" -Bonds that possess
one of these ratings are considered by Fitch to be speculative investments. The
ratings "BB" to "C" represent Fitch's assessment of the likelihood of timely
payment of principal and interest in accordance with the terms of obligation for
bond issues not in default. For defaulted bonds, the rating "DDD" to "D" is an
assessment of the ultimate recovery value through reorganization or liquidation.
To provide more detailed indications of credit quality, the Fitch
ratings from and including "AA" to "C" may be modified by the addition of a plus
(+) or minus (-) sign to show relative standing within these major rating
categories.
IBCA assesses the investment quality of unsecured debt with an
original maturity of more than one year which is issued by bank holding
companies and their principal bank subsidiaries. The following summarizes the
rating categories used by IBCA for long-term debt ratings:
"AAA" - Obligations for which there is the lowest expectation of
investment risk. Capacity for timely repayment of principal and interest is
substantial such that adverse changes in business, economic or financial
conditions are unlikely to increase investment risk substantially.
"AA" - Obligations for which there is a very low expectation of
investment risk. Capacity for timely repayment of principal and interest is
substantial. Adverse changes in business, economic or financial conditions may
increase investment risk albeit not very significantly.
"A" - Obligations for which there is a low expectation of investment
risk. Capacity for timely repayment of principal and interest is strong,
although adverse changes in business,
A-9
<PAGE>
economic or financial conditions may lead to increased investment risk.
"BBB" - Obligations for which there is currently a low expectation of
investment risk. Capacity for timely repayment of principal and interest is
adequate, although adverse changes in business, economic or financial conditions
are more likely to lead to increased investment risk than for obligations in
higher categories.
"BB," "B," "CCC," "CC," and "C" - Obligations are assigned one of
these ratings where it is considered that speculative characteristics are
present. "BB" represents the lowest degree of speculation and indicates a
possibility of investment risk developing. "C" represents the highest degree of
speculation and indicates that the obligations are currently in default.
IBCA may append a rating of plus (+) or minus (-) to a rating to
denote relative status within major rating categories.
Thomson BankWatch assesses the likelihood of an untimely repayment of
principal or interest over the term to maturity of long term debt and preferred
stock which are issued by United States commercial banks, thrifts and non-bank
banks; non-United States banks; and broker-dealers. The following summarizes
the rating categories used by Thomson BankWatch for long-term debt ratings:
"AAA" - This designation represents the highest category assigned by
Thomson BankWatch to long-term debt and indicates that the ability to repay
principal and interest on a timely basis is very high.
"AA" - This designation indicates a superior ability to repay
principal and interest on a timely basis with limited incremental risk versus
issues rated in the highest category.
"A" - This designation indicates that the ability to repay principal
and interest is strong. Issues rated "A" could be more vulnerable to adverse
developments (both internal and external) than obligations with higher ratings.
"BBB" - This designation represents Thomson BankWatch's lowest
investment grade category and indicates an acceptable capacity to repay
principal and interest. Issues rated "BBB" are, however, more vulnerable to
adverse developments (both internal and external) than obligations with higher
ratings.
A-10
<PAGE>
UST MASTER FUNDS, INC.
Equity Fund
Income and Growth Fund
Long-Term Supply of Energy Fund
Productivity Enhancers Fund
Environmentally-Related Products and Services Fund
Aging of America Fund
Communication and Entertainment Fund
Business and Industrial Restructuring Fund
Global Competitors Fund
Early Life Cycle Fund
STATEMENT OF ADDITIONAL INFORMATION
August 1, 1995
This Statement of Additional Information is not a prospectus but should be read
in conjunction with the current prospectus for the Equity, Income and Growth,
Long-Term Supply of Energy, Productivity Enhancers, Environmentally-Related
Products and Services, Aging of America, Communication and Entertainment,
Business and Industrial Restructuring, Global Competitors and Early Life Cycle
Funds (individually, a "Fund" and collectively, the "Funds") of UST Master
Funds, Inc. ("Master Fund") dated August 1, 1995 (the "Prospectuses"). Much of
the information contained in this Statement of Additional Information expands
upon the subjects discussed in the Prospectuses. No investment in shares of the
Funds described herein (collectively, the "Shares") should be made without
reading the Prospectuses. A copy of the Prospectus may be obtained by writing
Master Fund c/o Mutual Funds Service Company, 73 Tremont Street, Boston, MA
02108-3913 or by calling (800) 446-1012.
<PAGE>
TABLE OF CONTENTS
-----------------
<TABLE>
<CAPTION>
Page
----
<S> <C>
INVESTMENT OBJECTIVES AND POLICIES.................................... 1
Other Investment Considerations -
Equity and Theme Funds............................................ 1
Other Investment Considerations -
Income and Growth Fund............................................ 3
Additional Information on Portfolio Instruments..................... 4
Additional Investment Limitations................................... 10
ADDITIONAL PURCHASE AND REDEMPTION INFORMATION........................ 13
INVESTOR PROGRAMS..................................................... 17
Systematic Withdrawal Plan.......................................... 17
Exchange Privilege.................................................. 18
Other Investor Programs............................................. 18
DESCRIPTION OF CAPITAL STOCK.......................................... 18
MANAGEMENT OF THE FUNDS............................................... 20
Directors and Officers.............................................. 20
Investment Advisory and Administration Agreements................... 23
Service Organizations............................................... 26
Expenses............................................................ 28
Custodian and Transfer Agent........................................ 28
PORTFOLIO TRANSACTIONS................................................ 29
INDEPENDENT AUDITORS.................................................. 32
COUNSEL............................................................... 32
ADDITIONAL INFORMATION CONCERNING TAXES............................... 32
PERFORMANCE INFORMATION............................................... 34
MISCELLANEOUS......................................................... 37
FINANCIAL STATEMENTS.................................................. 38
APPENDIX.............................................................. A-1
</TABLE>
-i-
<PAGE>
INVESTMENT OBJECTIVES AND POLICIES
----------------------------------
The investment objective of the Equity Fund and of the Long-Term
Supply of Energy, Productivity Enhancers, Environmentally-Related Products and
Services, Aging of America, Communication and Entertainment, Business and
Industrial Restructuring, Global Competitors and Early Life Cycle Funds
(collectively, the "Theme Funds") is to seek long-term capital appreciation.
The investment objective of the Income and Growth Fund is to seek to provide
moderate current income and to attempt to achieve capital appreciation. Under
normal market and economic conditions, each Fund invests a significant portion
of its assets in common stock, preferred stock and debt securities convertible
into common stock. The following policies supplement the Funds' investment
objectives and policies as set forth in the Prospectuses.
Other Investment Considerations - Equity Fund and Theme Funds
-------------------------------------------------------------
The Equity Fund and the Theme Funds invest primarily in common stocks,
but each Fund may purchase both preferred stocks and securities convertible into
common stock at the discretion of United States Trust Company of New York (the
"Investment Adviser" or "U.S. Trust"). While current income is secondary to the
objective of long-term capital appreciation, Master Fund expects that the broad
and diversified strategies utilized by the Investment Adviser will result in
somewhat more current income than would be generated if the Investment Adviser
utilized a single strategy more narrowly focused on rapid growth of principal
and involving exposure to higher levels of risk.
The Investment Adviser's investment philosophy is to identify
investment values available in the market at attractive prices. Investment
value arises from the ability to generate earnings or from the ownership of
assets or resources. Underlying earnings potential and asset values are
frequently demonstrable but not recognized in the market prices of the
securities representing their ownership. The Investment Adviser employs the
following three different but closely interrelated portfolio strategies to focus
and organize its search for investment values.
1. Problem/Opportunity Companies. Important investment
-----------------------------
opportunities often occur where companies develop solutions to large, complex,
fundamental problems, such as declining industrial productivity; rising costs
and declining sources of energy; the economic imbalances and value erosion
caused by years of high inflation and interest rates; the soaring costs and
competing priorities of providing health care; and the accelerating
interdependence and "shrinking size" of the world.
<PAGE>
Solutions or parts of solutions to large problems may be generated by
established companies or comparatively new companies of all sizes through the
development of new products, technologies or services, or through new
applications of older ones.
Investment in such companies represents a very wide range of
investment potential, current income return rates, and exposure to fundamental
and market risks. Income generated by each Funds' investments in these
companies would be expected to be moderate, characterized by lesser rates than
those of a fund whose sole objective is current income, and somewhat higher
rates than those of a higher-risk growth fund.
2. Transaction Value Companies. In the opinion of the Investment
---------------------------
Adviser, the stock market frequently values the aggregate ownership of a company
at a substantially lower figure than its component assets would be worth if they
were sold off separately over time. Such assets may include intangible assets
such as product and market franchises, operating know-how, or distribution
systems, as well as such tangible properties as oil reserves, timber, real
estate, or production facilities. Investment opportunities in these companies
are determined by the magnitude of difference between economic worth and current
market price.
Market undervaluations are very often corrected by purchase and sale,
restructuring of the company, or market appreciation to recognize the actual
worth. The recognition process may well occur over time, however, incurring a
form of time-exposure risk. Success from investing in these companies is often
great, but may well be achieved only after a waiting period of inactivity.
Income derived from investing in undervalued companies is expected to
be moderately greater than that derived from investments in either the
Problem/Opportunity or Early Life Cycle companies.
3. Early Life Cycle Companies. Investments in Early Life Cycle
--------------------------
companies tend to be narrowly focused on an objective of higher rates of capital
appreciation. They correspondingly will involve a significantly greater degree
of risk and the reduction of current income to a negligible level. Such
investments will not be limited to new, small companies engaged only in frontier
technology, but will seek opportunities for maximum appreciation through the
full spectrum of business operations, products, services, and asset values.
Consequently, the Funds' investments in Early Life Cycle companies are primarily
in younger, small- to medium- sized companies in the early stages of their
development. Such companies are usually more flexible in trying new approaches
to problem-solving and in
-2-
<PAGE>
making new or different employment of assets. Because of the high risk level
involved, the ratio of success among such companies is lower than the average,
but for those companies which succeed, the magnitude of investment reward is
potentially higher.
Other Investment Considerations - Income and Growth Fund
--------------------------------------------------------
The Income and Growth Fund is expected to have a greater portion of
its assets invested in debt obligations under normal market conditions than the
Equity Fund and Theme Funds. Further, although the Investment Adviser will
generally use the three strategies described above for the Equity and Theme
Funds, the Income and Growth Fund will generally invest in those companies which
are expected to generate the greater income. As a result, the Income and Growth
Fund is likely to have a relatively small portion of its assets invested in
Early Life Cycle companies.
As stated in the Prospectuses, the Income and Growth Fund may invest
up to 10% of its assets in instruments such as liquidating trust receipts;
certificates of beneficial ownership; limited partnership interests; creditor
claims; loan participations; and warrants, options and other rights to purchase
securities. Liquidating trust receipts, as well as certificates of beneficial
interest, acquired by the Income and Growth Fund represent interests in trusts
holding specific assets. In the case of a liquidating trust, such assets may
include airplanes, ships and trucks that have been leased to third parties.
Limited partnership interests acquired by the Fund may represent equitable
interests in enterprises engaged in activities related to leasing of electronic,
computer and other types of equipment. Normally, the profits and losses
attributable to the foregoing types of instruments pass directly to the holders
of the instruments and are not taxed at the trust or partnership level.
Creditor claims (which may be in the form of notes or debentures)
acquired by the Income and Growth Fund comprise debt obligations of companies
being reorganized under bankruptcy or insolvency laws. Creditor claims normally
sell at a substantial discount from their face value, may be convertible into
stock of the reorganized company, and have a high degree of potential risk and
reward. Loan participations acquired by the Income and Growth Fund represent
interests in either separate, privately negotiated loans that have been made by
lending institutions to third parties or pools of privately negotiated loans
maintained in the loan portfolios of lending institutions. Lending institutions
may sell loan participations to the Income and Growth Fund and other
institutional investors in order to achieve additional revenues and to reduce
their exposure on the loans involved, as well as for other reasons. Loan
participations are
-3-
<PAGE>
considered to be illiquid securities subject to the 10% limitation on
investments in illiquid securities described in the Prospectuses.
The instruments described above may provide a higher than normal rate
of return but may also entail greater risks. These risks include the absence of
any secondary or other organized market for certain instruments that the Income
and Growth Fund may acquire; the likelihood that the transfer of certain
instruments will otherwise be restricted because they have not been registered
under Federal or state securities laws; the probability that certain instruments
will represent interests in a single asset or project and will be entirely
dependent upon market and economic factors affecting such asset or project and
upon the skill of project managers to produce value; the possibility of volatile
changes in the value of an instrument because of changes in the value of the
asset underlying the instrument; the possibility that certain instruments will
be subject to heavy cash flow dependency, defaults by borrowers, self-
liquidation and the risk that the underlying portfolio company will fail to
qualify for favorable tax treatment under the Internal Revenue Code of 1986, as
amended (the "Code"); the possibility that the Fund's loss with respect to an
instrument may exceed the amount of its investment; and, with respect to
creditor claims and other debt instruments, the quality of the credit extended.
In addition, as discussed in the Prospectuses, income from some of the
instruments described above may be non-qualifying income for purposes of the
Code and must be monitored by the Investment Adviser so that the amount of any
such non-qualifying income does not exceed the amount permitted by the Code.
The Investment Adviser will purchase such instruments only when it determines
that the expected return justifies the attendant risks.
Additional Information on Portfolio Instruments
-----------------------------------------------
Options
-------
As stated in the Prospectuses, the Income and Growth Fund and the
Theme Funds may purchase put and call options listed on a national securities
exchange and issued by the Options Clearing Corporation. Such purchases would
be in an amount not exceeding 5% of each such Fund's net assets. Purchase of
options is a highly specialized activity which entails greater than ordinary
investment risks. Regardless of how much the market price of the underlying
security increases or decreases, the option buyer's risk is limited to the
amount of the original investment for the purchase of the option. However,
options may be more volatile than the underlying securities, and therefore, on a
percentage basis, an investment in options may be subject to greater fluctuation
than an investment in the underlying securities. A listed call option gives the
purchaser of the
-4-
<PAGE>
option the right to buy from a clearing corporation, and the writer has the
obligation to sell to the clearing corporation, the underlying security at the
stated exercise price at any time prior to the expiration of the option,
regardless of the market price of the security. The premium paid to the writer
is in consideration for undertaking the obligations under the option contract.
A listed put option gives the purchaser the right to sell to a clearing
corporation the underlying security at the stated exercise price at any time
prior to the expiration date of the option, regardless of the market price of
the security. Put and call options purchased by the Income and Growth and Theme
Funds will be valued at the last sale price or, in the absence of such a price,
at the mean between bid and asked prices.
Also as stated in the Prospectuses, each Fund may engage in writing
covered call options and enter into closing purchase transactions with respect
to such options. When any of the Funds writes a covered call option, it may
terminate its obligation to sell the underlying security prior to the expiration
date of the option by executing a closing purchase transaction, which is
effected by purchasing on an exchange an option of the same series (i.e., same
underlying security, exercise price and expiration date) as the option
previously written. Such a purchase does not result in the ownership of an
option. A closing purchase transaction will ordinarily be effected to realize a
profit on an outstanding call option, to prevent an underlying security from
being called, to permit the sale of the underlying security or to permit the
writing of a new call option containing different terms on such underlying
security. The cost of such a liquidation purchase plus transaction costs may be
greater than the premium received upon the original option, in which event the
writer will have incurred a loss on the transaction. An option position may be
closed out only on an exchange which provides a secondary market for an option
of the same series. There is no assurance that a liquid secondary market on an
exchange will exist for any particular option. A covered option writer, unable
to effect a closing purchase transaction, will not be able to sell the
underlying security until the option expires or the underlying security is
delivered upon exercise, with the result that the writer in such circumstances
will be subject to the risk of market decline in the underlying security during
such period. The Funds will write an option on a particular security only if
the Investment Adviser believes that a liquid secondary market will exist on an
exchange for options of the same series, which will permit the Funds to make a
closing purchase transaction in order to close out its position.
When a Fund writes an option, an amount equal to the net premium (the
premium less the commission) received by that Fund is included in the liability
section of that Fund's statement of assets and liabilities as a deferred credit.
The
-5-
<PAGE>
amount of the deferred credit will be subsequently marked to market to reflect
the current value of the option written. The current value of the traded option
is the last sale price or, in the absence of a sale, the average of the closing
bid and asked prices. If an option expires on the stipulated expiration date,
or if the Fund involved enters into a closing purchase transaction, the Fund
will realize a gain (or loss if the cost of a closing purchase transaction
exceeds the net premium received when the option is sold), and the deferred
credit related to such option will be eliminated. If an option is exercised, the
Fund involved may deliver the underlying security from its portfolio or purchase
the underlying security in the open market. In either event, the proceeds of
the sale will be increased by the net premium originally received, and the Fund
involved will realize a gain or loss. Premiums from expired call options
written by the Funds and net gains from closing purchase transactions are
treated as short-term capital gains for Federal income tax purposes, and losses
on closing purchase transactions are short-term capital losses.
Repurchase Agreements
---------------------
The repurchase price under the repurchase agreements described in the
Prospectuses generally equals the price paid by a Fund plus interest negotiated
on the basis of current short-term rates (which may be more or less than the
rate on the securities underlying the repurchase agreement). Securities subject
to repurchase agreements are held by the Funds' custodian (or sub-custodian) or
in the Federal Reserve/Treasury book-entry system. Repurchase agreements are
considered loans by a Fund under the Investment Company Act of 1940 (the "1940
Act").
Futures Contracts and Related Options
-------------------------------------
The Theme Funds may invest in futures contracts and options thereon.
The Theme Funds may enter into interest rate futures contracts and other types
of financial futures contracts, including foreign currency futures contracts, as
well as any index or foreign market futures which are available on recognized
exchanges or in other established financial markets. A futures contract on
foreign currency creates a binding obligation on one party to deliver, and a
corresponding obligation on another party to accept delivery of, a stated
quantity of a foreign currency for an amount fixed in U.S. dollars. Foreign
currency futures, which operate in a manner similar to interest rate futures
contracts may be used by the Theme Funds to hedge against exposure to
fluctuations in exchange rates between the U.S. dollar and other currencies
arising from multinational transactions.
Futures contracts will not be entered into for speculative purposes,
but to hedge risks associated with a Fund's
-6-
<PAGE>
securities investments. Positions in futures contracts may be closed out only
on an exchange which provides a secondary market for such futures. However,
there can be no assurance that a liquid secondary market will exist for any
particular futures contract at any specific time. Thus, it may not be possible
to close a futures position. In the event of adverse price movements, a Fund
would continue to be required to make daily cash payments to maintain its
required margin. In such situations, if the Fund has insufficient cash, it may
have to sell portfolio securities to meet daily margin requirements at a time
when it may be disadvantageous to do so. In addition, the Fund may be required
to make delivery of the instruments underlying futures contracts it holds. The
inability to close options and futures positions also could have an adverse
impact on the Fund's ability to effectively hedge.
Successful use of futures by the Theme Funds is also subject to the
Investment Adviser's ability to correctly predict movements in the direction of
the market. For example, if a Fund has hedged against the possibility of a
decline in the market adversely affecting securities held by it and securities
prices increase instead, the Fund will lose part or all of the benefit to the
increased value of its securities which it has hedged because it will have
approximately equal offsetting losses in its futures positions. In addition, in
some situations, if a Fund has insufficient cash, it may have to sell securities
to meet daily variation margin requirements. Such sales of securities may be,
but will not necessarily be, at increased prices which reflect the rising
market. The Fund may have to sell securities at a time when it may be
disadvantageous to do so.
The risk of loss in trading futures contracts in some strategies can
be substantial, due both to the low margin deposits required, and the extremely
high degree of leverage involved in futures pricing. As a result, a relatively
small price movement in a futures contract may result in immediate and
substantial loss (as well as gain) to the investor. For example, if at the time
of purchase, 10% of the value of the futures contract is deposited as margin, a
subsequent 10% decrease in the value of the futures contract would result in a
total loss of the margin deposit, before any deduction for the transaction
costs, if the account were then closed out. A 15% decrease would result in a
loss equal to 150% of the original margin deposit, before any deduction for the
transaction costs, if the contract were closed out. Thus, a purchase or sale of
a futures contract may result in losses in excess of the amount invested in the
contract.
Utilization of futures transactions by the Theme Funds involves the
risk of loss by a Fund of margin deposits in the event of bankruptcy of a broker
with whom such Fund has an open position in a futures contract or related
option.
-7-
<PAGE>
Most futures exchanges limit the amount of fluctuation permitted in
futures contract prices during a single trading day. The daily limit
establishes the maximum amount that the price of a futures contract may vary
either up or down from the previous day's settlement price at the end of a
trading session. Once the daily limit has been reached in a particular type of
contract, no trades may be made on that day at a price beyond that limit. The
daily limit governs only price movement during a particular trading day and
therefore does not limit potential losses, because the limit may prevent the
liquidation of unfavorable positions. Futures contract prices have occasionally
moved to the daily limit for several consecutive trading days with little or no
trading, thereby preventing prompt liquidation of futures positions and
subjecting some futures traders to substantial losses.
The trading of futures contracts is also subject to the risk of
trading halts, suspensions, exchange or clearing house equipment failures,
government intervention, insolvency of a brokerage firm or clearing house or
other disruptions of normal trading activity, which could at times make it
difficult or impossible to liquidate existing positions or to recover excess
variation margin payments.
Options on Futures Contracts
----------------------------
The Theme Funds may purchase options on the futures contracts
described above. A futures option gives the holder, in return for the premium
paid, the right to buy (call) from or sell (put) to the writer of the option a
futures contract at a specified price at any time during the period of the
option. Upon exercise, the writer of the option is obligated to pay the
difference between the cash value of the futures contract and the exercise
price. Like the buyer or seller of a futures contract, the holder, or writer,
of an option has the right to terminate its position prior to the scheduled
expiration of the option by selling, or purchasing, an option of the same
series, at which time the person entering into the closing transaction will
realize a gain or loss.
Investments in futures options involve some of the same considerations
that are involved in connection with investments in futures contracts (for
example, the existence of a liquid secondary market). In addition, the purchase
of an option also entails the risk that changes in the value of the underlying
futures contract will not be fully reflected in the value of the option
purchased. Depending on the pricing of the option compared to either the
futures contract upon which it is based, or upon the price of the instruments
being hedged, an option may or may not be less risky than ownership of the
futures contract or such instruments. In general, the market prices of options
-8-
<PAGE>
can be expected to be more volatile than the market prices on the underlying
futures contract. Compared to the purchase or sale of futures contracts,
however, the purchase of call or put options on futures contracts may frequently
involve less potential risk to the Fund because the maximum amount at risk is
the premium paid for the options (plus transaction costs). Although permitted
by its fundamental investment policies, the Fund does not currently intend to
write futures options, and will not do so in the future absent any necessary
regulatory approvals.
When-Issued and Forward Transactions
------------------------------------
When a Fund agrees to purchase securities on a "when-issued" or
forward commitment basis, the custodian will set aside cash or liquid portfolio
securities equal to the amount of the commitment in a separate account.
Normally, the custodian will set aside portfolio securities to satisfy a
purchase commitment and, in such case, the Fund may be required subsequently to
place additional assets in the separate account in order to ensure that the
value of the account remains equal to the amount of the Fund's commitment. It
may be expected that a Fund's net assets will fluctuate to a greater degree when
it sets aside portfolio securities to cover such purchase commitments than when
it sets aside cash. Because a Fund will set aside cash or liquid assets to
satisfy its purchase commitments in the manner described, its liquidity and
ability to manage its portfolio might be affected in the event its forward
commitments or commitments to purchase "when-issued" securities ever exceed 25%
of the value of its assets.
A Fund will purchase securities on a "when-issued" or forward
commitment basis only with the intention of completing the transaction. If
deemed advisable as a matter of investment strategy, however, a Fund may dispose
of or renegotiate a commitment after it is entered into, and may sell securities
it has committed to purchase before those securities are delivered to the Fund
on the settlement date. In these cases, the Fund may realize a taxable capital
gain or loss.
When a Fund engages in "when-issued" or forward commitment
transactions, it relies on the other party to consummate the trade. Failure of
such other party to do so may result in the Fund incurring a loss or missing an
opportunity to obtain a price considered to be advantageous.
The market value of the securities underlying a "when-issued" purchase
or a forward commitment to purchase securities and any subsequent fluctuations
in their market value are taken into account when determining the market value
of a Fund starting
-9-
<PAGE>
on the day the Fund agrees to purchase the securities. The Fund does not earn
interest on the securities it has committed to purchase until they are paid for
and delivered on the settlement date.
Securities Lending
------------------
When a Fund lends its securities, it continues to receive interest or
dividends on the securities lent and may simultaneously earn interest on the
investment of the cash loan collateral, which will be invested in readily
marketable, high-quality, short-term obligations. Although voting rights, or
rights to consent, attendant to lent securities pass to the borrower, such loans
may be called at any time and will be called so that the securities may be voted
by a Fund if a material event affecting the investment is to occur.
Restricted Securities
---------------------
The Productivity Enhancers Fund may invest in restricted securities
(privately placed securities) and other securities without readily available
market quotations. The Fund's investments in securities without readily
available market quotations will not exceed 5% of its total assets at the time
of purchase. Restricted securities may be sold only in private transactions or
in a public offering with respect to which a registration statement is in effect
under the Securities Act of 1933 (the "1933 Act"). Where registration may be
required, the Fund may be obligated to pay all or part of the registration
expenses and a considerable period may elapse between the time of the decision
to sell and the time the Fund may be permitted to sell a security under an
effective registration statement. If, during such a period, adverse market
conditions were to develop, the Fund might obtain a less favorable price than
prevailed when it decided to sell. Certain transactions in restricted
securities may qualify for the registration exemption provided in Rule 144A
under the 1933 Act.
Additional Investment Limitations
---------------------------------
In addition to the investment limitations disclosed in the
Prospectuses, the Funds are subject to the investment limitations enumerated
below. Fundamental investment limitations may be changed with respect to a Fund
only by a vote of a majority of the holders of such Fund's outstanding Shares
(as defined under "Miscellaneous" in the Prospectuses). However, investment
limitations which are "operating policies" with respect to a Fund may be changed
by Master Fund's Board of Directors upon reasonable notice to Investors.
-10-
<PAGE>
The following investment limitations are fundamental with respect to
each Fund. Each Fund may not:
1. Act as an underwriter of securities within the meaning of the
Securities Act of 1933, except insofar as it might be deemed to be an
underwriter upon disposition of certain portfolio securities acquired within the
limitation on purchases of restricted securities;
2. Purchase or sell real estate, except that each Fund may purchase
securities of issuers which deal in real estate and may purchase securities
which are secured by interests in real estate; and
3. Issue any senior securities, except insofar as any borrowing in
accordance with a Fund's investment limitation contained in the Prospectuses
might be considered to be the issuance of a senior security.
The following investment limitations are fundamental with respect to
the Equity and Income and Growth Funds, but are operating policies with respect
to the Theme Funds. No Fund may:
4. Purchase securities on margin, make short sales of securities, or
maintain a short position;
5. Invest in or sell put options, call options, straddles, spreads,
or any combination thereof; provided, however, that each Fund may write covered
call options with respect to its portfolio securities that are traded on a
national securities exchange, and may enter into closing purchase transactions
with respect to such options if, at the time of the writing of such option, the
aggregate value of the securities subject to the options written by the Fund
involved does not exceed 25% of the value of its total assets; and provided that
the Income and Growth Fund and Theme Funds may purchase options and other rights
in accordance with their investment objectives and policies;
6. Invest in companies for the purpose of exercising management or
control;
7. Invest more than 5% of its total assets in securities issued by
companies which, together with any predecessor, have been in continuous
operation for fewer than three years; and
-11-
<PAGE>
8. Acquire any other investment company or investment company
security, except in connection with a merger, consolidation, reorganization, or
acquisition of assets or where otherwise permitted by the 1940 Act.
The following investment limitation is fundamental with respect to the
Equity and Income and Growth Funds. The Equity and Income and Growth Funds may
not:
9. Purchase or sell commodities futures contracts or invest in oil,
gas, or other mineral exploration or development programs; provided, however,
that this shall not prohibit either Fund from purchasing publicly traded
securities of companies engaging in whole or in part in such activities or the
Income and Growth Fund from investing in liquidating trust receipts,
certificates of beneficial ownership or other instruments in accordance with its
investment objectives and policies.
The following investment limitation is fundamental with respect to the
Theme Funds. Each Theme Fund may not:
10. Purchase or sell commodities or commodities futures contracts or
invest in oil, gas, or other mineral exploration or development programs;
provided, however, that i) this shall not prohibit any Theme Fund from
purchasing publicly traded securities of companies engaging in whole or in part
in such activities or from investing in liquidating trust receipts, certificates
of beneficial ownership or other instruments in accordance with its investment
objectives and policies, and ii) each Theme Fund may enter into futures
contracts and futures options.
* * *
For the purpose of Investment Limitation No. 2, the prohibition of
purchases of real estate includes acquisition of limited partnership interests
in partnerships formed with a view toward investing in real estate, but does not
prohibit purchases of shares in real estate investment trusts.
In addition to the above investment limitations, Master Fund currently
intends to limit the Funds' investments in warrants so that, valued at the lower
of cost or market value, they do not exceed 5% of the net assets of the Fund
involved. Included within that amount, but not to exceed 2% of the value of a
Fund's net assets, may be warrants which are not listed on the New York or
American Stock Exchanges. For the purpose of this limitation, warrants acquired
by a Fund in units or attached to securities will be deemed to be without value.
The Funds also intend to refrain from entering into arbitrage transactions.
-12-
<PAGE>
Each of the Equity and Income and Growth Funds may not purchase or
sell commodities except as provided in Investment Limitation No. 9 above.
Pursuant to the requirements of state securities laws, each Fund
currently intends to limit its option transactions so that they do not exceed,
at the time when they are written, 25% of the net (rather than total) assets of
the particular Fund involved. See Investment Limitation No. 5 above.
If a percentage limitation is satisfied at the time of investment, a
later increase or decrease in such percentage resulting from a change in value
of a Fund's securities will not constitute a violation of such limitation.
In order to permit the sale of Shares in certain states, Master Fund
may make on behalf of the Funds other commitments more restrictive than the
investment policies and limitations described above and in the Prospectuses.
Should Master Fund determine that any such commitment is no longer in the Funds'
best interests, it will revoke the commitment by terminating sales of Shares to
investors residing in the state involved.
ADDITIONAL PURCHASE AND REDEMPTION INFORMATION
----------------------------------------------
Shares are continuously offered for sale by Edgewood Service, Inc.
(the "Distributor"), a wholly-owned subsidiary of Federated Investors, and the
Distributor has agreed to use appropriate efforts to solicit all purchase
orders. As described in the Prospectuses, Shares may be sold to customers
("Customers") of financial institutions ("Shareholder Organizations"). Shares
are also offered for sale directly to institutional investors and to members of
the general public. Different types of Customer accounts at the Shareholder
Organizations may be used to purchase Shares, including eligible agency and
trust accounts. In addition, Shareholder Organizations may automatically
"sweep" a Customer's account not less frequently than weekly and invest amounts
in excess of a minimum balance agreed to by the Shareholder Organization and its
Customer in Shares selected by the Customer. Investors purchasing Shares may
include officers, directors, or employees of the particular Shareholder
Organization.
Shares of the Funds are offered for sale with a maximum sales charge
of 4.50%. An illustration of the computation of the offering price per share of
the Funds, using the value of each Fund's net assets and number of outstanding
securities at the close of business on March 31, 1995 is as follows:
-13-
<PAGE>
<TABLE>
<CAPTION>
Income &
Equity Fund Growth Fund
------------- -------------
<S> <C> <C>
Net Assets.................. $137,416,899 $99,924,587
Outstanding Shares.......... 6,420,813 8,455,564
Net Asset Value Per Share... $ 21.40 $ 11.82
Sales Charge (4.50% of the
offering price)........... $ 1.01 $ .56
Offering to Public.......... $ 22.41 $ 12.38
</TABLE>
<TABLE>
<CAPTION>
Long-Term Environmentally-
--------- ----------------
Supply Productivity Related Products Aging of
------ ------------ ---------------- --------
of Energy Enhancers and Services America
--------- --------- ------------ -------
Fund Fund Fund Fund
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net Assets.................. $ 15,812,874 $18,265,270 $ 4,359,023 $22,173,584
Outstanding Shares.......... 1,996,785 2,250,747 701,832 2,826,981
Net Asset Value Per Share... $ 7.92 $ 8.12 $ 6.21 $ 7.84
Sales Charge (4.50% of the
offering price)........... $ .37 $ .38 $ .29 $ .37
Offering to Public.......... $ 8.29 $ 8.50 $ 6.50 $ 8.21
</TABLE>
<TABLE>
<CAPTION>
Communication Business and
------------- ------------
and Industrial Global Early Life
--- ---------- ------ ----------
Entertainment Restructuring Competitors Cycle
------------- ------------- ----------- -----
Fund Fund Fund Fund
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net Assets.................. $ 29,914,390 $30,182,757 $25,494,628 $47,782,354
Outstanding Shares.......... 3,101,632 2,861,323 2,968,007 4,892,316
Net Asset Value Per Share... $ 9.64 $ 10.55 $ 8.59 $ 9.77
Sales Charge (4.50% of the
offering price)........... $ .45 $ .50 $ .40 $ .46
Offering to Public.......... $ 10.09 $ 11.05 $ 8.99 $ 10.23
</TABLE>
-14-
<PAGE>
As stated in the Prospectuses, the sales load described above will not
be applicable to: (a) purchases of Shares by customers of the Investment
Adviser or its affiliates; (b) trust, agency or custodial accounts opened
through the trust department of a bank, trust company or thrift institution,
provided that appropriate notification of such status is given at the time of
investment; (c) companies, corporations and partnerships (excluding full service
broker/dealers and financial planners, registered investment advisers and
depository institutions not covered by the exemptions in (d) and (e) below); (d)
financial planners and registered investment advisers not affiliated with or
clearing purchases through full service broker/dealers; (e) purchases of Shares
by depository institutions for their own account as principal; (f) exchange
transactions (described below under "Investor Programs -- Exchange Privilege")
where the Shares being exchanged were acquired in connection with the
distribution of assets held in trust, agency or custodial accounts maintained
with the trust department of a bank; (g) corporate/business retirement plans
(such as 401(k), 403(b)(7), 457 and Keogh accounts) sponsored by the Distributor
and IRA accounts sponsored by the Investment Adviser; (h) company-sponsored
employee pension or retirement plans making direct investments in the Funds; (i)
purchases of Shares by officers, trustees, directors, employees, former
employees and retirees of Master Fund, UST Master Tax-Exempt Funds, Inc.
("Master Tax-Exempt Fund"), the Investment Adviser, the Distributor or of any
direct or indirect affiliate of any of them; (j) purchases of Shares by all
beneficial shareholders of Master Fund or Master Tax-Exempt Fund as of May 22,
1989; (k) purchases of Shares by investment advisers registered under the
Investment Advisers Act of 1940 for their customers through an omnibus account
established with United States Trust Company of New York; (l) purchases of
Shares by directors, officers and employees of brokers and dealers selling
shares pursuant to a selling agreement with Master Fund and Master Tax-Exempt
Fund; (m) purchase of shares by investors who are members of affinity groups
serviced by USAffinity Investments Limited Partnership; and (n) customers of
certain financial institutions who purchase shares through a registered
representative of UST Financial Services Corp. on the premises of their
financial institutions. In addition, no sales load is charged on the
reinvestment of dividends or distributions or in connection with certain share
exchange transactions. Investors who have previously redeemed shares in a
portfolio of Master Fund or Master Tax-Exempt Fund on which a sales load has
been paid also have a one-time privilege of purchasing shares of another
portfolio of either company at net asset value without a sales charge, provided
that such privilege will apply only to purchases made within 30 calendar days
from the date of redemption and only with respect to the amount of the
redemption.
Total sales charges paid by shareholders of the Equity and Income and
Growth Funds during the fiscal years ended
-15-
<PAGE>
March 31, 1995, 1994 and 1993 were $7,492 and $1,713, respectively, $10,877 and
$5,866, respectively and $17,258 and $5,665, respectively. Of these respective
amounts, UST Distributors, Inc., the Funds' former distributor, retained
$7,092, $9,249 and $12,392 with respect to the Equity Fund and $1,703, $5,037
and $3,859 with respect to the Income and Growth Fund for the fiscal years ended
March 31, 1995, 1994 and 1993. The balance was paid to selling dealers. For
the fiscal years ended March 31, 1995 and 1994 and during the period from
December 31, 1992 (commencement of operations) to March 31, 1993, total sales
charges paid by shareholders of the Long-Term Supply of Energy, Productivity
Enhancers, Environmentally-Related Products and Services, Aging of America,
Communication and Entertainment, Business and Industrial Restructuring, Global
Competitors and Early Life Cycle Funds were $84, $315 and $0; $143, $181 and $2;
$0, $45 and $0; $357, $272 and $666; $438, $2,453 and $587; $779, $1,672 and
$558; $353, $136 and $0; and $1,107, $840 and $22, respectively. Of these
respective amounts, UST Distributors, Inc., the Funds' former distributor,
retained $84, $280 and $0 with respect to the Long-Term Supply of Energy Fund;
$143, $160 and $2 with respect to the Productivity Enhancers Fund; $0, $0 and $0
with respect to the Environmentally-Related Products and Services Fund; $37,
$200 and $600 with respect to the Aging of America Fund; $438, $2,175 and $48
with respect to the Communication and Entertainment Fund; $779, $1,282 and $68
with respect to the Business and Industrial Restructuring Fund; $353, $120 and
$0 with respect to the Global Competitors Fund; and $1,107, $744 and $22 with
respect to the Early Life Cycle Fund. The balance was paid to selling dealers.
Master Fund may suspend the right of redemption or postpone the date
of payment for Shares for more than 7 days during any period when (a) trading on
the New York Stock Exchange (the "Exchange") is restricted by applicable rules
and regulations of the Securities and Exchange Commission; (b) the Exchange is
closed for other than customary weekend and holiday closings; (c) the Securities
and Exchange Commission has by order permitted such suspension; or (d) an
emergency exists as determined by the Securities and Exchange Commission.
In the event that Shares are redeemed in cash at their net asset
value, a shareholder may receive in payment for such Shares an amount that is
more or less than his original investment due to changes in the market prices of
that Fund's portfolio securities.
Under limited circumstances, Master Fund may accept securities as
payment for Shares. Securities acquired in this manner will be limited to
securities issued in transactions involving a bona fide reorganization or
---------
statutory merger, or will be limited to other securities (except for municipal
debt securities issued by state political subdivisions or their
-16-
<PAGE>
agencies or instrumentalities) that: (a) meet the investment objective and
policies of any Fund acquiring such securities; (b) are acquired for investment
and not for resale; (c) are liquid securities that are not restricted as to
transfer either by law or liquidity of market; and (d) have a value that is
readily ascertainable (and not established only by evaluation procedures) as
evidenced by a listing on the American Stock Exchange, New York Stock Exchange
or NASDAQ, or as evidenced by their status as U.S. Government securities, bank
certificates of deposit, banker's acceptances, corporate and other debt
securities that are actively traded, money market securities and other similar
securities with a readily ascertainable value.
INVESTOR PROGRAMS
-----------------
Systematic Withdrawal Plan
--------------------------
An investor who owns Shares with a value of $10,000 or more may begin
a Systematic Withdrawal Plan. The withdrawal can be on a monthly, quarterly,
semiannual or annual basis. There are four options for such systematic
withdrawals. The investor may request:
(1) A fixed-dollar withdrawal;
(2) A fixed-share withdrawal;
(3) A fixed-percentage withdrawal (based on the current value of the
account); or
(4) A declining-balance withdrawal.
Prior to participating in a Systematic Withdrawal Plan, the investor must
deposit any outstanding certificates for Shares with Mutual Funds Service
Company, the Funds' sub-transfer agent. Under this Plan, dividends and
distributions are automatically reinvested in additional Shares of a Fund.
Amounts paid to investors under this Plan should not be considered as income.
Withdrawal payments represent proceeds from the sale of Shares, and there will
be a reduction of the shareholder's equity in the Fund involved if the amount of
the withdrawal payments exceeds the dividends and distributions paid on the
Shares and the appreciation of the investor's investment in the Fund. This in
turn may result in a complete depletion of the shareholder's investment. An
investor may not participate in a program of systematic investing in a Fund
while at the same time participating in the Systematic Withdrawal Plan with
respect to an account in the same Fund. Customers of Shareholder Organizations
may obtain information on the availability of, and the procedures and fees
relating to, the Systematic Withdrawal Plan directly from their Shareholder
Organizations.
-17-
<PAGE>
Exchange Privilege
------------------
Investors and Customers of Shareholder Organizations may exchange
Shares having a value of at least $500 for shares of any other portfolio of
Master Fund or Master Tax-Exempt Fund (the "Companies"). Shares may be
exchanged by wire, telephone or mail and must be made to accounts of identical
registration. There is no exchange fee imposed by the Companies. The Companies
may modify or terminate the exchange program at any time upon 60 days' written
notice to shareholders, and may reject any exchange request. In order to
prevent abuse of this privilege to the disadvantage of other shareholders, the
Companies reserve the right to limit the number of exchange requests of
investors to no more than six per year. Customers of Shareholder Organizations
may obtain information on the availability of, and the procedures relating to,
such programs directly from their Shareholder Organizations.
For Federal income tax purposes, exchanges are treated as sales on
which the shareholder will realize a gain or loss, depending upon whether the
value of the Shares to be given up in exchange is more or less than the basis in
such Shares at the time of the exchange. Generally, a shareholder may include
sales loads incurred upon the purchase of Shares in his or her tax basis for
such Shares for the purpose of determining gain or loss on a redemption,
transfer or exchange of such Shares. However, if the shareholder effects an
exchange of Shares for shares of another portfolio of the Companies within 90
days of the purchase and is able to reduce the sales load applicable to the new
shares (by virtue of the Companies' exchange privilege), the amount equal to
such reduction may not be included in the tax basis of the shareholder's
exchanged Shares but may be included (subject to the limitation) in the tax
basis of the new shares.
Other Investor Programs
-----------------------
As described in the Prospectuses, Shares of the Funds may be purchased
in connection with the Automatic Investment Program, and certain Retirement
Programs. Customers of Shareholder Organizations may obtain information on the
availability of, and the fees and procedures relating to, such programs directly
from their Shareholder Organizations.
DESCRIPTION OF CAPITAL STOCK
----------------------------
Master Fund's Charter authorizes its Board of Directors to issue up to
thirty-five billion full and fractional shares of capital stock, and to classify
or reclassify any unissued shares of Master Fund into one or more classes or
series by setting or changing in any one or more respects their respective
preferences, conversion or other rights, voting powers, restrictions,
-18-
<PAGE>
limitations as to dividends, qualifications, and terms and conditions of
redemption. The Prospectuses describe the classes of shares into which Master
Fund's authorized capital is currently classified.
Shares have no preemptive rights and only such conversion or exchange
rights as the Board of Directors may grant in its discretion. When issued for
payment as described in the Prospectuses, Shares will be fully paid and non-
assessable. In the event of a liquidation or dissolution of a Fund,
shareholders of that Fund are entitled to receive the assets available for
distribution belonging to that Fund and a proportionate distribution, based upon
the relative asset values of Master Fund's portfolios, of any general assets of
Master Fund not belonging to any particular portfolio of Master Fund which are
available for distribution. In the event of a liquidation or dissolution of
Master Fund, its shareholders will be entitled to the same distribution process.
Shareholders of Master Fund are entitled to one vote for each full
share held, and fractional votes for fractional shares held, and will vote in
the aggregate and not by class, except as otherwise required by the 1940 Act or
other applicable law or when the matter to be voted upon affects only the
interests of the shareholders of a particular class. Voting rights are not
cumulative and, accordingly, the holders of more than 50% of the aggregate of
Master Fund's shares may elect all of Master Fund's directors, regardless of
votes of other shareholders.
Rule 18f-2 under the 1940 Act provides that any matter required to be
submitted to the holders of the outstanding voting securities of an investment
company such as Master Fund shall not be deemed to have been effectively acted
upon unless approved by the holders of a majority of the outstanding shares of
each portfolio affected by the matter. A portfolio is affected by a matter
unless it is clear that the interests of each portfolio in the matter are
substantially identical or that the matter does not affect any interest of the
portfolio. Under the Rule, the approval of an investment advisory agreement or
any change in a fundamental investment policy would be effectively acted upon
with respect to a portfolio only if approved by a majority of the outstanding
shares of such portfolio. However, the Rule also provides that the ratification
of the appointment of independent public accountants, the approval of principal
underwriting contracts, and the election of directors may be effectively acted
upon by shareholders of Master Fund voting without regard to class.
Master Fund's Charter authorizes its Board of Directors, without
shareholder approval (unless otherwise required by applicable law), to (a) sell
and convey the assets of
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<PAGE>
a Fund to another management investment company for consideration which may
include securities issued by the purchaser and, in connection therewith, to
cause all outstanding Shares of the Fund involved to be redeemed at a price
which is equal to their net asset value and which may be paid in cash or by
distribution of the securities or other consideration received from the sale and
conveyance; (b) sell and convert a Fund's assets into money and, in connection
therewith, to cause all outstanding Shares of the Fund involved to be redeemed
at their net asset value; or (c) combine the assets belonging to a Fund with the
assets belonging to another portfolio of Master Fund, if the Board of Directors
reasonably determines that such combination will not have a material adverse
effect on shareholders of any portfolio participating in such combination, and,
in connection therewith, to cause all outstanding Shares of the Fund involved to
be redeemed at their net asset value or converted into shares of another class
of Master Fund's capital stock at net asset value. The exercise of such
authority by the Board of Directors will be subject to the provisions of the
1940 Act, and the Board of Directors will not take any action described in this
paragraph unless the proposed action has been disclosed in writing to the
particular Fund's shareholders at least 30 days prior thereto.
Notwithstanding any provision of Maryland law requiring a greater vote
of Master Fund's Common Stock (or of the Shares of a Fund voting separately as a
class) in connection with any corporate action, unless otherwise provided by law
(for example, by Rule 18f-2, discussed above) or by Master Fund's Charter,
Master Fund may take or authorize such action upon the favorable vote of the
holders of more than 50% of the outstanding Common Stock of Master Fund voting
without regard to class.
MANAGEMENT OF THE FUNDS
-----------------------
Directors and Officers
----------------------
The directors and executive officers of Master Fund, their addresses,
ages, principal occupations during the past five years, and other affiliations
are as follows:
-20-
<PAGE>
<TABLE>
<CAPTION>
Position Principal Occupation
with During Past 5 Years and
Name and Address Master Fund Other Affiliations
---------------- ----------- -----------------------
<S> <C> <C>
Alfred C. Tannachion/1/ Chairman of the Retired.
1135 Hyde Park Court Board, President
Mahwah, NJ 07430 and Treasurer
Age 69
Donald L. Campbell Director Retired; Senior Vice
333 East 69th Street President, Royal Insurance
Apt. 10-H Company, Inc., until August,
New York, NY 10021 1989; Director, Royal Life
Age 69 Insurance Co. of N.Y.
Joseph H. Dugan Director Retired; President, CEO and
913 Franklin Lake Road Director, L.B. Foster
Franklin Lakes, NJ 07417 Company (tubular products),
Age 70 from September, 1987 until
May, 1990; Executive Vice
President and COO, L.B. Foster
Company, from September, 1986
until September, 1987; Senior
Vice President -- Finance,
Chief Financial Officer and
Director, Todd Shipyards
Corporation, prior to
January 3, 1986.
Wolfe J. Frankl Director Retired; Director, Deutsche Bank
40 Gooseneck Lane Financial, Inc.; Director,
Charlottesville, VA 22903 The Harbus Corporation;
Age 74 Trustee, Mariner Funds Trust.
Robert A. Robinson Director President Emeritus, The
Church Pension Fund Church Pension Fund and its
800 Second Avenue affiliated companies, since
New York, NY 10017 1968; Trustee, Mariner Funds
Age 69 Trust; Trustee, H.B. and F.H. Bugher
Foundation and Director of its
wholly owned subsidiaries --
Rosiclear Lead and Flourspar Mining
Co. and The Pigmy Corporation;
Director, Morehouse Publishing Co.
W. Bruce McConnel, III Secretary Partner of the law firm
Philadelphia National of Drinker Biddle & Reath.
Bank Building
1345 Chestnut Street
Philadelphia, PA 19107
Age 52
</TABLE>
---------------------
/1/ This director is considered to be an "interested person" of Master Fund as
defined in the 1940 Act.
-21-
<PAGE>
<TABLE>
<CAPTION>
Position Principal Occupation
with During Past 5 Years and
Name and Address Master Fund Other Affiliations
---------------- ----------- -----------------------
<S> <C> <C>
Frank M. Deutchki Assistant Vice President, Mutual
Mutual Funds Service Co. Secretary Funds Service Company
73 Tremont Street since February, 1989; Senior
Boston, MA 02108-3913 Vice President - Risk Analysis
Age 41 and Avoidance, Putnam Investor
Services (mutual fund group), from
October, 1987 to January, 1989.
John M. Corcoran Assistant Assistant Vice President,
Mutual Funds Service Co. Treasurer Manager of Administration,
73 Tremont Street Mutual Funds Service Company,
Boston, MA 02108-3913 since October, 1993; Audit
Age 30 Manager, Ernst & Young, from August,
1987 to September, 1993.
</TABLE>
Each director of Master Fund receives an annual fee of $9,000 plus a
meeting fee of $1,500 for each meeting attended and is reimbursed for expenses
incurred in attending meetings. The Chairman of the Board is entitled to
receive an additional $5,000 per annum for services in such capacity. Drinker
Biddle & Reath, of which Mr. McConnel is a partner, receives legal fees as
counsel to Master Fund. The employees of Mutual Funds Service Company do not
receive any compensation from Master Fund for acting as officers of Master Fund.
No person who is currently an officer, director or employee of the Investment
Adviser serves as an officer, director or employee of Master Fund. The
directors and officers of Master Fund as a group own less than 1% of the Shares
of each Fund.
The following chart provides certain information about the fees
received by Master Fund's directors in the most recently completed fiscal year.
-22-
<PAGE>
<TABLE>
<CAPTION>
Pension or
Retirement Total
Benefits Compensation
Accrued as from Master Fund
Aggregate Part of and Fund
Name of Compensation from Fund Complex/*/ Paid
Person/Position Master Fund Expenses to Directors
--------------- ----------------- -------- ----------------
<S> <C> <C> <C>
Alfred C. Tannachion $20,000 None $40,000
Chairman of the Board,
President and Treasurer
Donald L. Campbell $15,000 None $30,000
Director
Joseph H. Dugan $15,000 None $30,000
Director
Wolfe J. Frankl $15,000 None $30,000
Director
Robert A. Robinson $15,000 None $30,000
Director
</TABLE>
---------------------------
/*/ The "Fund Complex" consists of UST Master Funds, Inc., UST Master Tax-
Exempt Funds, Inc. and UST Master Variable Series, Inc. For the fiscal
year ended March 31, 1995, UST Master Variable Series, Inc. did not pay any
directors' fees.
Investment Advisory and Administration Agreements
-------------------------------------------------
United States Trust Company of New York serves as Investment Adviser
to the Funds. In the Investment Advisory Agreement, the Investment Adviser has
agreed to provide the services described in the Prospectuses. The Investment
Adviser has also agreed to pay all expenses incurred by it in connection with
its activities under the respective agreements other than the cost of
securities, including brokerage commissions, purchased for the Funds.
For the fiscal year ended March 31, 1993, Master Fund paid the
Investment Adviser $658,533 and $233,667 with respect to the Equity Fund and the
Income and Growth Fund, respectively. For the period from December 31, 1992
(commencement of operations) to March 31, 1993, the Investment Adviser received
no advisory fees with respect to the Long-Term Supply of Energy, Productivity
Enhancers, Environmentally-Related Products and Services, Aging of America,
Communication and Entertainment, Business and Industrial Restructuring, Global
Competitors and Early Life Cycle Funds. For the same period, the Investment
Adviser waived fees totalling $900, $2,899, $2,681, $2,353,
-23-
<PAGE>
$4,787, $1,266, $1,731 and $4,895 with respect to the Long-Term Supply of
Energy, Productivity Enhancers, Environmentally-Related Products and Services,
Aging of America, Communication and Entertainment, Business and Industrial
Restructuring, Global Competitors and Early Life Cycle Funds, respectively.
For the fiscal year ended March 31, 1994, Master Fund paid the
Investment Adviser $870,735, $555,404, $599, $12,682, $0, $2,216, $59,196,
$4,566, $5,162 and $53,036 with respect to the Equity, Income and Growth, Long-
Term Supply of Energy, Productivity Enhancers, Environmentally-Related Products
and Services, Aging of America, Communication and Entertainment, Business and
Industrial Restructuring, Global Competitors and Early Life Cycle Funds,
respectively. For the same period, the Investment Adviser waived fees totalling
$1,516, $1,179, $22,139, $30,754, $18,247, $32,626, $22,594, $29,394, $26,625
and $23,696 with respect to the Equity, Income and Growth, Long-Term Supply of
Energy, Productivity Enhancers, Environmentally-Related Products and Services,
Aging of America, Communication and Entertainment, Business and Industrial
Restructuring, Global Competitors and Early Life Cycle Funds, respectively.
For the fiscal year ended March 31, 1995, the particular Company paid
the Investment Adviser advisory fees of $880,638, $726,295, $48,882, $79,570,
$0, $68,122, $136,328, $120,783, $79,924 and $194,501 with respect to the
Equity, Income and Growth, Long-Term Supply of Energy, Productivity Enhancers,
Environmentally-Related Products and Services, Aging of America, Communication
and Entertainment, Business and Industrial Restructuring, Global Competitors and
Early Life Cycle Funds, respectively. For the same period, the Investment
Adviser waived fees totalling $26,987, $24,620, $20,193, $22,983, $26,278,
$24,503, $17,130, $18,380, $15,637 and $26,625 with respect to the Equity,
Income and Growth, Long-Term Supply of Energy, Productivity Enhancers,
Environmentally-Related Products and Services, Aging of America, Communication
and Entertainment, Business and Industrial Restructuring, Global Competitors and
Early Life Cycle Funds, respectively.
The Investment Advisory Agreement provides that the Investment Adviser
shall not be liable for any error of judgment or mistake of law or for any loss
suffered by the Funds in connection with the performance of such agreements,
except a loss resulting from a breach of fiduciary duty with respect to the
receipt of compensation for services or a loss resulting from willful
misfeasance, bad faith or gross negligence on the part of the Investment Adviser
in the performance of its duties or from reckless disregard by it of its duties
and obligations thereunder. In addition, the Investment Adviser has undertaken
in the Investment Advisory Agreement to maintain its policy and practice of
conducting its Asset Management Group independently of its Banking Group.
-24-
<PAGE>
Mutual Funds Service Company ("MFSC") and Federated Administrative
Services, an affiliate of the Distributor, jointly serve as the Funds'
administrators. Under the administration Agreement, the administrators have
agreed to maintain office facilities for the Funds, furnish the Funds with
statistical and research data, clerical, accounting and bookkeeping services,
and certain other services required by the Funds, and to compute the net asset
value, net income and realized capital gains or losses, if any, of the
respective Funds. The administrators prepare semiannual reports to the
Securities and Exchange Commission, prepare Federal and state tax returns,
prepare filings with state securities commissions, arrange for and bear the cost
of processing Share purchase and redemption orders, maintain the Funds'
financial accounts and records, and generally assist in the Funds' operations.
Prior to August 1, 1995, administrative services were provided to the
Funds by MFSC and Concord Holding Corporation (collectively, the
"Administrators") under an administration agreement having substantially the
same terms as the Administration Agreement currently in effect.
For the fiscal year ended March 31, 1993, Master Fund paid the
Administrators $136,795 and $48,727 in the aggregate with respect to the Equity
and Income and Growth Funds, respectively. For the period from December 31,
1992 (commencement of operations) to March 31, 1993, the Administrators received
fees, before expense reimbursements, with respect to the Long-Term Supply of
Energy, Productivity Enhancers, Environmentally-Related Products and Services,
Aging of America, Communication and Entertainment, Business and Industrial
Restructuring, Global Competitors and Early Life Cycle Funds of $4,500, $4,500,
$4,500, $4,500, $4,500, $4,500, $4,500, and $4,500, respectively. For the same
period, the Administrators reimbursed expenses totalling $8,219, $12,971,
$6,053, $9,172, $5,101, $9,035, $7,034 and $9,326 with respect to the Long-Term
Supply of Energy, Productivity Enhancers, Environmentally - Related Products and
Services, Aging of America, Communication and Entertainment, Business and
Industrial Restructuring, Global Competitors and Early Life Cycle Funds,
respectively.
For the fiscal year ended March 31, 1994, Master Fund paid the
Administrators $179,398, $114,452, $5,826, $17,527, $4,739, $7,444, $22,881,
$10,016, $10,462 and $21,420 in the aggregate with respect to the Equity, Income
and Growth, Long-Term Supply of Energy, Productivity Enhancers, Environmentally-
Related Products and Services, Aging of America, Communication and
Entertainment, Business and Industrial Restructuring, Global Competitors and
Early Life Cycle Funds, respectively. For the same period, the Administrators
waived fees totalling $17,424, $5,723, $18,511, $15,806, $2,360, $13,234,
$12,788 and $1,861
-25-
<PAGE>
with respect to the Long-Term Supply of Energy, Productivity Enhancers,
Environmentally-Related Products and Services, Aging of America, Communication
and Entertainment, Business and Industrial Restructuring, Global Competitors and
Early Life Cycle Funds, respectively.
For the fiscal year ended March 31, 1995, Master Fund paid $186,366,
$154,582, $19,660, $26,357, $5,451, $24,003, $39,403, $35,765, $24,816 and
$56,809 in the aggregate with respect to the Equity, Income and Growth, Long-
Term Supply of Energy, Productivity Enhancers, Environmentally-Related Products
and Services, Aging of America, Communication and Entertainment, Business and
Industrial Restructuring, Global Competitors and Early Life Cycle Funds,
respectively. For the same period, the Administrators waived fees totalling
$22,090, $15,393, $36,299, $17,747, $2,347, $5,985 and $16,934 with respect to
the Long-Term Supply of Energy, Productivity Enhancers, Environmentally-Related
Products and Services, Aging of America, Communication and Entertainment,
Business and Industrial Restructuring and Global Competitors Funds,
respectively.
Service Organizations
---------------------
As stated in the Prospectuses, Master Fund will enter into agreements
with Service Organizations. Such shareholder servicing agreements will require
the Service Organizations to provide shareholder administrative services to
their Customers who beneficially own Shares in consideration for a Fund's
payment (on an annualized basis) of up to .40% of the average daily net assets
of the Fund's Shares beneficially owned by Customers of the Service
Organization. Such services may include: (a) assisting Customers in designating
and changing dividend options, account designations and addresses; (b) providing
necessary personnel and facilities to establish and maintain certain shareholder
accounts and records, as may reasonably be requested from time to time by Master
Fund; (c) assisting in processing purchases, exchange and redemption
transactions; (d) arranging for the wiring of funds; (e) transmitting and
receiving funds in connection with Customer orders to purchase, exchange or
redeem Shares; (f) verifying and guaranteeing Customer signatures in connection
with redemption orders, transfers among and changes in Customer-designated
accounts; (g) providing periodic statements showing a Customer's account
balances and, to the extent practicable, integrating such information with
information concerning other client transactions otherwise effected with or
through the Service Organization; (h) furnishing on behalf of Master Fund's
distributor (either separately or on an integrated basis with other reports sent
to a Customer by the Service Organization) periodic statements and confirmations
of all purchases, exchanges and redemptions of Shares in a Customer's account
required by applicable federal or state law; (i) transmitting proxy statements,
annual reports, updating
-26-
<PAGE>
prospectuses and other communications from Master Fund to Customers; (j)
receiving, tabulating and transmitting to Master Fund proxies executed by
Customers with respect to annual and special meetings of shareholders of Master
Fund; (k) providing reports (at least monthly, but more frequently if so
requested by Master Fund's distributor) containing state-by-state listings of
the principal residences of the beneficial owners of the Shares; and (l)
providing or arranging for the provision of such other related services as
Master Fund or a Customer may reasonably request.
Master Fund's agreements with Service Organizations are governed by an
Administrative Services Plan (the "Plan") adopted by Master Fund. Pursuant to
the Plan, Master Fund's Board of Directors will review, at least quarterly, a
written report of the amounts expended under Master Fund's agreements with
Service Organizations and the purposes for which the expenditures were made. In
addition, the arrangements with Service Organizations will be approved annually
by a majority of Master Fund's directors, including a majority of the directors
who are not "interested persons" of Master Fund as defined in the 1940 Act and
have no direct or indirect financial interest in such arrangements (the
"Disinterested Directors").
Any material amendment to Master Fund's arrangements with Service
Organizations must be approved by a majority of Master Fund's Board of Directors
(including a majority of the Disinterested Directors). So long as Master Fund's
arrangements with Service Organizations are in effect, the selection and
nomination of the members of Master Fund's Board of Directors who are not
"interested persons" (as defined in the 1940 Act) of Master Fund will be
committed to the discretion of such non-interested Directors.
For the fiscal years ended March 31, 1995 and 1994, payments to
Service Organizations totalled $26,987 and $1,516, $24,620 and $1,179, $3,576
and $124, $4,525 and $239, $1,660 and $83, $4,051 and $180, $7,168 and $382,
$5,189 and $196, $3,243 and $117, and $17,091 and $779 with respect to the
Equity, Income and Growth, Long-Term Supply of Energy, Productivity Enhancers,
Environmentally-Related Products and Services, Aging of America, Communication
and Entertainment, Business and Industrial Restructuring, Global Competitors and
Early Life Cycle Funds, respectively. Of these amounts, $18,606 and $1,516,
$22,697 and $1,179, $3,525 and $124, $4,446 and $239, $1,626 and $83, $3,902 and
$180, $6,707 and $382, $4,851 and $196, $3,163 and $717, and $16,428 and $779
were paid to affiliates of U.S. Trust with respect to the Equity, Income and
Growth, Long-Term Supply of Energy, Productivity Enhancers, Environmentally-
Related Products and Services, Aging of America, Communication and
Entertainment, Business and Industrial Restructuring, Global Competitors and
Early Life Cycle Funds, respectively.
-27-
<PAGE>
Expenses
--------
Except as otherwise noted, the Investment Adviser and the
Administrators bear all expenses in connection with the performance of their
services. The Funds bear the expenses incurred in their operations. Expenses
of the Funds include taxes; interest; fees (including fees paid to Master Fund's
Directors and officers who are not affiliated with the Distributor or the
Administrators); Securities and Exchange Commission fees; state securities
qualifications fees; costs of preparing and printing prospectuses for regulatory
purposes and for distribution to shareholders; advisory, administration and
administrative servicing fees; charges of the custodian, transfer agent, and
dividend disbursing agent; certain insurance premiums; outside auditing and
legal expenses; costs of shareholders reports and shareholder meetings; and any
extraordinary expenses. The Funds also pay for brokerage fees and commissions
in connection with the purchase of portfolio securities.
If the expenses borne by a Fund in any fiscal year exceed expense
limitations imposed by applicable state securities regulations, the Investment
Adviser and the Administrators will reimburse such Fund for a portion of any
such excess to the extent required by such regulations in proportion to the fees
received by them in such year up to the amount of the fees payable to them,
provided, however, to the extent required by such state regulations, the
Investment Adviser and the Administrators have agreed to effect such
reimbursement regardless of the fees payable to them. The amounts of the above
reimbursements, if any, will be estimated, reconciled and paid on a monthly
basis. To Master Fund's knowledge, of the applicable expense limitations in
effect on the date of this Statement of Additional Information, none is more
restrictive than the following: 2 1/2% of the first $30 million of average
annual net assets, 2% of the next $70 million of average annual net assets and 1
1/2% of average annual net assets in excess of $100 million.
Custodian and Transfer Agent
----------------------------
United States Trust Company of New York also serves as custodian of
the Funds' assets. Under the custodian agreement, U.S. Trust has agreed to (i)
maintain a separate account or accounts in the name of the Funds; (ii) make
receipts and disbursements of money on behalf of the Funds; (iii) collect and
receive all income and other payments and distributions on account of the Funds'
portfolio securities; (iv) respond to correspondence from securities brokers and
others relating to its duties; (v) maintain certain financial accounts and
records; and (vi) make periodic reports to Master Fund's Board of Directors
concerning the Funds' operations. U.S. Trust is entitled to monthly fees for
furnishing custodial services according to the
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<PAGE>
following fee schedule: on the face value of debt securities and the market
value of equity securities, a fee at the annual rate of .05%; on issues held,
$50.00 for each physical issue held, $25.00 for each book-entry issue held and
1/4 of 1% of market value for each foreign issue held; on transactions, $25.00
for each physical transaction, $15.00 for each book-entry transaction and $50.00
for each foreign security transaction. In addition, U.S. Trust is entitled to
reimbursement for its out-of-pocket expenses in connection with the above
services.
U.S. Trust also serves as the Funds' transfer agent and dividend
disbursing agent. In such capacity, U.S. Trust has agreed to (i) issue and
redeem Shares; (ii) address and mail all communications by the Funds to their
shareholders, including reports to shareholders, dividend and distribution
notices, and proxy materials for its meetings of shareholders; (iii) respond to
correspondence by shareholders and others relating to its duties; (iv) maintain
shareholder accounts; and (v) make periodic reports to Master Fund concerning
the Funds' operations. For its transfer agency, dividend disbursing, and
subaccounting services, U.S. Trust is entitled to receive $15.00 per annum per
account and subaccount. In addition, U.S. Trust is entitled to be reimbursed
for its out-of-pocket expenses for the cost of forms, postage, processing
purchase and redemption orders, handling of proxies, and other similar expenses
in connection with the above services.
U.S. Trust may, at its own expense, open and maintain custody accounts
with respect to the Funds with other banks or trust companies, and may delegate
its transfer agency obligations to another transfer agent registered or
qualified under applicable law, provided that U.S. Trust shall remain liable for
the performance of all of its custodial and transfer agency duties under the
Custodian and Transfer Agency Agreement, notwithstanding any delegation.
Pursuant to this provision in the agreement, U.S. Trust has entered into a sub-
transfer agency arrangement with MFSC, an affiliate of U.S. Trust, with respect
to accounts of shareholders who are not Customers of U.S. Trust. For the
services provided by MFSC, U.S. Trust has agreed to pay MFSC $15.00 per annum
per account or subaccount plus out-of-pocket expenses. MFSC receives no fee
directly from Master Fund for any of its sub-transfer agency services.
PORTFOLIO TRANSACTIONS
----------------------
Subject to the general control of Master Fund's Board of Directors,
the Investment Adviser is responsible for, makes decisions with respect to, and
places orders for all purchases and sales of all portfolio securities of each of
the Funds.
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<PAGE>
The Funds may engage in short-term trading to achieve their investment
objectives. Portfolio turnover may vary greatly from year to year as well as
within a particular year. The Funds' portfolio turnover rate may also be
affected by cash requirements for redemptions of Shares and by regulatory
provisions which enable the Funds to receive certain favorable tax treatment.
Portfolio turnover will not be a limiting factor in making portfolio decisions.
See "Financial Highlights" in the Funds' Prospectuses for the Funds' portfolio
turnover rates.
Transactions on U.S. stock exchanges involve the payment of negotiated
brokerage commissions. On exchanges on which commissions are negotiated, the
cost of transactions may vary among different brokers. For the fiscal years
ended March 31, 1993, March 31, 1994 and March 31, 1995, the Equity Fund paid
brokerage commissions aggregating $94,569, $61,608, and $123,112, respectively,
and the Income and Growth Fund paid brokerage commissions aggregating $57,207,
$140,168 and $89,218, respectively.
For the period from December 31, 1992 (commencement of operations) to
March 31, 1993 and for the fiscal years ended March 31, 1994 and March 31, 1995,
the Long-Term Supply of Energy, Productivity Enhancers, Environmentally-Related
Products and Services, Aging of America, Communication and Entertainment,
Business and Industrial Restructuring, Global Competitors and Early Life Cycle
Funds paid brokerage commissions aggregating $3,493, $15,871 and $36,759;
$6,074, $40,563 and $141,290; $7,605, $13,602 and $16,669; $4,379, 20,905 and
$28,296; $11,086, $40,593 and $50,724; $5,202, $46,444 and $121,755; $3,604,
$17,428 and $41,638; and $7,077, $40,397 and $73,534, respectively.
Transactions in domestic over-the-counter markets are generally
principal transactions with dealers, and the costs of such transactions involve
dealer spreads rather than brokerage commissions. With respect to over-the-
counter transactions, the Funds, where possible, 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.
The Investment Advisory Agreement between Master Fund and the
Investment Adviser provides that, in executing portfolio transactions and
selecting brokers or dealers, the Investment Adviser will seek to obtain the
best net price and the most favorable execution. The Investment Adviser shall
consider factors it deems relevant, including the breadth of the market in the
security, the price of the security, the financial condition and execution
capability of the broker or dealer and whether such broker or dealer is selling
shares of Master Fund, and the
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<PAGE>
reasonableness of the commission, if any, for the specific transaction and on a
continuing basis.
In addition, the Investment Advisory Agreement authorizes the
Investment Adviser, to the extent permitted by law and subject to the review of
Master Fund's Board of Directors from time to time with respect to the extent
and continuation of the policy, to cause the Funds to pay a broker which
furnishes brokerage and research services a higher commission than that which
might be charged by another broker for effecting the same transaction, provided
that the Investment Adviser determines in good faith that such commission is
reasonable in relation to the value of the brokerage and research services
provided by such broker, viewed in terms of either that particular transaction
or the overall responsibilities of the Investment Adviser to the accounts as to
which it exercises investment discretion. Such brokerage and research services
might consist of reports and statistics on specific companies or industries,
general summaries of groups of stocks and their comparative earnings, or broad
overviews of the stock market and the economy.
Supplementary research information so received is in addition to and
not in lieu of services required to be performed by the Investment Adviser and
does not reduce the investment advisory fees payable by the Funds. Such
information may be useful to the Investment Adviser in serving the Funds and
other clients and, conversely, supplemental information obtained by the
placement of business of other clients may be useful to the Investment Adviser
in carrying out its obligations to the Funds.
Portfolio securities will not be purchased from or sold to the
Investment Adviser, Distributor, or any affiliated person of either of them (as
such term is defined in the 1940 Act) acting as principal, except to the extent
permitted by the Securities and Exchange Commission.
Investment decisions for the Funds are made independently from those
for other investment companies, common trust funds and other types of funds
managed by the Investment Adviser. Such other investment companies and funds
may also invest in the same securities as the Funds. When a purchase or sale of
the same security is made at substantially the same time on behalf of a Fund and
another investment company or common trust fund, the transaction will be
averaged as to price, and available investments allocated as to amount, in a
manner which the Investment Adviser believes to be equitable to the Fund and
such other investment company or common trust fund. In some instances, this
investment procedure may adversely affect the price paid or received by the
Funds or the size of the position obtained by the Funds. To the extent
permitted by law, the Investment Adviser may aggregate the securities to be sold
or purchased for the Funds with those to be sold or purchased for
-31-
<PAGE>
other investment companies or common trust funds in order to obtain best
execution.
Master Fund is required to identify any securities of its regular
brokers or dealers (as defined in Rule 10b-1 under the 1940 Act) or their
parents held by Master Fund as of the close of its most recent fiscal year. As
of March 31, 1995, none of the Funds held any securities of Master Fund's
regular brokers or dealers or their parents.
INDEPENDENT AUDITORS
--------------------
Ernst & Young LLP, independent auditors, 200 Clarendon Street, Boston,
MA 02116, serve as auditors of Master Fund. The Funds' Financial Highlights
included in the Prospectuses and the financial statements for the period ended
March 31, 1995 incorporated by reference in this Statement of Additional
Information have been audited by Ernst & Young LLP for the periods included in
their reports thereon which appear therein.
COUNSEL
-------
Drinker Biddle & Reath (of which Mr. McConnel, Secretary of Master
Fund, is a partner), Philadelphia National Bank Building, 1345 Chestnut Streets,
Philadelphia, Pennsylvania 19107, is counsel to Master Fund and will pass upon
the legality of the Shares offered by the Prospectuses.
ADDITIONAL INFORMATION CONCERNING TAXES
---------------------------------------
The following supplements the tax information contained in the
Prospectuses.
Each Fund is treated as a separate corporate entity under the Internal
Revenue Code of 1986, as amended (the "Code"), and intends to qualify as a
regulated investment company. If, for any reason, a Fund does not qualify for a
taxable year for the special Federal tax treatment afforded regulated investment
companies, such Fund would be subject to Federal tax on all of its taxable
income at regular corporate rates, without any deduction for distributions to
shareholders. In such event, dividend distributions (whether or not derived
from interest on Municipal Securities) would be taxable as ordinary income to
shareholders to the extent of the Fund's current and accumulated earnings and
profits and would be eligible for the dividends received deduction in the case
of corporate shareholders.
A Fund will designate any distribution of the excess of net long-term
capital gain over net short-term capital loss as a
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<PAGE>
capital gain dividend in a written notice mailed to shareholders within 60 days
after the close of the Fund's taxable year. Upon the sale or exchange of
Shares, if the shareholder has not held such Shares for more than six months,
any loss on the sale or exchange of those Shares will be treated as long-term
capital loss to the extent of the capital gain dividends received with respect
to the Shares.
A 4% non-deductible excise tax is imposed on regulated investment
companies that fail to currently distribute an amount equal to specified
percentages of their ordinary taxable income and capital gain net income (excess
of capital gains over capital losses). The Funds intend to make sufficient
distributions or deemed distributions of their ordinary taxable income and any
capital gain net income prior to the end of each calendar year to avoid
liability for this excise tax.
A Fund will not be treated as a regulated investment company under the
Code if 30% or more of the Fund's gross income for a taxable year is derived
from gains realized on the sale or other disposition of the following
investments held for less than three months (the "30% test"): (1) stock and
securities (as defined in section 2(a)(36) of the 1940 Act); (2) options,
futures and forward contracts other than those on foreign currencies; and (3)
foreign currencies (and options, futures and forward contracts on foreign
currencies) that are not directly related to the Fund's principal business of
investing in stock and securities (and options and futures with respect to
stocks and securities). Interest (including original issue discount and accrued
market discount) received by a Fund upon maturity or disposition of a security
held for less than three months will not be treated as gross income derived from
the sale or other disposition of such security within the meaning of this
requirement. However, any other income which is attributable to realized market
appreciation will be treated as gross income from the sale or other disposition
of securities for this purpose. With respect to covered call options, if the
call is exercised by the holder, the premium and the price received on exercise
constitute the proceeds of sale, and the difference between the proceeds and the
cost of the securities subject to the call is capital gain or loss. Premiums
from expired call options written by a Fund and net gains from closing purchase
transactions are treated as short-term capital gains for Federal income tax
purposes, and losses on closing purchase transactions are short-term capital
losses. With respect to forward contracts, futures contracts, options on
futures contracts, and other financial instruments subject to the "marking-to-
market" rules, the Internal Revenue Service has ruled in private letter rulings
that a gain realized from such a contract, option or financial instrument will
be treated as being derived from a security held for three months or more
(regardless of the actual period for which the contract, option or instrument is
held) if the gain
-33-
<PAGE>
arises as a result of a constructive sale under the marking-to-market rules, and
will be treated as being derived from a security held for less than three months
only if the contract, option or instrument is terminated (or transferred) during
the taxable year (other than by reason of marking-to-market) and less than three
months has elapsed between the date the contract, option or instrument was
acquired and the termination date. Increases and decreases in the value of the
forward contracts, futures contracts, options on futures contracts and other
investments that qualify as part of a "designated hedge," as defined in Section
851(g) of the Code, may be netted for purposes of determining whether the 30%
test is met.
Each Fund will be required in certain cases to withhold and remit to
the U.S. Treasury 31% of taxable dividends or gross proceeds realized upon sale
paid to shareholders who have failed to provide a correct tax identification
number in the manner required, who are subject to withholding by the Internal
Revenue Service for failure properly to include on their return payments of
taxable interest or dividends, or who have failed to certify to the Fund when
required to do so either that they are not subject to backup withholding or that
they are "exempt recipients."
The foregoing discussion is based on Federal tax laws and regulations
which are in effect on the date of this Statement of Additional Information;
such laws and regulations may be changed by legislative or administrative
action. Shareholders are advised to consult their tax advisers concerning their
specific situations and the application of state and local taxes.
PERFORMANCE INFORMATION
-----------------------
The Funds may advertise the "average annual total return" for its
Shares. Such return is computed by determining the average annual compounded
rate of return during specified periods that equates the initial amount invested
to the ending redeemable value of such investment according to the following
formula:
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<PAGE>
ERV /1/n/
T = [(-----) - 1]
P
Where: T = average annual total return.
ERV = ending redeemable value of a hypothetical $1,000
payment made at the beginning of the 1, 5 or 10 year
(or other) periods at the end of the applicable period
(or a fractional portion thereof).
P = hypothetical initial payment of $1,000.
n = period covered by the computation, expressed in years.
Each Fund that advertises an "aggregate total return" for its Shares
computes such return by determining the aggregate compounded rates of return
during specified periods that likewise equate the initial amount invested to the
ending redeemable value of such investment. The formula for calculating
aggregate total return is as follows:
ERV
Aggregate Total Return = [(------)] - 1
P
The above calculations are made assuming that (1) all dividends and
capital gain distributions are reinvested on the reinvestment dates at the price
per Share existing on the reinvestment date (reflecting any sales load charged
upon such reinvestment), (2) all recurring fees charged to all shareholder
accounts are included, and (3) for any account fees that vary with the size of
the account, a mean (or median) account size in a Fund during the periods is
reflected. The ending redeemable value (variable "ERV" in the formula) is
determined by assuming complete redemption of the hypothetical investment after
deduction of all nonrecurring charges at the end of the measuring period. In
addition, the Funds' average annual total return and aggregate total return
quotations will reflect the deduction of the maximum sales load charged in
connection with the purchase of Shares.
Based on the foregoing calculations, the average annual total returns
for Shares of the Equity, Income and Growth, Long-Term Supply of Energy,
Productivity Enhancers, Environmentally-Related Products and Services, Aging of
America, Communication and Entertainment, Business and Industrial Restructuring,
Global
-35-
<PAGE>
Competitors and Early Life Cycle Funds for the one year period ended March 31,
1995 were 9.51%, 1.01%, (0.38)%, (0.23)%, (4.69)%, 7.72%, 7.82%, 6.51%, 7.69%
and 9.95%, respectively. The average annual total returns for Shares of the
Equity Fund and the Income and Growth Fund for the five year period ended March
31, 1995 were 11.30% and 9.27%, respectively. The average annual total returns
for the Shares of the Equity Fund and the Income and Growth Fund for the periods
from April 25, 1985 and January 6, 1987 (the commencement of operations of such
respective Funds) to March 31, 1995 were 14.10% and 9.25%, respectively. The
average annual total returns for the Shares of the Long-Term Supply of Energy,
Productivity Enhancers, Environmentally-Related Products and Services, Aging of
America, Communication and Entertainment, Business and Industrial Restructuring,
Global Competitors and Early Life Cycle Funds for the period from December 31,
1992 (commencement of operations) to March 31, 1995 were 4.53%, 5.04%, (6.99%),
3.49%, 16.40%, 19.12%, 8.04% and 15.21%, respectively.
The Funds may also from time to time include in advertisements, sales
literature and communications to shareholders a total return figure that is not
calculated according to the formula set forth above in order to compare more
accurately a Fund's performance with other measures of investment return. For
example, in comparing a Fund's total return with data published by Lipper
Analytical Services, Inc., CDA Investment Technologies, Inc. or Weisenberger
Investment Company Service, or with the performance of an index, a Fund may
calculate its aggregate total return for the period of time specified in the
advertisement or communication by assuming the investment of $10,000 in Shares
and assuming the reinvestment of each dividend or other distribution at net
asset value on the reinvestment date. Percentage increases are determined by
subtracting the initial value of the investment from the ending value and by
dividing the remainder by the beginning value. A Fund does not, for these
purposes, deduct from the initial value invested any amount representing sales
charges. A Fund will, however, disclose the maximum sales charge and will also
disclose that the performance data does not reflect sales charges and that
inclusion of sales charges would reduce the performance quoted.
The total return of Shares of a Fund may be compared to those of other
mutual funds with similar investment objectives and to other relevant indices or
to ratings prepared by independent services or other financial or industry
publications that monitor the performance of mutual funds. For example, the
total return of a Fund may be compared to data prepared by Lipper Analytical
Services, Inc., CDA Investment Technologies, Inc. and Weisenberger Investment
Company Service. Total return and yield data as reported in national financial
publications such as Money Magazine, Forbes, Barron's, The Wall Street Journal
----- -------- ------ -------- --- ---- ------ -------
and The New York Times, or in publications of a local or regional nature, may
--- --- ---- -----
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<PAGE>
also be used in comparing the performance of a Fund. Advertisements, sales
literature or reports to shareholders may from time to time also include a
discussion and analysis of each Fund's performance, including without
limitation, those factors, strategies and techniques that together with market
conditions and events, materially affected each Fund's performance.
The Funds may also from time to time include discussions or
illustrations of the effects of compounding in advertisements. "Compounding"
refers to the fact that, if dividends or other distributions on a Fund
investment are reinvested by being paid in additional Fund Shares, any future
income or capital appreciation of a Fund would increase the value, not only of
the original Fund investment, but also of the additional Fund Shares received
through reinvestment. As a result, the value of the Fund investment would
increase more quickly than if dividends or other distributions had been paid in
cash. The Funds may also include discussions or illustrations of the potential
investment goals of a prospective investor, investment management techniques,
policies or investment suitability of a Fund, economic conditions, the effects
of inflation and historical performance of various asset classes, including but
not limited to, stocks, bonds and Treasury bills. From time to time
advertisements, sales literature or communications to shareholders may summarize
the substance of information contained in shareholder reports (included the
investment composition of a Fund), as well as the views of the Investment
Adviser as to current market, economy, trade and interest rate trends,
legislative, regulatory and monetary developments, investment strategies and
related matters believes to be of relevance to a Fund. The Funds may also
include in advertisements charts, graphs or drawings which illustrate the
potential risks and rewards of investment in various investment vehicles,
including but not limited to, stocks, bonds, treasure bills and Shares of a
Fund. In addition, advertisement, sales literature or shareholder
communications may include a discussion of certain attributes or benefits to be
derived by an investment in a Fund. Such advertisements or communicators may
include symbols, headlines or other material which highlight or summarize the
information discussed in more detail therein.
MISCELLANEOUS
-------------
As used in the Prospectuses, "assets belonging to a Fund" means the
consideration received upon the issuance of Shares in the Fund, together with
all income, earnings, profits, and proceeds derived from the investment thereof,
including any proceeds from the sale of such investments, any funds or payments
derived from any reinvestment of such proceeds, and a portion of any general
assets of Master Fund not belonging to a particular portfolio of Master Fund.
In determining a Fund's net asset
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<PAGE>
value, assets belonging to the Fund are charged with the direct liabilities in
respect of the Fund and with a share of the general liabilities of Master Fund
which are normally allocated in proportion to the relative asset values of
Master Fund's portfolios at the time of allocation. Subject to the provisions
of Master Fund's Charter, determinations by the Board of Directors as to the
direct and allocable liabilities, and the allocable portion of any general
assets with respect to a particular Fund, are conclusive.
As of July 11, 1995, U.S. Trust held of record substantially all of
the Shares in the Funds, in each case as agent or custodian for its customers,
but did not own such Shares beneficially because it did not have discretion to
vote or invest such Shares.
FINANCIAL STATEMENTS
--------------------
Master Fund's Annual Report to Shareholders for the fiscal year ended
March 31, 1995 (the "Annual Report") for the domestic equity portfolios
accompanies this Statement of Additional Information. The financial statements
in the Annual Report for the Equity, Income and Growth, Long-Term Supply of
Energy, Productivity Enhancers, Environmentally-Related Products and Services,
Aging of America, Communication and Entertainment, Business and Industrial
Restructuring, Global Competitors and Early Life Cycle Funds (the "Financial
Statements") are incorporated in this Statement of Additional Information by
reference. The Financial Statements included in the Annual Report for the
fiscal year ended March 31, 1995 have been audited by Master Fund's independent
auditors, Ernst & Young LLP, whose reports thereon also appear in such Annual
Report and are incorporated herein by reference. The Financial Statements in
such Annual Report have been incorporated herein in reliance upon such report
given upon the authority of such firm as experts in accounting and auditing.
Additional copies of the Annual Report may be obtained at no charge by
telephoning MFSC at the telephone number appearing on the front page of this
Statement of Additional Information.
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<PAGE>
APPENDIX A
----------
Commercial Paper Ratings
------------------------
A Standard & Poor's commercial paper rating is a current assessment of
the likelihood of timely payment of debt considered short-term in the relevant
market. The following summarizes the rating categories used by Standard and
Poor's for commercial paper:
"A-1" - Issue's degree of safety regarding timely payment is strong.
Those issues determined to possess extremely strong safety characteristics are
denoted "A-1+."
"A-2" - Issue's capacity for timely payment is satisfactory. However,
the relative degree of safety is not as high as for issues designated "A-1."
"A-3" - Issue has an adequate capacity for timely payment. It is,
however, somewhat more vulnerable to the adverse effects of changes and
circumstances than an obligation carrying a higher designation.
"B" - Issue has only a speculative capacity for timely payment.
"C" - Issue has a doubtful capacity for payment.
"D" - Issue is in payment default.
Moody's commercial paper ratings are opinions of the ability of
issuers to repay punctually promissory obligations not having an original
maturity in excess of 9 months. The following summarizes the rating categories
used by Moody's for commercial paper:
"Prime-1" - Issuer or related supporting institutions are considered
to have a superior capacity for repayment of short-term promissory obligations.
Prime-1 repayment capacity will normally be evidenced by the following
characteristics: leading market positions in well established industries; high
rates of return on funds employed; conservative capitalization structures with
moderate reliance on debt and ample asset protection; broad margins in earning
coverage of fixed financial charges and high internal cash generation; and well
established access to a range of financial markets and assured sources of
alternate liquidity.
"Prime-2" - Issuer or related supporting institutions are considered
to have a strong capacity for repayment of short-
A-1
<PAGE>
term promissory obligations. This will normally be evidenced by many of the
characteristics cited above but to a lesser degree. Earnings trends and
coverage ratios, while sound, will be more subject to variation. Capitalization
characteristics, while still appropriate, may be more affected by external
conditions. Ample alternative liquidity is maintained.
"Prime-3" - Issuer or related supporting institutions have an
acceptable capacity for repayment of short-term promissory obligations. The
effects of industry characteristics and market composition may be more
pronounced. Variability in earnings and profitability may result in changes in
the level of debt protection measurements and the requirement for relatively
high financial leverage. Adequate alternate liquidity is maintained.
"Not Prime" - Issuer does not fall within any of the Prime rating
categories.
The three rating categories of Duff & Phelps for investment grade
commercial paper and short-term debt are "D-1," "D-2" and "D-3." Duff & Phelps
employs three designations, "D-1+," "D-1" and "D-1-," within the highest rating
category. The following summarizes the rating categories used by Duff & Phelps
for commercial paper:
"D-1+" - Debt possesses highest certainty of timely payment. Short-
term liquidity, including internal operating factors and/or access to
alternative sources of funds, is outstanding, and safety is just below risk-free
U.S. Treasury short-term obligations.
"D-1" - Debt possesses very high certainty of timely payment.
Liquidity factors are excellent and supported by good fundamental protection
factors. Risk factors are minor.
"D-1-" - Debt possesses high certainty of timely payment. Liquidity
factors are strong and supported by good fundamental protection factors. Risk
factors are very small.
"D-2" - Debt possesses good certainty of timely payment. Liquidity
factors and company fundamentals are sound. Although ongoing funding needs may
enlarge total financing requirements, access to capital markets is good. Risk
factors are small.
"D-3" - Debt possesses satisfactory liquidity, and other protection
factors qualify issue as investment grade. Risk factors are larger and subject
to more variation. Nevertheless, timely payment is expected.
A-2
<PAGE>
"D-4" - Debt possesses speculative investment characteristics.
Liquidity is not sufficient to ensure against disruption in debt service.
Operating factors and market access may be subject to a high degree of
variation.
"D-5" - Issuer has failed to meet scheduled principal and/or
interest payments.
Fitch short-term ratings apply to debt obligations that are payable on
demand or have original maturities of up to three years. The following
summarizes the rating categories used by Fitch for short-term obligations:
"F-1+" - Securities possess exceptionally strong credit quality.
Issues assigned this rating are regarded as having the strongest degree of
assurance for timely payment.
"F-1" - Securities possess very strong credit quality. Issues
assigned this rating reflect an assurance of timely payment only slightly less
in degree than issues rated "F-1+."
"F-2" - Securities possess good credit quality. Issues assigned this
rating have a satisfactory degree of assurance for timely payment, but the
margin of safety is not as great as the "F-1+" and "F-1" categories.
"F-3" - Securities possess fair credit quality. Issues assigned this
rating have characteristics suggesting that the degree of assurance for timely
payment is adequate; however, near-term adverse changes could cause these
securities to be rated below investment grade.
"F-S" - Securities possess weak credit quality. Issues assigned this
rating have characteristics suggesting a minimal degree of assurance for timely
payment and are vulnerable to near-term adverse changes in financial and
economic conditions.
"D" - Securities are in actual or imminent payment default.
Fitch may also use the symbol "LOC" with its short-term ratings to
indicate that the rating is based upon a letter of credit issued by a commercial
bank.
Thomson BankWatch short-term ratings assess the likelihood of an
untimely or incomplete payment of principal or interest of unsubordinated
instruments having a maturity of one year or less which is issued by United
States commercial banks, thrifts and non-bank banks; non-United States banks;
and broker-
A-3
<PAGE>
dealers. The following summarizes the ratings used by Thomson BankWatch:
"TBW-1" - This designation represents Thomson BankWatch's highest
rating category and indicates a very high degree of likelihood that principal
and interest will be paid on a timely basis.
"TBW-2" - This designation indicates that while the degree of safety
regarding timely payment of principal and interest is strong, the relative
degree of safety is not as high as for issues rated "TBW-1."
"TBW-3" - This designation represents the lowest investment grade
category and indicates that while the debt is more susceptible to adverse
developments (both internal and external) than obligations with higher ratings,
capacity to service principal and interest in a timely fashion is considered
adequate.
"TBW-4" - This designation indicates that the debt is regarded as
non-investment grade and therefore speculative.
IBCA assesses the investment quality of unsecured debt with an
original maturity of less than one year which is issued by bank holding
companies and their principal bank subsidiaries. The following summarizes the
rating categories used by IBCA for short-term debt ratings:
"A1" - Obligations are supported by the highest capacity for timely
repayment. Where issues possess a particularly strong credit feature, a rating
of A1+ is assigned.
"A2" - Obligations are supported by a good capacity for timely
repayment.
"A3" - Obligations are supported by a satisfactory capacity for
timely repayment.
"B" - Obligations for which there is an uncertainty as to the
capacity to ensure timely repayment.
"C" - Obligations for which there is a high risk of default or which
are currently in default.
A-4
<PAGE>
Corporate and Municipal Long-Term Debt Ratings
----------------------------------------------
The following summarizes the ratings used by Standard & Poor's for
corporate and municipal debt:
"AAA" - This designation represents the highest rating assigned by
Standard & Poor's to a debt obligation and indicates an extremely strong
capacity to pay interest and repay principal.
"AA" - Debt is considered to have a very strong capacity to pay
interest and repay principal and differs from AAA issues only in small degree.
"A" - Debt is considered to have a strong capacity to pay interest and
repay principal although such issues are somewhat more susceptible to the
adverse effects of changes in circumstances and economic conditions than debt in
higher-rated categories.
"BBB" - Debt is regarded as having an adequate capacity to pay
interest and repay principal. Whereas such issues normally exhibit adequate
protection parameters, adverse economic conditions or changing circumstances are
more likely to lead to a weakened capacity to pay interest and repay principal
for debt in this category than in higher-rated categories.
"BB," "B," "CCC," "CC" and "C" - Debt is regarded, on balance, as
predominantly speculative with respect to capacity to pay interest and repay
principal in accordance with the terms of the obligation. "BB" indicates the
lowest degree of speculation and "C" the highest degree of speculation. While
such debt will likely have some quality and protective characteristics, these
are outweighed by large uncertainties or major risk exposures to adverse
conditions.
"BB" - Debt has less near-term vulnerability to default than other
speculative issues. However, it faces major ongoing uncertainties or exposure
to adverse business, financial or economic conditions which could lead to
inadequate capacity to meet timely interest and principal payments. The "BB"
rating category is also used for debt subordinated to senior debt that is
assigned an actual or implied "BBB-" rating.
"B" - Debt has a greater vulnerability to default but currently has
the capacity to meet interest payments and principal repayments. Adverse
business, financial or economic conditions will likely impair capacity or
willingness to pay interest and repay principal. The "B" rating category is
also used for debt subordinated to senior debt that is assigned an actual or
implied "BB" or "BB-" rating.
A-5
<PAGE>
"CCC" - Debt has a currently identifiable vulnerability to default,
and is dependent upon favorable business, financial and economic conditions to
meet timely payment of interest and repayment of principal. In the event of
adverse business, financial or economic conditions, it is not likely to have the
capacity to pay interest and repay principal. The "CCC" rating category is also
used for debt subordinated to senior debt that is assigned an actual or implied
"B" or "B-" rating.
"CC" - This rating is typically applied to debt subordinated to senior
debt that is assigned an actual or implied "CCC" rating.
"C" - This rating is typically applied to debt subordinated to senior
debt which is assigned an actual or implied "CCC-" debt rating. The "C" rating
may be used to cover a situation where a bankruptcy petition has been filed, but
debt service payments are continued.
"CI" - This rating is reserved for income bonds on which no interest
is being paid.
"D" - Debt is in payment default. This rating is used when interest
payments or principal payments are not made on the date due, even if the
applicable grace period has not expired, unless S & P believes such payments
will be made during such grace period. "D" rating is also used upon the filing
of a bankruptcy petition if debt service payments are jeopardized.
PLUS (+) OR MINUS (-) - The ratings from "AA" through "CCC" may be
modified by the addition of a plus or minus sign to show relative standing
within the major rating categories.
"r" - This rating is attached to highlight derivative, hybrid, and
certain other obligations that S & P believes may experience high volatility or
high variability in expected returns due to non-credit risks. Examples of such
obligations are: securities whose principal or interest return is indexed to
equities, commodities, or currencies; certain swaps and options; and interest
only and principal only mortgage securities.
The following summarizes the ratings used by Moody's for corporate
and municipal long-term debt:
"Aaa" - Bonds are judged to be of the best quality. They carry the
smallest degree of investment risk and are generally referred to as "gilt
edged." Interest payments are protected by a large or by an exceptionally
stable margin and principal is secure. While the various protective elements
are likely to change, such changes as can be visualized are most unlikely to
impair the fundamentally strong position of such issues.
A-6
<PAGE>
"Aa" - Bonds are judged to be of high quality by all standards.
Together with the "Aaa" group they comprise what are generally known as high
grade bonds. They are rated lower than the best bonds because margins of
protection may not be as large as in "Aaa" securities or fluctuation of
protective elements may be of greater amplitude or there may be other elements
present which make the long-term risks appear somewhat larger than in "Aaa"
securities.
"A" - Bonds possess many favorable investment attributes and are to be
considered as upper medium grade obligations. Factors giving security to
principal and interest are considered adequate but elements may be present which
suggest a susceptibility to impairment sometime in the future.
"Baa" - Bonds considered medium-grade obligations, i.e., they are
neither highly protected nor poorly secured. Interest payments and principal
security appear adequate for the present but certain protective elements may be
lacking or may be characteristically unreliable over any great length of time.
Such bonds lack outstanding investment characteristics and in fact have
speculative characteristics as well.
"Ba," "B," "Caa," "Ca," and "C" - Bonds that possess one of these
ratings provide questionable protection of interest and principal ("Ba"
indicates some speculative elements; "B" indicates a general lack of
characteristics of desirable investment; "Caa" represents a poor standing; "Ca"
represents obligations which are speculative in a high degree; and "C"
represents the lowest rated class of bonds). "Caa," "Ca" and "C" bonds may be in
default.
Con. (---) - Bonds for which the security depends upon the completion
of some act or the fulfillment of some condition are rated conditionally. These
are bonds secured by (a) earnings of projects under construction, (b) earnings
of projects unseasoned in operation experience, (c) rentals which begin when
facilities are completed, or (d) payments to which some other limiting condition
attaches. Parenthetical rating denotes probable credit stature upon completion
of construction or elimination of basis of condition.
Moody's applies numerical modifiers 1, 2 and 3 in each generic
classification from "Aa" to "B" in its bond rating system. The modifier 1
indicates that the issuer ranks in the higher end of its generic rating
category; the modifier 2 indicates a mid-range ranking; and the modifier 3
indicates that the issuer ranks at the lower end of its generic rating category.
A-7
<PAGE>
The following summarizes the long-term debt ratings used by Duff &
Phelps for corporate and municipal long-term debt:
"AAA" - Debt is considered to be of the highest credit quality. The
risk factors are negligible, being only slightly more than for risk-free U.S.
Treasury debt.
"AA" - Debt is considered of high credit quality. Protection factors
are strong. Risk is modest but may vary slightly from time to time because of
economic conditions.
"A" - Debt possesses protection factors which are average but
adequate. However, risk factors are more variable and greater in periods of
economic stress.
"BBB" - Debt possesses below average protection factors but such
protection factors are still considered sufficient for prudent investment.
Considerable variability in risk is present during economic cycles.
"BB," "B," "CCC," "DD," and "DP" - Debt that possesses one of these
ratings is considered to be below investment grade. Although below investment
grade, debt rated "BB" is deemed likely to meet obligations when due. Debt
rated "B" possesses the risk that obligations will not be met when due. Debt
rated "CCC" is well below investment grade and has considerable uncertainty as
to timely payment of principal, interest or preferred dividends. Debt rated
"DD" is a defaulted debt obligation, and the rating "DP" represents preferred
stock with dividend arrearages.
To provide more detailed indications of credit quality, the "AA," "A,"
"BBB," "BB" and "B" ratings may be modified by the addition of a plus (+) or
minus (-) sign to show relative standing within these major categories.
The following summarizes the highest four ratings used by Fitch for
corporate and municipal bonds:
"AAA" - Bonds considered to be investment grade and of the highest
credit quality. The obligor has an exceptionally strong ability to pay interest
and repay principal, which is unlikely to be affected by reasonably foreseeable
events.
"AA" - Bonds considered to be investment grade and of very high credit
quality. The obligor's ability to pay interest and repay principal is very
strong, although not quite as strong as bonds rated "AAA." Because bonds rated
in the "AAA" and "AA" categories are not significantly vulnerable to foreseeable
future developments, short-term debt of these issuers is generally rated "F-1+."
A-8
<PAGE>
"A" - Bonds considered to be investment grade and of high credit
quality. The obligor's ability to pay interest and repay principal is
considered to be strong, but may be more vulnerable to adverse changes in
economic conditions and circumstances than bonds with higher ratings.
"BBB" - Bonds considered to be investment grade and of satisfactory
credit quality. The obligor's ability to pay interest and repay principal is
considered to be adequate. Adverse changes in economic conditions and
circumstances, however, are more likely to have an adverse impact on these
bonds, and therefore, impair timely payment. The likelihood that the ratings of
these bonds will fall below investment grade is higher than for bonds with
higher ratings.
"BB," "B," "CCC," "CC," "C," "DDD," "DD," and "D" -Bonds that possess
one of these ratings are considered by Fitch to be speculative investments. The
ratings "BB" to "C" represent Fitch's assessment of the likelihood of timely
payment of principal and interest in accordance with the terms of obligation for
bond issues not in default. For defaulted bonds, the rating "DDD" to "D" is an
assessment of the ultimate recovery value through reorganization or liquidation.
To provide more detailed indications of credit quality, the Fitch
ratings from and including "AA" to "C" may be modified by the addition of a plus
(+) or minus (-) sign to show relative standing within these major rating
categories.
IBCA assesses the investment quality of unsecured debt with an
original maturity of more than one year which is issued by bank holding
companies and their principal bank subsidiaries. The following summarizes the
rating categories used by IBCA for long-term debt ratings:
"AAA" - Obligations for which there is the lowest expectation of
investment risk. Capacity for timely repayment of principal and interest is
substantial such that adverse changes in business, economic or financial
conditions are unlikely to increase investment risk substantially.
"AA" - Obligations for which there is a very low expectation of
investment risk. Capacity for timely repayment of principal and interest is
substantial. Adverse changes in business, economic or financial conditions may
increase investment risk albeit not very significantly.
"A" - Obligations for which there is a low expectation of investment
risk. Capacity for timely repayment of principal and interest is strong,
although adverse changes in business,
A-9
<PAGE>
economic or financial conditions may lead to increased investment risk.
"BBB" - Obligations for which there is currently a low expectation of
investment risk. Capacity for timely repayment of principal and interest is
adequate, although adverse changes in business, economic or financial conditions
are more likely to lead to increased investment risk than for obligations in
higher categories.
"BB," "B," "CCC," "CC," and "C" - Obligations are assigned one of
these ratings where it is considered that speculative characteristics are
present. "BB" represents the lowest degree of speculation and indicates a
possibility of investment risk developing. "C" represents the highest degree of
speculation and indicates that the obligations are currently in default.
IBCA may append a rating of plus (+) or minus (-) to a rating to
denote relative status within major rating categories.
Thomson BankWatch assesses the likelihood of an untimely repayment of
principal or interest over the term to maturity of long term debt and preferred
stock which are issued by United States commercial banks, thrifts and non-bank
banks; non-United States banks; and broker-dealers. The following summarizes
the rating categories used by Thomson BankWatch for long-term debt ratings:
"AAA" - This designation represents the highest category assigned by
Thomson BankWatch to long-term debt and indicates that the ability to repay
principal and interest on a timely basis is very high.
"AA" - This designation indicates a superior ability to repay
principal and interest on a timely basis with limited incremental risk versus
issues rated in the highest category.
"A" - This designation indicates that the ability to repay principal
and interest is strong. Issues rated "A" could be more vulnerable to adverse
developments (both internal and external) than obligations with higher ratings.
"BBB" - This designation represents Thomson BankWatch's lowest
investment grade category and indicates an acceptable capacity to repay
principal and interest. Issues rated "BBB" are, however, more vulnerable to
adverse developments (both internal and external) than obligations with higher
ratings.
"BB," "B," "CCC," and "CC," - These designations are assigned by
Thomson BankWatch to non-investment grade long-term
A-10
<PAGE>
debt. Such issues are regarded as having speculative characteristics regarding
the likelihood of timely payment of principal and interest. "BB" indicates the
lowest degree of speculation and "CC" the highest degree of speculation.
"D" - This designation indicates that the long-term debt is in
default.
PLUS (+) OR MINUS (-) - The ratings from "AAA" through "CC" may
include a plus or minus sign designation which indicates where within the
respective category the issue is placed.
Municipal Note Ratings
----------------------
A Standard and Poor's rating reflects the liquidity concerns and
market access risks unique to notes due in three years or less. The following
summarizes the ratings used by Standard & Poor's Ratings Group for municipal
notes:
"SP-1" - The issuers of these municipal notes exhibit very strong or
strong capacity to pay principal and interest. Those issues determined to
possess overwhelming safety characteristics are given a plus (+) designation.
"SP-2" - The issuers of these municipal notes exhibit satisfactory
capacity to pay principal and interest.
"SP-3" - The issuers of these municipal notes exhibit speculative
capacity to pay principal and interest.
Moody's ratings for state and municipal notes and other short-term
loans are designated Moody's Investment Grade ("MIG") and variable rate demand
obligations are designated Variable Moody's Investment Grade ("VMIG"). Such
ratings recognize the differences between short-term credit risk and long-term
risk. The following summarizes the ratings by Moody's Investors Service, Inc.
for short-term notes:
"MIG-1"/"VMIG-1" - Loans bearing this designation are of the best
quality, enjoying strong protection by established cash flows, superior
liquidity support or demonstrated broad-based access to the market for
refinancing.
"MIG-2"/"VMIG-2" - Loans bearing this designation are of high quality,
with margins of protection ample although not so large as in the preceding
group.
"MIG-3"/"VMIG-3" - Loans bearing this designation are of favorable
quality, with all security elements accounted for but lacking the undeniable
strength of the preceding grades.
A-11
<PAGE>
Liquidity and cash flow protection may be narrow and market access for
refinancing is likely to be less well established.
"MIG-4"/"VMIG-4" - Loans bearing this designation are of adequate
quality, carrying specific risk but having protection commonly regarded as
required of an investment security and not distinctly or predominantly
speculative.
"SG" - Loans bearing this designation are of speculative quality and
lack margins of protection.
Fitch and Duff & Phelps use the short-term ratings described under
Commercial Paper Ratings for municipal notes.
A-12
<PAGE>
UST MASTER FUNDS, INC.
International Fund
Emerging Americas Fund
Pacific/Asia Fund
Pan European Fund
STATEMENT OF ADDITIONAL INFORMATION
August 1, 1995
This Statement of Additional Information is not a prospectus but should be read
in conjunction with the current prospectus for the International, Emerging
Americas, Pacific/Asia and Pan European Funds (each a "Fund" and collectively
the "Funds") of UST Master Funds, Inc. ("Master Fund") dated August 1, 1995 (the
"Prospectus"). Much of the information contained in this Statement of
Additional Information expands upon the subjects discussed in the Prospectuses.
No investment in shares of the Funds described herein (collectively, the
"Shares") should be made without reading the Prospectuses. A copy of the
Prospectuses may be obtained by writing Master Fund c/o Mutual Funds Service
Company, 73 Tremont Street, Boston, MA 02108-3913 or by calling (800) 446-1012.
<PAGE>
TABLE OF CONTENTS
-----------------
<TABLE>
<CAPTION>
Page
----
<S> <C>
INVESTMENT OBJECTIVE AND POLICIES...................... 1
Other Investment Considerations................... 1
Additional Information on Portfolio Instruments... 2
Additional Investment Limitations................. 9
ADDITIONAL PURCHASE AND REDEMPTION INFORMATION......... 11
INVESTOR PROGRAMS...................................... 14
Systematic Withdrawal Plan........................ 14
Exchange Privilege................................ 15
Other Investor Programs........................... 16
DESCRIPTION OF CAPITAL STOCK........................... 16
MANAGEMENT OF THE FUND................................. 18
Directors and Officers............................ 18
Investment Advisory, Sub-Advisory and
Administration Agreements..................... 20
Service Organizations............................. 23
Expenses.......................................... 24
Custodian and Transfer Agent...................... 25
PORTFOLIO TRANSACTIONS................................. 26
INDEPENDENT AUDITORS................................... 29
COUNSEL................................................ 29
ADDITIONAL INFORMATION CONCERNING TAXES................ 29
Generally......................................... 29
Taxation of Certain Financial Instruments......... 31
PERFORMANCE INFORMATION................................ 33
MISCELLANEOUS.......................................... 36
FINANCIAL STATEMENTS................................... 37
APPENDIX............................................... A-1
</TABLE>
(i)
<PAGE>
INVESTMENT OBJECTIVE AND POLICIES
---------------------------------
The following policies and discussions supplement the Funds'
investment objectives and policies as set forth in the Prospectuses.
Other Investment Considerations
-------------------------------
In determining the preferred distribution of investments of the Funds
among various geographic regions and countries, United States Trust Company of
New York ("U.S. Trust" or the "Investment Adviser"), Foreign and Colonial Asset
Management ("FACAM") and Foreign & Colonial Emerging Markets Limited ("FCEML")
(FACAM and FCEML hereinafter collectively referred to as the "Sub-Advisers")
will consider, among other things, regional and country-by-country prospects for
economic growth, anticipated levels of inflation, prevailing interest rates, the
historical patterns of government regulation of the economy and the outlook for
currency relationships.
The transaction costs to the Funds of engaging in forward currency
transactions described in the Prospectus vary with factors such as the currency
involved, the length of the contract period and prevailing currency market
conditions. Because currency transactions are usually conducted on a principal
basis, no fees or commissions are involved. The use of forward currency
contracts does not eliminate fluctuations in the underlying prices of the
securities being hedged, but it does establish a rate of exchange that can be
achieved in the future. Thus, although forward currency contracts used for
transaction or position hedging purposes may limit the risk of loss due to an
increase in the value of the hedged currency, at the same time they limit
potential gain that might result were the contracts not entered into. Further,
the Investment Adviser and the Sub-Advisers may be incorrect in their
expectations as to currency fluctuations, and a Fund may incur losses in
connection with its currency transactions that it would not otherwise incur. If
a price movement in a particular currency is generally anticipated, a Fund may
not be able to contract to sell or purchase that currency at an advantageous
price.
At or before the maturity of a forward sale contract, a Fund may sell
a portfolio security and make delivery of the currency, or retain the security
and offset its contractual obligation to deliver the currency by purchasing a
second contract pursuant to which the Fund will obtain, on the same maturity
date, the same amount of the currency which it is obligated to deliver. If the
Fund retains the portfolio security and engages in an offsetting transaction,
the Fund, at the time of execution of the offsetting transaction, will incur a
gain or a loss to the extent that movement has occurred in forward
<PAGE>
contract prices. Should forward prices decline during the period between a
Fund's entering into a forward contract for the sale of a currency and the date
it enters into an offsetting contract for the purchase of the currency, the Fund
will realize a gain to the extent the price of the currency it has agreed to
sell exceeds the price of the currency it has agreed to purchase. Should
forward prices increase, the Fund will suffer a loss to the extent the price of
the currency it has agreed to sell is less than the price of the currency it has
agreed to purchase in the offsetting contract. The foregoing principles
generally apply also to forward purchase contracts.
Each Fund may purchase gold bars primarily of standard weight
(approximately 400 troy ounces) at the best available prices in the New York
bullion market. However, the Investment Adviser and Sub-Advisers will have
discretion to purchase or sell gold bullion in other markets, including foreign
markets, if better prices can be obtained. Gold bullion is valued by the Funds
at the mean between the closing bid and asked prices in the New York bullion
market as of the close of the New York Stock Exchange each business day. When
there is no readily available market quotation for gold bullion, the bullion
will be valued by such method as determined by Master Fund's Board of Directors
to best reflect its fair value. For purpose of determining net asset value,
gold held by a Fund, if any, will be valued in U.S. dollars.
Additional Information on Portfolio Instruments
-----------------------------------------------
Repurchase Agreements
---------------------
The repurchase price under the repurchase agreements described in the
Prospectuses generally equals the price paid by a Fund plus interest negotiated
on the basis of current short-term rates (which may be more or less than the
rate on the securities underlying the repurchase agreement). Securities subject
to repurchase agreements are held by the Funds' custodian (or sub-custodian) or
in the Federal Reserve/Treasury book-entry system. Repurchase agreements are
considered to be loans by a Fund under the Investment Company Act of 1940 (the
"1940 Act").
Securities Lending
------------------
When a Fund lends its portfolio securities, it continues to receive
interest or dividends on the securities lent and may simultaneously earn
interest on the investment of the cash loan collateral, which will be invested
in readily marketable, high-quality, short-term obligations. Although voting
rights, or rights to consent, attendant to securities lent pass to the borrower,
such loans may be called at any time and will be called so that the securities
may be voted by a Fund if a material event affecting the investment is to occur.
-2-
<PAGE>
Government Obligations
----------------------
Examples of the types of U.S. Government obligations that may be held
by the Funds include, in addition to U.S. Treasury Bills, the obligations of
Federal Home Loan Banks, Federal Farm Credit Banks, Federal Land Banks, the
Federal Housing Administration, Farmers Home Administration, Export-Import Bank
of the United States, Small Business Administration, Government National
Mortgage Association, Federal National Mortgage Association, General Services
Administration, Student Loan Marketing Association, Central Bank for
Cooperatives, Federal Home Loan Mortgage Corporation, Federal Intermediate
Credit Banks and Maritime Administration.
American and European Depository Receipts
-----------------------------------------
American Depository Receipts ("ADRs") that may be purchased by the
Funds are receipts typically issued by a U.S. bank or trust company which
evidence ownership of underlying securities of a foreign issuer. ADRs may be
sponsored or unsponsored. Investments in unsponsored ADRs involve additional
risk because financial information based on generally accepted accounting
principles ("GAAP") may not be available with respect to the foreign issuers of
the underlying securities. European Depository Receipts ("EDRs"), which are
sometimes referred to as Continental Depository Receipts ("CDRs"), are receipts
issued in Europe typically by non-U.S. banks or trust companies and foreign
branches of U.S. banks that evidence ownership of foreign or United States
securities. Generally, ADRs, which are in registered form, are designed for use
in U.S. securities markets, and EDRs, which are in bearer form, are designed for
use in European securities markets.
Covered Call Options
--------------------
When a Fund writes a covered call option, it may terminate its
obligation to sell the underlying security prior to the expiration date of the
option by executing a closing purchase transaction, which is effected by
purchasing on an exchange an option of the same series (i.e., same underlying
security, exercise price and expiration date) as the option previously written.
Such a purchase does not result in the ownership of an option. A closing
purchase transaction will ordinarily be effected to realize a profit on an
outstanding call option, to prevent an underlying security from being called, to
permit the sale of the underlying security or to permit the writing of a new
call option containing different terms on such underlying security. The cost of
such a liquidation purchase plus transaction costs may be greater than the
premium received upon the original option, in which event the writer will have
incurred a loss on the transaction. An option position may be closed out only
on an exchange which provides a secondary market for an
-3-
<PAGE>
option of the same series. There is no assurance that a liquid secondary market
on an exchange will exist for any particular option. A covered option writer,
unable to effect a closing purchase transaction, will not be able to sell the
underlying security until the option expires or the underlying security is
delivered upon exercise, with the result that the writer in such circumstances
will be subject to the risk of market decline in the underlying security during
such period. A Fund will write an option on a particular security only if the
Investment Adviser and the Sub-Advisers believe that a liquid secondary market
will exist on an exchange for options of the same series, which will permit the
Fund to make a closing purchase transaction in order to close out its position.
When a Fund writes an option, an amount equal to the net premium (the
premium less the commission) received by the Fund is included in the liability
section of the Fund's statement of assets and liabilities as a deferred credit.
The amount of the deferred credit will be subsequently marked to market to
reflect the current value of the option written. The current value of the
traded option is the last sale price or, in the absence of a sale, the average
of the closing bid and asked prices. If an option expires on the stipulated
expiration date, or if a Fund enters into a closing purchase transaction, it
will realize a gain (or loss if the cost of a closing purchase transaction
exceeds the net premium received when the option is sold) and the deferred
credit related to such option will be eliminated. If an option is exercised, the
Fund may deliver the underlying security from its portfolio or purchase the
underlying security in the open market. In either event, the proceeds of the
sale will be increased by the net premium originally received, and the Fund will
realize a gain or loss. Premiums from expired call options written by a Fund
and net gains from closing purchase transactions are treated as short-term
capital gains for Federal income tax purposes, and losses on closing purchase
transactions are short-term capital losses.
Futures Contracts and Related Options
-------------------------------------
Each Fund may invest in futures contracts and related options. Each
Fund may enter into interest rate futures contracts and other types of financial
futures contracts, including foreign currency futures contracts, as well as any
index or foreign market futures which are available on recognized exchanges or
in other established financial markets. A futures contract on foreign currency
creates a binding obligation on one party to deliver, and a corresponding
obligation on another party to accept delivery of, a stated quantity of a
foreign currency for an amount fixed in U.S. dollars. Foreign currency futures,
which operate in a manner similar to interest rate futures contracts, may be
used by the Funds to hedge against exposure to
-4-
<PAGE>
fluctuations in exchange rates between the U.S. dollar and other currencies
arising from multinational transactions.
Futures contracts will not be entered into for speculative purposes,
but to hedge risks associated with a Fund's securities investments. Positions
in futures contracts may be closed out only on an exchange which provides a
secondary market for such futures. However, there can be no assurance that a
liquid secondary market will exist for any particular futures contract at any
specific time. Thus, it may not be possible to close a futures position. In
the event of adverse price movements, a Fund would continue to be required to
make daily cash payments to maintain its required margin. In such situations,
if a Fund has insufficient cash, it may have to sell portfolio securities to
meet daily margin requirements at a time when it may be disadvantageous to do
so. In addition, the Fund may be required to make delivery of the instruments
underlying futures contracts it holds. The inability to close options and
futures positions also could have an adverse impact on a Fund's ability to
effectively hedge.
Successful use of futures by the Funds is also subject to the ability
of the Investment Adviser or Sub-Advisers to correctly predict movements in the
direction of the market. For example, if a Fund has hedged against the
possibility of a decline in the market adversely affecting securities held by it
and securities prices increase instead, the Fund will lose part or all of the
benefit to the increased value of its securities which it has hedged because it
will have approximately equal offsetting losses in its futures positions. In
addition, in some situations, if a Fund has insufficient cash, it may have to
sell securities to meet daily variation margin requirements. Such sales of
securities may be, but will not necessarily be, at increased prices which
reflect the rising market. A Fund may have to sell securities at a time when it
may be disadvantageous to do so.
The risk of loss in trading futures contracts in some strategies can
be substantial, due both to the low margin deposits required, and the extremely
high degree of leverage involved in futures pricing. As a result, a relatively
small price movement in a futures contract may result in immediate and
substantial loss (as well as gain) to the investor. For example, if at the time
of purchase, 10% of the value of the futures contract is deposited as margin, a
subsequent 10% decrease in the value of the futures contract would result in a
total loss of the margin deposit, before any deduction for the transaction
costs, if the account were then closed out. A 15% decrease would result in a
loss equal to 150% of the original margin deposit, before any deduction for the
transaction costs, if the contract were closed out. Thus, a purchase or sale of
a futures contract may
-5-
<PAGE>
result in losses in excess of the amount invested in the contract.
Utilization of futures transactions by a Fund involves the risk of
loss by the Fund of margin deposits in the event of bankruptcy of a broker with
whom the Fund has an open position in a futures contract or related option.
Most futures exchanges limit the amount of fluctuation permitted in
futures contract prices during a single trading day. The daily limit
establishes the maximum amount that the price of a futures contract may vary
either up or down from the previous day's settlement price at the end of a
trading session. Once the daily limit has been reached in a particular type of
contract, no trades may be made on that day at a price beyond that limit. The
daily limit governs only price movement during a particular trading day and
therefore does not limit potential losses, because the limit may prevent the
liquidation of unfavorable positions. Futures contract prices have occasionally
moved to the daily limit for several consecutive trading days with little or no
trading, thereby preventing prompt liquidation of futures positions and
subjecting some futures traders to substantial losses.
The trading of futures contracts is also subject to the risk of
trading halts, suspensions, exchange or clearing house equipment failures,
government intervention, insolvency of a brokerage firm or clearing house or
other disruptions of normal trading activity, which could at times make it
difficult or impossible to liquidate existing positions or to recover excess
variation margin payments.
Options on Futures Contracts
----------------------------
Each Fund may purchase options on the futures contracts described
above. A futures option gives the holder, in return for the premium paid, the
right to buy (call) from or sell (put) to the writer of the option a futures
contract at a specified price at any time during the period of the option. Upon
exercise, the writer of the option is obligated to pay the difference between
the cash value of the futures contract and the exercise price. Like the buyer
or seller of a futures contract, the holder, or writer, of an option has the
right to terminate its position prior to the scheduled expiration of the option
by selling, or purchasing, an option of the same series, at which time the
person entering into the closing transaction will realize a gain or loss.
Investments in futures options involve some of the same considerations
that are involved in connection with investments in futures contracts (for
example, the existence of a liquid secondary market). In addition, the purchase
of an option also
-6-
<PAGE>
entails the risk that changes in the value of the underlying futures contract
will not be fully reflected in the value of the option purchased. Depending on
the pricing of the option compared to either the futures contract upon which it
is based, or upon the price of the instruments being hedged, an option may or
may not be less risky than ownership of the futures contract or such
instruments. In general, the market prices of options can be expected to be
more volatile than the market prices on the underlying futures contract.
Compared to the purchase or sale of futures contracts, however, the purchase of
call or put options on futures contracts may frequently involve less potential
risk to the Fund because the maximum amount at risk is the premium paid for the
options (plus transaction costs). Although permitted by its fundamental
investment policies, the Funds do not currently intend to write futures options,
and will not do so in the future absent any necessary regulatory approvals.
When-Issued and Forward Transactions
------------------------------------
When a Fund agrees to purchase securities on a "when-issued" or
forward commitment basis, the custodian will set aside cash or liquid portfolio
securities equal to the amount of the commitment in a separate account.
Normally, the custodian will set aside portfolio securities to satisfy a
purchase commitment and, in such case, the Fund may be required subsequently to
place additional assets in the separate account in order to ensure that the
value of the account remains equal to the amount of the Fund's commitment. It
may be expected that a Fund's net assets will fluctuate to a greater degree when
it sets aside portfolio securities to cover such purchase commitments than when
it sets aside cash. Because a Fund will set aside cash or liquid assets to
satisfy its purchase commitments in the manner described, its liquidity and
ability to manage its portfolio might be affected in the event its forward
commitments or commitments to purchase "when-issued" securities ever exceed 25%
of the value of its assets.
A Fund will purchase securities on a "when-issued" or forward
commitment basis only with the intention of completing the transaction. If
deemed advisable as a matter of investment strategy, however, a Fund may dispose
of or renegotiate a commitment after it is entered into, and may sell securities
it has committed to purchase before those securities are delivered to the Fund
on the settlement date. In these cases, the Fund may realize a taxable capital
gain or loss.
When a Fund engages in "when-issued" or forward commitment
transactions, it relies on the other party to consummate the trade. Failure of
such other party to do so may result in the Fund incurring a loss or missing an
opportunity to obtain a price considered to be advantageous.
-7-
<PAGE>
The market value of the securities underlying a "when-issued" purchase
or a forward commitment to purchase securities and any subsequent fluctuations
in their market value are taken into account when determining the market value
of a Fund starting on the day the Fund agrees to purchase the securities. The
Fund does not earn interest on the securities it has committed to purchase until
they are paid for and delivered on the settlement date.
Brady Bonds
-----------
The Emerging Americas Fund may invest in Brady Bonds, which are
securities created through the exchange of existing commercial bank loans to
Latin American public and private entities for new bonds in connection with debt
restructurings under a debt restructuring plan announced by former U.S.
Secretary of the Treasury Nicholas F. Brady (the "Brady Plan"). Brady Bonds may
be collateralized or uncollateralized, are issued in various currencies
(primarily the U.S. dollar) and are currently actively traded in the over-the-
counter secondary market for Latin American debt instruments.
Dollar-denominated, collateralized Brady Bonds, which may be fixed
rate par bonds or floating rate discount bonds, are collateralized in full as to
principal by U.S. Treasury zero coupon bonds having the same maturity as the
bonds. Interest payments on these Brady Bonds generally are collateralized by
cash or securities in an amount that, in the case of fixed rate bonds, is equal
to at least one year of rolling interest payments or, in the case of floating
rate bonds, initially is equal to at least one year's rolling interest payments
based on the applicable interest rate at that time and is adjusted at regular
intervals thereafter.
All Mexican Brady Bonds issued to date, except New Money Bonds, have
principal repayments at final maturity fully collateralized by U.S. Treasury
zero coupon bonds (or comparable collateral in other currencies) and interest
coupon payments collateralized on an 18-month rolling-forward basis by funds
held in escrow by an agent for the bondholders. Approximately half of the
Venezuelan Brady Bonds issued to date have principal repayments at final
maturity collateralized by U.S. Treasury zero coupon bonds (or comparable
collateral in other currencies), while slightly more than half have interest
coupon payments collateralized on a 14-month rolling-forward basis by securities
held by the Federal Reserve Bank of New York as collateral agent.
Brady Bonds are often viewed as having three or four valuation
components: the collateralized repayment of principal at final maturity; the
collateralized interest payments; the uncollateralized interest payments; and
any uncollateralized
-8-
<PAGE>
repayment of principal at maturity (these uncollateralized amounts constituting
the "residual risk").
Miscellaneous
-------------
The Funds may not invest in oil, gas or mineral leases.
Additional Investment Limitations
---------------------------------
In addition to the investment limitations disclosed in the
Prospectuses, the Funds are subject to the investment limitations enumerated
below. Fundamental investment limitations may be changed with respect to a Fund
only by a vote of a majority of the holders of such Fund's outstanding Shares
(as defined under "Miscellaneous" in the Prospectuses). However, investment
limitations which are "operating policies" with respect to a Fund may be changed
by Master Fund's Board of Directors upon reasonable notice to shareholders.
The following investment limitations are fundamental with respect to
each Fund. A Fund may not:
1. Act as an underwriter of securities within the meaning of the
Securities Act of 1933, except insofar as it might be deemed to be an
underwriter upon disposition of certain portfolio securities acquired within the
limitation on purchases of restricted securities;
2. Purchase or sell real estate, except that the Fund may purchase
securities of issuers which deal in real estate and may purchase securities
which are secured by interests in real estate; and
3. Issue any senior securities, except insofar as any borrowing in
accordance with the Funds' investment limitation contained in the Prospectuses
might be considered to be the issuance of a senior security.
The following investment limitations are fundamental with respect to
the International Fund, but are operating policies with respect to the Emerging
Americas, Pacific/Asia and Pan European Funds (collectively, the "Regional
Funds"). Each Fund may not:
4. Purchase securities on margin, make short sales of securities, or
maintain a short position;
5. Invest in or sell put options, call options, straddles, spreads,
or any combination thereof; provided, however, that each Fund may write covered
call options with respect to its portfolio securities that are traded on a
national securities exchange or on foreign exchanges and may enter into
-9-
<PAGE>
closing purchase transactions with respect to such options if, at the time of
the writing of such option, the aggregate value of the securities subject to the
options written by the Fund does not exceed 25% of the value of its total
assets; and provided that each Fund may enter into forward currency contracts in
accordance with its investment objective and policies;
6. Invest in companies for the purpose of exercising management or
control;
7. Invest more than 5% of its total assets in securities issued by
companies which, together with any predecessor, have been in continuous
operation for fewer than three years; and
8. Acquire any other investment company or investment company
security, except in connection with a merger, consolidation, reorganization, or
acquisition of assets or where otherwise permitted by the Investment Company Act
of 1940.
The following investment limitation is fundamental with respect to the
International Fund. The International Fund may not:
9. Purchase or sell commodities futures contracts or invest in oil,
gas, or other mineral exploration or development programs; provided, however,
that (i) this shall not prohibit the Fund from purchasing publicly traded
securities of companies engaging in whole or in part in such activities; and
(ii) the Fund may enter into forward currency contracts, futures contracts and
related options and may invest up to 5% of its total assets in gold bullion.
The following investment limitation is fundamental with respect to the
Regional Funds. Each Regional Fund may not:
10. Purchase or sell commodities or commodities futures contracts or
invest in oil, gas, or other mineral exploration or development programs;
provided, however, that (i) this shall not prohibit a Fund from purchasing
publicly traded securities of companies engaging in whole or in part in such
activities; and (ii) a Fund may enter into forward currency contracts, futures
contracts and related options and may invest up to 5% of its total assets in
gold bullion.
* * *
For the purpose of Investment Limitation No. 2, the prohibition of
purchases of real estate includes acquisition of
-10-
<PAGE>
limited partnership interests in partnerships formed with a view toward
investing in real estate, but does not prohibit purchases of shares in real
estate investment trusts.
In addition to the above investment limitations, Master Fund currently
intends to limit each Fund's investments in warrants so that, valued at the
lower of cost or market value, they do not exceed 5% of the net assets of the
particular Fund. Included within that amount, but not to exceed 2% of the value
of a Fund's net assets, may be warrants which are not listed on the New York or
American Stock Exchanges. For the purpose of this limitation, warrants acquired
by a Fund in units or attached to securities will be deemed to be without value.
Each Fund also intends to refrain from entering into arbitrage transactions.
Pursuant to the requirements of state securities laws, each Fund
currently intends to limit its option transactions so that they do not exceed,
at the time when they are written, 25% of the net (rather than total) assets of
the particular Fund. See Investment Limitation No. 5 above.
The International Fund may not purchase or sell commodities except as
provided in Investment Limitation No. 9 above.
If a percentage limitation is satisfied at the time of investment, a
later increase or decrease in such percentage resulting from a change in value
of a Fund's portfolio securities will not constitute a violation of such
limitation.
In order to permit the sale of Shares in certain states, Master Fund
may make on behalf of a Fund other commitments more restrictive than the
investment policies and limitations described above and in the Prospectuses.
Should Master Fund determine that any such commitment is no longer in a Fund's
best interests, it will revoke the commitment by terminating sales of such
Fund's Shares to investors residing in the state involved.
ADDITIONAL PURCHASE AND REDEMPTION INFORMATION
----------------------------------------------
Shares are continuously offered for sale by Edgewood Services, Inc.
(the "Distributor"), a wholly-owned subsidiary of Federated Investors, and the
Distributor has agreed to use appropriate efforts to solicit all purchase
orders. As described in the Prospectuses, Shares may be sold to customers
("Customers") of financial institutions ("Shareholder Organizations"). Shares
are also offered for sale directly to institutional investors and to members of
the general public. Different types of Customer accounts at the Shareholder
Organizations may be used to purchase Shares, including eligible agency and
trust accounts. In addition, Shareholder
-11-
<PAGE>
Organizations may automatically "sweep" a Customer's account not less frequently
than weekly and invest amounts in excess of a minimum balance agreed to by the
Shareholder Organization and its Customer in Shares selected by the Customer.
Investors purchasing Shares may include officers, directors, or employees of the
particular Shareholder Organization.
Shares of the Funds are offered for sale with a maximum sales charge
of 4.50%. An illustration of the computation of the offering price per share of
the Funds, using the value of each Fund's net assets and number of outstanding
securities at the close of business on March 31, 1995 is as follows:
<TABLE>
<CAPTION>
Emerging Americas
International Fund Fund Pacific/Asia Fund Pan European Fund
------------------ ----------------- ----------------- -----------------
<S> <C> <C> <C> <C>
Net Assets........ $64,051,958 $27,343,730 $47,617,199 $39,976,962
Outstanding
Shares........... 6,525,104 4,668,226 5,635,215 4,882,358
Net Asset Value
Per Share........ $ 9.82 $ 5.86 $ 8.45 $ 8.19
Sales Charge
(4.50% of the
offering price).. $ .46 $ .28 $ .40 $ .39
Offering to
Public........... $ 10.28 $ 6.14 $ 8.85 $ 8.58
</TABLE>
As stated in the Prospectuses, the sales load described above will not
be applicable to: (a) purchases of Shares by customers of the Investment Adviser
or its affiliates; (b) trust, agency or custodial accounts opened through the
trust department of a bank, trust company or thrift institution, provided that
appropriate notification of such status is given at the time of investment; (c)
companies, corporations and partnerships (excluding full service broker/dealers
and financial planners, registered investment advisers and depository
institutions not covered by the exemptions in (d) and (e) below); (d) financial
planners and registered investment advisers not affiliated with or clearing
purchases through full service broker/dealers; (e) purchases of Shares by
depository institutions for their own account as principal; (f) exchange
transactions (described below under "Investor Programs - Exchange Privilege")
where the Shares being exchanged were acquired in connection with the
distribution of assets held in trust, agency or custodial accounts maintained
with the trust department of a bank; (g) corporate/business retirement plans
(such as 401(k), 403(b)(7), 457 and Keogh accounts) sponsored by the Distributor
and IRA accounts sponsored by the Investment Adviser; (h) company-sponsored
employee pension or retirement plans making direct investments in the Funds; (i)
purchases of Shares by officers, trustees, directors, employees,
-12-
<PAGE>
former employees and retirees of Master Fund, UST Master Tax-Exempt Funds, Inc.
("Master Tax-Exempt Fund"), the Investment Adviser, the Distributor or of any
direct or indirect affiliate of any of them; (j) purchases of Shares by all
beneficial shareholders of Master Fund or Master Tax-Exempt Fund as of May 22,
1989; (k) purchases of Shares by investment advisers registered under the
Investment Advisers Act of 1940 for their customers through an omnibus account
established with United States Trust Company of New York; (l) purchases of
Shares by directors, officers and employees of brokers and dealers selling
shares pursuant to a selling agreement with Master Fund and Master Tax-Exempt
Fund; (m) purchase of Shares by investors who are members of affinity groups
services by USAffinity Investments Limited Partnership; and (n) customers of
certain financial institutions who purchase shares through a registered
representative of UST Financial Services Corp. on the premises of their
financial institutions. In addition, no sales load is charged on the
reinvestment of dividends or distributions or in connection with certain share
exchange transactions. Investors who have previously redeemed shares in a
portfolio of Master Fund or Master Tax-Exempt Fund on which a sales load has
been paid also have a one-time privilege of purchasing shares of another
portfolio of either company at net asset value without a sales charge, provided
that such privilege will apply only to purchases made within 30 calendar days
from the date of redemption and only with respect to the amount of the
redemption.
Total sales charges paid by shareholders of the International Fund for
the fiscal years ended March 31, 1995, 1994 and 1993 were $4,219, $7,779 and
$2,186, respectively. Of these respective amounts, UST Distributors, Inc., the
Funds' former distributor, retained $4,169, $4,786 and $1,850. The balance was
paid to selling dealers. Total sales charges paid by shareholders of the
Emerging Americas, Pacific/Asia and Pan European Funds for the fiscal year ended
March 31, 1995 and 1994 and for the period from December 31, 1992 (commencement
of operations) to March 31, 1993 were $8,465, $19,985 and $0; $144, $6,489 and
$273; and $183, $1,112 and $273, respectively. Of these respective amounts, UST
Distributors, Inc., the Funds' former distributor, retained $1,403, $8,643 and
$0 with respect to the Emerging Americas Fund; $69, $1,988 and $0 with respect
to the Pacific/Asia Fund; and $11, $980 and $0 with respect to the Pan European
Fund. The balance was paid to selling dealers.
Master Fund may suspend the right of redemption or postpone the date
of payment for Shares for more than 7 days during any period when (a) trading on
the New York Stock Exchange (the "Exchange") is restricted by applicable rules
and regulations of the Securities and Exchange Commission; (b) the Exchange is
closed for other than customary weekend and holiday closings; (c) the Securities
and Exchange Commission has by order
-13-
<PAGE>
permitted such suspension; or (d) an emergency exists as determined by the
Securities and Exchange Commission.
In the event that Shares are redeemed in cash at their net asset
value, a shareholder may receive in payment for such Shares an amount that is
more or less than his original investment due to changes in the market prices of
a Fund's portfolio securities.
Under limited circumstances, Master Fund may accept securities as
payment for Shares. Securities acquired in this manner will be limited to
securities issued in transactions involving a bona fide reorganization or
---------
statutory merger, or will be limited to other securities (except for municipal
debt securities issued by state political subdivisions or their agencies or
instrumentalities) that: (a) meet the investment objective and policies of any
Fund acquiring such securities; (b) are acquired for investment and not for
resale; (c) are liquid securities that are not restricted as to transfer either
by law or liquidity of market; and (d) have a value that is readily
ascertainable (and not established only by evaluation procedures) as evidenced
by a listing on the American Stock Exchange, New York Stock Exchange or NASDAQ,
or as evidenced by their status as U.S. Government securities, bank certificates
of deposit, banker's acceptances, corporate and other debt securities that are
actively traded, money market securities and other similar securities with a
readily ascertainable value.
INVESTOR PROGRAMS
-----------------
Systematic Withdrawal Plan
--------------------------
An investor who owns Shares with a value of $10,000 or more may begin
a Systematic Withdrawal Plan. The withdrawal can be on a monthly, quarterly,
semiannual or annual basis. There are four options for such systematic
withdrawals. The investor may request:
(1) A fixed-dollar withdrawal;
(2) A fixed-share withdrawal;
(3) A fixed-percentage withdrawal (based on the current value of the
account); or
(4) A declining-balance withdrawal.
Prior to participating in a Systematic Withdrawal Plan, the investor must
deposit any outstanding certificates for Shares with Mutual Funds Service
Company, the Funds' sub-transfer agent. Under this Plan, dividends and
distributions are automatically
-14-
<PAGE>
reinvested in additional Shares of a Fund. Amounts paid to investors under this
Plan should not be considered as income. Withdrawal payments represent proceeds
from the sale of Shares, and there will be a reduction of the shareholder's
equity in the Fund involved if the amount of the withdrawal payments exceeds the
dividends and distributions paid on the Shares and the appreciation of the
investor's investment in the Fund. This in turn may result in a complete
depletion of the shareholder's investment. An investor may not participate in a
program of systematic investing in a Fund while at the same time participating
in the Systematic Withdrawal Plan with respect to an account in the same Fund.
Customers of Shareholder Organizations may obtain information on the
availability of, and the procedures and fees relating to, the Systematic
Withdrawal Plan directly from their Shareholder Organizations.
Exchange Privilege
------------------
Investors and Customers of Shareholder Organizations may exchange
Shares having a value of at least $500 for shares of any other portfolio of
Master Fund or Master Tax-Exempt Fund ("the Companies"). Shares may be
exchanged by wire, telephone or mail and must be made to accounts of identical
registration. There is no exchange fee imposed by the Companies. The Companies
may modify or terminate the exchange program at any time upon 60 days' written
notice to shareholders, and may reject any exchange request. In order to
prevent abuse of this privilege to the disadvantage of other shareholders, the
Companies reserve the right to limit the number of exchange requests of
investors to no more than six per year. Customers of Shareholder Organizations
may obtain information on the availability of, and the procedures relating to,
such programs directly from their Shareholder Organizations.
For Federal income tax purposes, exchanges are treated as sales on
which the shareholder will realize a gain or loss, depending upon whether the
value of the Shares to be given up in exchange is more or less than the basis in
such Shares at the time of the exchange. Generally, a shareholder may include
sales loads incurred upon the purchase of Shares in his or her tax basis for
such Shares for the purpose of determining gain or loss on a redemption,
transfer or exchange of such Shares. However, if the shareholder effects an
exchange of Shares for shares of another portfolio of the Companies within 90
days of the purchase and is able to reduce the sales load applicable to the new
shares (by virtue of the Companies' exchange privilege), the amount equal to
such reduction may not be included in the tax basis of the shareholder's
exchanged Shares but may be included (subject to the limitation) in the tax
basis of the new shares.
-15-
<PAGE>
Other Investor Programs
-----------------------
As described in the Prospectuses, Shares of a Fund may be purchased in
connection with the Automatic Investment Program, and certain Retirement
Programs. Customers of Shareholder Organizations may obtain information on the
availability of, and the fees and procedures relating to, such programs directly
from their Shareholder Organizations.
DESCRIPTION OF CAPITAL STOCK
----------------------------
Master Fund's Charter authorizes its Board of Directors to issue up to
thirty-five billion full and fractional shares of capital stock, and to classify
or reclassify any unissued shares of Master Fund into one or more classes or
series by setting or changing in any one or more respects their respective
preferences, conversion or other rights, voting powers, restrictions,
limitations as to dividends, qualifications, and terms and conditions of
redemption. The Prospectuses describe the classes of shares into which Master
Fund's authorized capital is currently classified.
Shares have no preemptive rights and only such conversion or exchange
rights as the Board of Directors may grant in its discretion. When issued for
payment as described in the Prospectuses, Shares will be fully paid and non-
assessable. In the event of a liquidation or dissolution of a Fund, its
shareholders are entitled to receive the assets available for distribution
belonging to the particular Fund and a proportionate distribution, based upon
the relative asset values of Master Fund's portfolios, of any general assets of
Master Fund not belonging to any particular portfolio of Master Fund which are
available for distribution. In the event of a liquidation or dissolution of
Master Fund, its shareholders will be entitled to the same distribution process.
Shareholders of Master Fund are entitled to one vote for each full
share held, and fractional votes for fractional shares held, and will vote in
the aggregate and not by class, except as otherwise required by the 1940 Act or
other applicable law or when the matter to be voted upon affects only the
interests of the shareholders of a particular class. Voting rights are not
cumulative and, accordingly, the holders of more than 50% of the aggregate of
Master Fund's shares may elect all of Master Fund's directors, regardless of the
votes of other shareholders.
Rule 18f-2 under the 1940 Act provides that any matter required to be
submitted to the holders of the outstanding voting securities of an investment
company such as Master Fund shall not be deemed to have been effectively acted
upon unless approved by
-16-
<PAGE>
the holders of a majority of the outstanding shares of each portfolio affected
by the matter. A portfolio is affected by a matter unless it is clear that the
interests of each portfolio in the matter are substantially identical or that
the matter does not affect any interest of the portfolio. Under the Rule, the
approval of an investment advisory agreement or any change in a fundamental
investment policy would be effectively acted upon with respect to a portfolio
only if approved by a majority of the outstanding shares of such portfolio.
However, the Rule also provides that the ratification of the appointment of
independent public accountants, the approval of principal underwriting
contracts, and the election of directors may be effectively acted upon by
shareholders of Master Fund voting without regard to class.
Master Fund's Charter authorizes its Board of Directors, without
shareholder approval (unless otherwise required by applicable law), to (a) sell
and convey the assets of a Fund to another management investment company for
consideration which may include securities issued by the purchaser and, in
connection therewith, to cause all outstanding Shares of the Fund to be redeemed
at a price which is equal to their net asset value and which may be paid in cash
or by distribution of the securities or other consideration received from the
sale and conveyance; (b) sell and convert a Fund's assets into money and, in
connection therewith, to cause all outstanding Shares of the Fund to be redeemed
at their net asset value; or (c) combine the assets belonging to a Fund with the
assets belonging to another portfolio of Master Fund, if Master Fund's Board of
Directors reasonably determines that such combination will not have a material
adverse effect on shareholders of any portfolio participating in such
combination, and, in connection therewith, to cause all outstanding Shares of
the Fund to be redeemed at their net asset value or converted into shares of
another class of Master Fund's capital stock at net asset value. The exercise
of such authority by the Board of Directors will be subject to the provisions of
the 1940 Act, and the Board of Directors will not take any action described in
this paragraph unless the proposed action has been disclosed in writing to the
affected Fund's shareholders at least 30 days prior thereto.
Notwithstanding any provision of Maryland law requiring a greater vote
of Master Fund's Common Stock (or of the Shares of a Fund voting separately as a
class) in connection with any corporate action, unless otherwise provided by law
(for example, by Rule 18f-2, discussed above) or by Master Fund's Charter,
Master Fund may take or authorize such action upon the favorable vote of the
holders of more than 50% of the outstanding Common Stock of Master Fund voting
without regard to class.
-17-
<PAGE>
MANAGEMENT OF THE FUND
----------------------
Directors and Officers
----------------------
The directors and executive officers of Master Fund, their addresses,
ages, principal occupations during the past five years, and other affiliations
are as follows:
<TABLE>
<CAPTION>
Position Principal Occupation
with During Past 5 Years and
Name and Address Master Fund Other Affiliations
---------------- ----------- -----------------------
<S> <C> <C>
Alfred C. Tannachion/1/ Chairman of Retired.
1135 Hyde Park the Board,
Mahwah, NJ 07430 President and
Age 69 Treasurer
Donald L. Campbell Director Retired; Senior Vice
333 East 69th Street President, Royal Insur-
Apt. 10-H ance Company, Inc., until
New York, NY 10021 August, 1989; Director, Royal
Age 69 Life Insurance Co. of N.Y.
Joseph H. Dugan Director Retired; President, CEO and
913 Franklin Lake Road and Director, L.B. Foster
Franklin Lakes, NJ 07417 Company (tubular products),
Age 70 from September, 1987 until
May, 1990; Executive Vice
President and CEO, L.B. Foster
Company, from September, 1986
until September, 1987; Senior
Vice President -- Finance,
Chief Financial Officer and
Director, Todd Shipyards
Corporation, prior to
January 3, 1986.
Wolfe J. Frankl Director Retired; Director, Deutsche
40 Gooseneck Lane Bank, Financial, Inc.;
Charlottesville, VA 22903 Director, The Harbus
Age 74 Corporation; Trustee, Mariner
Funds Trust.
</TABLE>
--------------------
/1/ This director is considered to be an "interested person" of Master Fund as
defined in the 1940 Act.
-18-
<PAGE>
<TABLE>
<CAPTION>
Position Principal Occupation
with During Past 5 Years and
Name and Address Master Fund Other Affiliations
---------------- ----------- -----------------------
<S> <C> <C>
Robert A. Robinson Director President Emeritus, The
Church Pension Fund Church Pension Fund and its
800 Second Avenue affiliated companies, since
New York, NY 10017 1968; Trustee, Mariner Funds
Age 69 Trust; Trustee, H.B. and F.H.
Bugher Foundation and Director
of its wholly owned
subsidiaries -- Rosiclear Lead
and Flourspar Mining Co. and
The Pigmy Corporation;
Director, Morehouse Publishing
Co.
W. Bruce McConnel, III Secretary Partner of the law firm
Philadelphia National of Drinker Biddle & Reath.
Bank Building
1345 Chestnut Street
Philadelphia, PA 19107-3496
Age 52
Frank M. Deutchki Assistant Vice President, Mutual Funds
Mutual Funds Service Co. Secretary Service Company since
73 Tremont Street February, 1989; Senior Vice
Boston, MA 02108-3913 President - Risk Analysis and
Age 41 Avoidance, Putnam Investor
Services (mutual fund group),
from October, 1987 to January,
1989.
John M. Corcoran Assistant Assistant Vice President,
Mutual Funds Service Co. Treasurer Manager of Administration,
73 Tremont Street Mutual Funds Service Company,
Boston, MA 02108-3913 since October, 1993; Audit
Age 30 Manager, Ernst & Young, from
August, 1987 to September,
1993.
</TABLE>
Each director receives an annual fee of $9,000 plus a meeting fee of
$1,500 for each meeting attended and is reimbursed for expenses incurred in
attending meetings. The Chairman of the Board is entitled to receive an
additional $5,000 per annum for services in such capacity. Drinker Biddle &
Reath, of which Mr. McConnel is a partner, receives legal fees as counsel to
Master Fund. The employees of Mutual Funds Service Company do not receive any
compensation from Master Fund for acting as officers of Master Fund. No person
who is currently an officer, director or employee of the Investment Adviser or
any Sub-Adviser serves as an officer, director or employee of Master Fund. The
directors and officers of Master Fund as a group own less than 1% of the Shares
of any Fund.
-19-
<PAGE>
The following chart provides certain information about the fees
received by Master Fund's directors in the most recently completed fiscal year.
<TABLE>
<CAPTION>
Pension or Total
Retirement Compensation
Benefits from Master Fund
Aggregate Accrued as Part ofand Fund
Name of Compensation from Fund Complex/*/ Paid
Person/Position Master Fund Expenses to Directors
--------------- ----------------- -------- ---------------
<S> <C> <C> <C>
Alfred C. Tannachion $20,000 None $40,000
Chairman of the Board,
President and Treasurer
Donald L. Campbell $15,000 None $30,000
Director
Joseph H. Dugan $15,000 None $30,000
Director
Wolfe J. Frankl $15,000 None $30,000
Director
Robert A. Robinson $15,000 None $30,000
Director
</TABLE>
---------------------------
/*/ The "Fund Complex" consists of UST Master Funds, Inc., UST Master Tax-
Exempt Funds, Inc. and UST Master Variable Series, Inc. For the fiscal
year ended March 31, 1995, UST Master Variable Series, Inc. did not pay any
directors' fees.
Investment Advisory, Sub-Advisory and Administration Agreements
---------------------------------------------------------------
United States Trust Company of New York serves as Investment Adviser
to the Funds, and FACAM provides Sub-Advisory services with respect to the
International and Pan European Funds. FCEML serves as Sub-Adviser to the
Emerging Americas and Pacific/Asia Funds. In the Investment Advisory and Sub-
Advisory Agreements, the Investment Adviser and Sub-Advisers have agreed to
provide the services described in the Prospectuses. The Investment Adviser and
Sub-Advisers have also agreed to pay all expenses incurred by them in connection
with their activities under the respective agreements other than the cost of
securities, including brokerage commissions, purchased for the Funds.
For the fiscal year ended March 31, 1993, Master Fund paid the
Investment Adviser $405,494 with respect to the International Fund. During this
period, FACAM received
-20-
<PAGE>
sub-advisory fees with respect to the International Fund from the Investment
Adviser totalling $283,846. For the period from December 31, 1992 (commencement
of operations) to March 31, 1993, Master Fund paid the Investment Adviser $561,
$10,010 and $0 with respect to the Emerging Americas, Pacific/Asia and Pan
European Funds, respectively. For the same period, the Investment Adviser
waived fees totalling $5,530, $5,144 and $5,876 with respect to the Emerging
Americas, Pacific/Asia and Pan European Funds, respectively. During this
period, FCEML received sub-advisory fees with respect to the Emerging Americas
Fund totalling $3,045 and FACAM received sub-advisory fees with respect to the
Pan European Fund totalling $4,113. FACAM served as sub-adviser to the
Pacific/Asia Fund from its commencement of operations to June 30, 1993. During
the period from commencement of operations to March 31, 1993, FACAM received
sub-advisory fees of $10,608 with respect to the Pacific/Asia Fund.
For the fiscal year ended March 31, 1994, Master Fund paid the
Investment Adviser $417,136, $131,416, $240,305 and $160,310 with respect to the
International, Emerging Americas, Pacific/Asia and Pan European Funds,
respectively. For the same period the Investment Adviser waived fees totalling
$2,244, $36,056, $75,624 and $20,318 with respect to the International, Emerging
Americas, Pacific/Asia and Pan European Funds, respectively. For the fiscal
year ended March 31, 1994, FACAM received sub-advisory fees with respect to the
International and Pan European Funds from the Investment Adviser totalling
$293,566 and $126,440, respectively. For the same period, FCEML received sub-
advisory fees with respect to the Emerging Americas Fund and FCEML and FACAM
received aggregate sub-advisory fees with respect to the Pacific/Asia Fund from
the Investment Adviser totalling $65,708 and $168,214, respectively.
For the fiscal year ended March 31, 1995, Master Fund paid the
Investment Adviser advisory fees of $574,455, $368,128, $480,194, and $375,873
with respect to the International, Emerging Americas, Pacific/Asia, and Pan
European Funds, respectively. For the same period, the Investment Adviser
waived fees totalling $37,822, $28,097, $27,189 and $22,473, with respect to the
International, Emerging Americas, Pacific/Asia and Pan European Funds,
respectively. For the fiscal year ended March 31, 1995, FACAM received sub-
advisory fees with respect to the International and Pan European Funds totalling
$428,594 and $278,842, respectively, and FCEML received sub-advisory fees with
respect to the Emerging Americas and Pacific/Asia Funds totalling $196,098 and
$355,168, respectively.
The Investment Adviser may, from time to time, voluntarily waive a
portion of its fees, which waiver may be terminated at any time.
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<PAGE>
The Investment Advisory Agreement and the Sub-Advisory Agreements
provide that the Investment Adviser and Sub-Advisers shall not be liable for any
error of judgment or mistake of law or for any loss suffered by the Funds in
connection with the performance of such agreements, except a loss resulting from
a breach of fiduciary duty with respect to the receipt of compensation for
services or a loss resulting from willful misfeasance, bad faith or gross
negligence on the part of the Investment Adviser or Sub-Advisers in the
performance of their duties or from reckless disregard by either of them of
their duties and obligations thereunder.
Mutual Funds Service Company ("MFSC") and Federated Administrative
Services, an affiliate of the Distributor, jointly serve as the Funds'
administrators. Under the Administration Agreement, the administrators have
agreed to maintain office facilities for the Funds, furnish the Funds with
statistical and research data, clerical, accounting, and bookkeeping services,
and certain other services required by the Funds, and to compute the net asset
values, net income and realized capital gains or losses, if any, of the Funds.
The administrators prepare semi-annual reports to the Securities and Exchange
Commission, prepare Federal and state tax returns, prepare filings with state
securities commissions, arrange for and bear the cost of processing Share
purchase and redemption orders, maintain the Funds' financial accounts and
records, and generally assist in the Funds' operations.
Prior to August 1, 1995, administrative services were provided by MFSC
and Concord Holding Corporation (collectively, the "Administrators") under an
administration agreement having substantially the same terms as the
Administration Agreement currently in effect.
For the fiscal year ended March 31, 1993, Master Fund paid the
Administrators $81,099 in the aggregate with respect to the International Fund.
For the period from December 31, 1992 (commencement of operations) to March 31,
1993, Master Fund paid the Administrators, after expense reimbursements, $4,500,
$1,450 and $4,500 in the aggregate with respect to the Emerging Americas,
Pacific/Asia and Pan European Funds, respectively. For the same period, the
Administrators reimbursed expenses totalling $3,050 with respect to the Pan
European Fund.
For the fiscal year ended March 31, 1994, Master Fund paid the
Administrators $83,885, $37,765, $63,192 and $41,471 in the aggregate with
respect to the International, Emerging Americas, Pacific/Asia and Pan European
Funds, respectively.
For the fiscal year ended March 31, 1995, Master Fund paid the
Administrators $122,374, $78,418, $101,468 and $79,669 in the aggregate with
respect to the International, Emerging
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Americas, Pacific/Asia and Pan European Funds, respectively. For the same
period, the Administrators waived fees totalling $81, $21 and $9 with respect to
the International, Emerging Americas and Pacific/Asia Funds, respectively.
Service Organizations
---------------------
As stated in the Prospectuses, Master Fund will enter into agreements
with Service Organizations. Such shareholder servicing agreements will require
the Service Organizations to provide shareholder administrative services to
their Customers who beneficially own Shares in consideration for a Fund's
payment (on an annualized basis) of up to .40% of the average daily net assets
of the Fund's Shares beneficially owned by Customers of the Service
Organization. Such services may include: (a) assisting Customers in designating
and changing dividend options, account designations and addresses; (b) providing
necessary personnel and facilities to establish and maintain certain shareholder
accounts and records, as may reasonably be requested from time to time by Master
Fund; (c) assisting in processing purchases, exchange and redemption
transactions; (d) arranging for the wiring of funds; (e) transmitting and
receiving funds in connection with Customer orders to purchase, exchange or
redeem Shares; (f) verifying and guaranteeing Customer signatures in connection
with redemption orders, transfers among and changes in Customer-designated
accounts; (g) providing periodic statements showing a Customer's account
balances and, to the extent practicable, integrating such information with
information concerning other client transactions otherwise effected with or
through the Service Organization; (h) furnishing on behalf of Master Fund's
distributor (either separately or on an integrated basis with other reports sent
to a Customer by the Service Organization) periodic statements and confirmations
of all purchases, exchanges and redemptions of Shares in a Customer's account
required by applicable federal or state law; (i) transmitting proxy statements,
annual reports, updating prospectuses and other communications from the Master
Fund's to Customers; (j) receiving, tabulating and transmitting to the Master
Fund's proxies executed by Customers with respect to annual and special meetings
of shareholders of Master Fund; (k) providing reports (at least monthly, but
more frequently if so requested by Master Fund's distributor) containing state-
by-state listings of the principal residences of the beneficial owners of the
Shares; and (l) providing or arranging for the provision of such other related
services as Master Fund or a Customer may reasonably request.
Master Fund's agreements with Service Organizations are governed by an
Administrative Services Plan (the "Plan") adopted by Master Fund. Pursuant to
the Plan, Master Fund's Board of Directors will review, at least quarterly, a
written report of the amounts expended under Master Fund's agreements with
Service
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Organizations and the purpose for which the expenditures were made. In
addition, the arrangements with Service Organizations will be approved annually
by a majority of Master Fund's directors, including a majority of the directors
who are not "interested persons" of Master Fund as defined in the 1940 Act and
have no direct or indirect financial interest in such arrangements (the
"Disinterested Directors").
Any material amendment to Master Fund's arrangements with Service
Organizations must be approved by a majority of Master Fund's Board of Directors
(including a majority of the Disinterested Directors). So long as Master Fund's
arrangements with Service Organizations are in effect, the selection and
nomination of the members of Master Fund's Board of Directors who are not
"interested persons" (as defined in the 1940 Act) of Master Fund will be
committed to the discretion of such non-interested Directors.
For the fiscal years ended March 31, 1995 and 1994, payments to
Service Organizations totalled $37,903 and $2,244, $24,089 and $2,025, $27,198
and $2,555, and $22,473 and $1,499 with respect to the International, Emerging
Americas, Pacific/Asia and Pan European Funds, respectively. Of these amounts,
$36,955 and $2,244, $23,712 and $2,025, $26,836 and $2,555, and $22,338 and
$1,499 were paid to affiliates of U.S. Trust with respect to the International,
Emerging Americas, Pacific/Asia and Pan European Funds, respectively.
Expenses
--------
Except as otherwise noted, the Investment Adviser, Sub-Advisers and
the Administrators bear all expenses in connection with the performance of their
services. Each Fund bears the expenses incurred in its operations. Expenses of
a Fund include taxes; interest; fees (including fees paid to its directors and
officers who are not affiliated with the Distributor or the Administrators);
Securities and Exchange Commission fees; state securities qualification fees;
costs of preparing and printing prospectuses for regulatory purposes and for
distribution to shareholders; advisory, administration and administrative
servicing fees; charges of the custodian, transfer agent, and dividend
disbursing agent; certain insurance premiums; outside auditing and legal
expenses; costs of shareholder reports and meetings; and any extraordinary
expenses. A Fund also pays for brokerage fees and commissions in connection
with the purchase of portfolio securities.
If the expenses borne by a Fund in any fiscal year exceed expense
limitations imposed by applicable state securities regulations, the Investment
Adviser and the Administrators will reimburse the affected Fund for a portion of
any such excess to the extent required by such regulations in proportion to the
fees
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<PAGE>
received by them in such year up to the amount of the fees payable to them,
provided, however, to the extent required by such state regulations, the
Investment Adviser and the Administrators have agreed to effect such
reimbursement regardless of the fees payable to them. In addition, FACAM and
FCEML have agreed to pay the Investment Adviser an amount equal to 70% and 50%,
respectively, of each expense reimbursement made by the Investment Adviser to
any Fund for which they are Sub-Adviser pursuant to the foregoing undertaking.
The amounts of the above reimbursements, if any, will be estimated, reconciled
and paid on a monthly basis. To Master Fund's knowledge, of the applicable
expense limitations in effect on the date of this Statement of Additional
Information, none is more restrictive than the following: 2 1/2% of the first
$30 million of average annual net assets, 2% of the next $70 million of average
annual net assets and 1 1/2% of average annual net assets in excess of $100
million.
Custodian and Transfer Agent
----------------------------
United States Trust Company of New York also serves as custodian of
the Funds' assets. Under the custodian agreement, U.S. Trust has agreed to (i)
maintain a separate account or accounts in the name of the Funds; (ii) make
receipts and disbursements of money on behalf of the Funds; (iii) collect and
receive all income and other payments and distributions on account of the Funds'
portfolio securities; (iv) respond to correspondence from securities brokers and
others relating to its duties; (v) maintain certain financial accounts and
records; and (vi) make periodic reports to Master Fund's Board of Directors
concerning the Funds' operations. U.S. Trust is entitled to monthly fees for
furnishing custodial services according to the following fee schedule: on the
face value of debt securities and the market value of equity securities, a fee
at the annual rate of .05%; on issues held, $50.00 for each physical issue held,
$25.00 for each book-entry issue held and 1/4 of 1% of market value for each
foreign issue held; on transactions, $25.00 for each physical transaction,
$15.00 for each book-entry transaction and $50.00 for each foreign security
transaction. In addition, U.S. Trust is entitled to reimbursement for its
out-of-pocket expenses in connection with the above services.
U.S. Trust also serves as the Funds' transfer agent and dividend
disbursing agent. In such capacity, U.S. Trust has agreed to (i) issue and
redeem Shares; (ii) address and mail all communications by the Funds to their
shareholders, including reports to shareholders, dividend and distribution
notices, and proxy materials for its meetings of shareholders; (iii) respond to
correspondence by shareholders and others relating to its duties; (iv) maintain
shareholder accounts; and (v) make periodic reports to Master Fund concerning
the Fund's operations. For its
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<PAGE>
transfer agency, dividend disbursing, and subaccounting services, U.S. Trust is
entitled to receive $15.00 per annum per account and subaccount. In addition,
U.S. Trust is entitled to be reimbursed for its out-of-pocket expenses for the
cost of forms, postage, processing purchase and redemption orders, handling of
proxies, and other similar expenses in connection with the above services.
U.S. Trust may, at its own expense, open and maintain custody accounts
with respect to the Funds with other banks or trust companies, and may delegate
its transfer agency obligations to another transfer agent registered or
qualified under applicable law, provided that U.S. Trust shall remain liable for
the performance of all of its custodial and transfer agency duties under the
Custodian and Transfer Agency Agreement, notwithstanding any delegation.
Pursuant to this provision in the agreement, U.S. Trust has entered into a sub-
transfer agency arrangement with MFSC, an affiliate of U.S. Trust, with respect
to accounts of shareholders who are not Customers of U.S. Trust. For the
services provided by MFSC, U.S. Trust has agreed to pay MFSC $15.00 per annum
per account or subaccount plus out-of-pocket expenses. MFSC receives no fee
directly from Master Fund for any of its sub-transfer agency services.
PORTFOLIO TRANSACTIONS
----------------------
Subject to the general control of Master Fund's Board of Directors,
the Investment Adviser is responsible for and makes decisions with respect to
all U.S. securities acquired for the Funds. FACAM and FCEML supervise through
their trading desks the execution of all transactions in foreign securities for
the Funds for which they serve as Sub-Adviser.
The Funds may engage in short-term trading to achieve their investment
objectives. Portfolio turnover may vary greatly from year to year as well as
within a particular year. The Funds' portfolio turnover rate may also be
affected by cash requirements for redemptions of Shares and by regulatory
provisions which enable a Fund to receive certain favorable tax treatment.
Portfolio turnover will not be a limiting factor in making portfolio decisions.
See "Financial Highlights" in the Funds' Prospectuses for the Funds' portfolio
turnover rates.
Transactions on U.S. stock exchanges involve the payment of negotiated
brokerage commissions. On exchanges on which commissions are negotiated, the
cost of transactions may vary among different brokers. Transactions on foreign
stock exchanges involve payment for brokerage commissions which are generally
fixed. For the fiscal years ended March 31, 1993, March 31, 1994 and March 31,
1995, the International Fund paid brokerage commissions aggregating $177,294,
$187,670 and
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<PAGE>
$234,115, respectively. For the period from December 31, 1992 (commencement of
operations) to March 31, 1993 and for the fiscal years ended March 31, 1994 and
March 31, 1995, the Emerging Americas, Pacific/Asia and Pan European Funds paid
brokerage commissions aggregating $13,100, $167,502 and $200,467; $57,218,
$377,060 and $300,058; and $3,660, $97,169 and $88,275, respectively.
Transactions in both foreign and domestic over-the-counter markets are
generally principal transactions with dealers, and the costs of such
transactions involve dealer spreads rather than brokerage commissions. With
respect to over-the-counter transactions, a Fund, where possible, 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. The cost of securities purchased from underwriters includes an
underwriting commission or concession.
The Investment Advisory Agreements between Master Fund and U.S. Trust,
and the Sub-Advisory Agreements between U.S. Trust and FACAM and between U.S.
Trust and FCEML, provide that, in executing portfolio transactions and selecting
brokers or dealers, the Investment Adviser and Sub-Advisers will seek to obtain
the best net price and the most favorable execution. The Investment Adviser and
Sub-Advisers shall consider factors they deem relevant, including the breadth of
the market in the security, the price of the security, the financial condition
and execution capability of the broker or dealer and whether such broker or
dealer is selling shares of Master Fund, and the reasonableness of the
commission, if any, for the specific transaction and on a continuing basis.
In addition, the Investment Advisory and Sub-Advisory Agreements
authorize the Investment Adviser and Sub-Advisers, to the extent permitted by
law and subject to the review of Master Fund's Board of Directors from time to
time with respect to the extent and continuation of the policy, to cause a Fund
to pay a broker which furnishes brokerage and research services a higher
commission than that which might be charged by another broker for effecting the
same transaction, provided that the Investment Adviser and Sub-Advisers
determine in good faith that such commission is reasonable in relation to the
value of the brokerage and research services provided by such broker, viewed in
terms of either that particular transaction or the overall responsibilities of
the Investment Adviser and Sub-Advisers to the accounts as to which they
exercise investment discretion. Such brokerage and research services might
consist of reports and statistics on specific companies or industries, general
summaries of groups of stocks and their comparative earnings, or broad overviews
of the stock market and the economy. Such services might also include reports
on global, regional, and country-by-
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<PAGE>
country prospects for economic growth, anticipated levels of inflation,
prevailing and expected interest rates, and the outlook for currency
relationships.
Supplementary research information so received is in addition to and
not in lieu of services required to be performed by U.S. Trust, FACAM and FCEML
and does not reduce the investment advisory fees payable by the Funds. Such
information may be useful to U.S. Trust, FACAM or FCEML in serving the Funds and
other clients and, conversely, supplemental information obtained by the
placement of business of other clients may be useful to U.S. Trust, FACAM and
FCEML in carrying out their obligations to the Funds.
Portfolio securities will not be purchased from or sold to the
Investment Adviser, Sub-Advisers, or the Distributor, or any affiliated person
of any of them (as such term is defined in the 1940 Act) acting as principal,
except to the extent permitted by the Securities and Exchange Commission.
Investment decisions for each Fund are made independently from those
for other investment companies, common trust funds and other types of funds
managed by U.S. Trust or FACAM or FCEML. Such other investment companies and
funds may also invest in the same securities as the Funds. When a purchase or
sale of the same security is made at substantially the same time on behalf of a
Fund and another investment company or common trust fund, the transaction will
be averaged as to price, and available investments allocated as to amount, in a
manner which U.S. Trust, FACAM or FCEML, as applicable, believes to be equitable
to the Fund and such other investment company or common trust fund. In some
instances, this investment procedure may adversely affect the price paid or
received by a Fund or the size of the position obtained by the Fund. To the
extent permitted by law, U.S. Trust, FACAM and FCEML may aggregate the
securities to be sold or purchased for the Funds with those to be sold or
purchased for other investment companies or common trust funds in order to
obtain best execution.
Master Fund is required to identify any securities of its regular
brokers or dealers (as defined in Rule 10b-1 under the 1940 Act) or their
parents held by Master Fund as of the close of its most recent fiscal year. As
of March 31, 1995, the following Funds held the following securities of Master
Fund's regular brokers or dealers or their parents: (a) the International Fund
held the following security: 27,000 shares of Nomura Securities Co., Ltd.; and
(b) the Pacific/Asia Fund held the following security: 26,000 shares of Nomura
Securities Co., Ltd. Nomura Securities International, Inc. is considered to be
a regular broker or dealer of Master Fund.
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<PAGE>
INDEPENDENT AUDITORS
--------------------
Ernst & Young LLP, independent auditors, 200 Clarendon Street, Boston,
MA 02116, serve as auditors of Master Fund. The Funds' Financial Highlights
included in the Prospectuses and the financial statements for the period ended
March 31, 1995 incorporated by reference in this Statement of Additional
Information have been audited by Ernst & Young LLP for the periods included in
their reports thereon which appear therein.
COUNSEL
-------
Drinker Biddle & Reath (of which Mr. McConnel, Secretary of Master
Fund, is a partner), 1345 Chestnut Street, Philadelphia, Pennsylvania 19107, is
counsel to Master Fund and will pass upon the legality of the Shares offered by
the Prospectuses.
ADDITIONAL INFORMATION CONCERNING TAXES
---------------------------------------
Generally
---------
The following supplements the tax information contained in the
Prospectuses.
Each Fund is treated as a separate corporate entity under the Internal
Revenue Code of 1986, as amended (the "Code"), and intends to qualify as a
regulated investment company. If, for any reason, a Fund does not qualify for a
taxable year for the special Federal tax treatment afforded regulated investment
companies, the Fund would be subject to Federal tax on all of its taxable income
at regular corporate rates, without any deduction for distributions to
shareholders. In such event, dividend distributions would be taxable as
ordinary income to shareholders to the extent of such Fund's current and
accumulated earnings and profits and would be eligible for the dividends
received deduction in the case of corporate shareholders.
A 4% non-deductible excise tax is imposed on regulated investment
companies that fail to currently distribute an amount equal to specified
percentages of their ordinary taxable income and capital gain net income (excess
of capital gains over capital losses). Each Fund intends to make sufficient
distributions or deemed distributions of its ordinary taxable income and any
capital gain net income prior to the end of each calendar year to avoid
liability for this excise tax.
A Fund will not be treated as a regulated investment company under the
Code if 30% or more of the Fund's gross income for a taxable year is derived
from gains realized on the sale or
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<PAGE>
other disposition of the following investments held for less than three months
(the "30% test"): (1) stock and securities (as defined in section 2(a)(36) of
the 1940 Act); (2) options, futures and forward contracts other than those on
foreign currencies; and (3) foreign currencies (and options, futures and forward
contracts on foreign currencies) that are not directly related to the Fund's
principal business of investing in stock and securities (and options and futures
with respect to stocks and securities). Interest (including original issue
discount and, accrued market discount) received by a Fund upon maturity or
disposition of a security held for less than three months will not be treated as
gross income derived from the sale or other disposition of such security within
the meaning of this requirement. However, any other income which is
attributable to realized market appreciation will be treated as gross income
from the sale or other disposition of securities for this purpose. With respect
to covered call options, if the call is exercised by the holder, the premium and
the price received on exercise constitute the proceeds of sale, and the
difference between the proceeds and the cost of the securities subject to the
call is capital gain or loss. Premiums from expired call options written by a
Fund and net gains from closing purchase transactions are treated as short-term
capital gains for Federal income tax purposes, and losses on closing purchase
transactions are short-term capital losses. With respect to forward contracts,
futures contracts, options on futures contracts, and other financial instruments
subject to the marking-to-market rules described below under "Taxation of
Certain Financial Instruments," the Internal Revenue Service has ruled in
private letter rulings that a gain realized from such a contract, option or
financial instrument will be treated as being derived from a security held for
three months or more (regardless of the actual period for which the contract,
option or instrument is held) if the gain arises as a result of a constructive
sale under the marking-to-market rules, and will be treated as being derived
from a security held for less than three months only if the contract, option or
instrument is terminated (or transferred) during the taxable year (other than by
reason of marking-to-market) and less than three months have elapsed between the
date the contract, option or instrument is acquired and the termination date.
Increases and decreases in the value of a Fund's forward contracts, futures
contracts, options on futures contracts and other investments that qualify as
part of a "designated hedge," as defined in Section 851(g) of the Code, may be
netted for purposes of determining whether the 30% test is met.
Each Fund will designate any distribution of the excess of net long-
term capital gain over net short-term capital loss as a capital gain dividend in
a written notice mailed to shareholders within 60 days after the close of the
Fund's taxable year. Shareholders should note that, upon the sale or exchange
of Fund Shares, if the shareholder has not held such Shares for
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<PAGE>
more than six months, any loss on the sale or exchange of those Shares will be
treated as long-term capital loss to the extent of the capital gain dividends
received with respect to the Shares.
A Fund will be required in certain cases to withhold and remit to the
U.S. Treasury 31% of taxable dividends or gross proceeds realized upon sale paid
to shareholders who have failed to provide a correct tax identification number
in the manner required, who are subject to withholding by the Internal Revenue
Service for failure properly to include on their return payments of taxable
interest or dividends, or who have failed to certify to the Fund when required
to do so either that they are not subject to backup withholding or that they are
"exempt recipients."
Taxation of Certain Financial Instruments
-----------------------------------------
Generally, futures contracts and options on futures held by a Fund at
the close of its taxable year will be treated for Federal income tax purposes as
sold for their fair market value on the last business day of such year, a
process known as "marking-to-market." Forty percent of any gain or loss
resulting from such constructive sale will be treated as short-term capital gain
or loss and 60% of such gain or loss will be treated as long-term capital gain
or loss without regard to the length of time the Fund holds the futures contract
or related option (the "40%-60% rule"). The amount of any capital gain or loss
actually realized by a Fund in a subsequent sale or other disposition of those
futures contracts and related options will be adjusted to reflect any capital
gain or loss taken into account by the Fund in a prior year as a result of the
constructive sale of the contracts and options. Losses with respect to futures
contracts to sell and related options, which are regarded as parts of a "mixed
straddle" because their values fluctuate inversely to the values of specific
securities held by a Fund, are subject to certain loss deferral rules which
limit the amount of loss currently deductible on either part of the straddle to
the amount thereof which exceeds the unrecognized gain (if any) with respect to
the other part of the straddle, and to certain wash sales regulations. Under
short sales rules, which are also applicable, the holding period of the
securities forming part of the straddle will (if they have not been held for the
long-term holding period) be deemed not to begin prior to termination of the
straddle. With respect to certain futures contracts and related options,
deductions for interest and carrying charges will not be allowed.
Notwithstanding the rules described above, with respect to futures contracts to
sell and related options which are properly identified as such, a Fund may make
an election which will exempt (in whole or in part) those identified futures
contracts and options from being treated for Federal income tax purposes as sold
on the last business day of the Fund's taxable year, but gains and losses will
be subject to
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<PAGE>
such short sales, wash sales and loss deferral rules, and the requirement to
capitalize interest and carrying charges. Under Temporary Regulations, a Fund
would be allowed (in lieu of the foregoing) to elect either (1) to offset gains
or losses from positions which are part of a mixed straddle by separately
identifying each mixed straddle to which such treatment applies, or (2) to
establish a mixed straddle account for which gains and losses would be
recognized and offset on a periodic basis during the taxable year. Under either
election, the 40%-60% rule will apply to the net gain or loss attributable to
the futures contracts and options, but in the case of a mixed straddle account
election, not more than 50 percent of any net gain may be treated as long term
and no more than 40 percent of any net loss may be treated as short term.
Certain foreign currency contracts entered into by the Funds
(including forward foreign currency exchange transactions) may be subject to the
"marking-to-market" rules described above. To receive such treatment, a foreign
currency contract must meet the following conditions: (1) the contract must
require delivery of a foreign currency of a type in which regulated futures
contracts are traded or upon which the settlement value of the contract depends;
(2) the contract must be entered into at arm's length at a price determined by
reference to the price in the interbank market; and (3) the contract must be
traded in the interbank market. The Treasury Department has broad authority to
issue regulations under these provisions. As of the date of this Statement of
Additional Information, the Treasury Department has not issued any such
regulations. Other foreign currency contracts entered into by the Funds may
result in the creation of one or more straddles for Federal income tax purposes,
in which case certain loss deferral, short sales, and wash sales rules and the
requirement to capitalize interest and carrying charges may apply.
The Funds' investments may also be subject to the provisions of
Subpart J of the Code which govern the Federal income tax treatment of certain
transactions denominated in terms of a currency other than the U.S. dollar or
determined by reference to the value of one or more currencies other than the
U.S. dollar. The types of transactions covered by the special rules include the
following: (1) the acquisition of, or becoming the obligor under, a bond or
other debt instrument (including, to the extent provided in Treasury
regulations, preferred stock); (2) the accruing of certain trade receivables and
payables; and (3) the entering into or acquisition of any forward contract,
futures contract, option and similar financial instrument. The disposition of a
currency other than the U.S. dollar by a U.S. taxpayer is also treated as a
transaction subject to the special currency rules. However, foreign currency-
related regulated futures contracts and nonequity options are generally not
subject to the special currency rules if they are or would be treated as
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<PAGE>
sold for their fair market value at year-end under the marking-to-market rules
unless an election is made to have such currency rules apply. With respect to
transactions covered by the special rules, foreign currency gain or loss is
calculated separately from any gain or loss on the underlying transaction and is
normally taxable as ordinary gain or loss. A taxpayer may elect to treat as
capital gain or loss foreign currency gain or loss arising from certain
identified forward contracts, futures contracts and options that are capital
assets in the hands of the taxpayer and which are not part of a straddle. In
accordance with the Treasury regulations, certain transactions that are part of
a "Section 988 hedging transaction" (as defined in the Code and Treasury
regulations) will be integrated and treated as a single transaction or otherwise
treated consistently for purposes of the Code. "Section 988 hedging
transactions" are not subject to the marking-to-market or loss deferral rules
under the Code. It is anticipated that some of the non-U.S. dollar-denominated
investments that a Fund may make (such as non-U.S. dollar-denominated debt
securities and obligations and certain preferred stocks) and some of the foreign
currency contracts a Fund may enter into will be subject to the special currency
rules described above. Exchange gains and losses attributable to foreign
currency transactions engaged in by a Fund which are not subject to the special
currency rules (such as foreign equity investments other than certain preferred
stocks) will be treated as capital gains or losses and will not be segregated
from the gain or loss on the underlying transaction.
The foregoing discussion is based on Federal tax laws and regulations
which are in effect on the date of this Statement of Additional Information;
such laws and regulations may be changed by legislative or administrative
action. Shareholders are advised to consult their tax advisers concerning their
specific situations and the application of state and local taxes.
PERFORMANCE INFORMATION
-----------------------
The Funds may advertise the "average annual total return" for its
Shares. Such return is computed by determining the average annual compounded
rate of return during specified periods that equates the initial amount invested
to the ending redeemable value of such investment according to the following
formula:
ERV /1/n/
T = [(-----) - 1]
P
Where: T = average annual total return.
-33-
<PAGE>
ERV = ending redeemable value of a hypothetical $1,000 payment
made at the beginning of the 1, 5 or 10 year (or other)
periods at the end of the applicable period (or a fractional
portion thereof).
P = hypothetical initial payment of $1,000.
n = period covered by the computation, expressed in years.
Each Fund that advertises an "aggregate total return" for its Shares
computes such return by determining the aggregate compounded rates of return
during specified periods that likewise equate the initial amount invested to the
ending redeemable value of such investment. The formula for calculating
aggregate total return is as follows:
ERV
Aggregate Total Return = [(------)] - 1
P
The above calculations are made assuming that (1) all dividends and
capital gain distributions are reinvested on the reinvestment dates at the price
per Share existing on the reinvestment date (reflecting any sales load charged
upon such reinvestment), (2) all recurring fees charged to all shareholder
accounts are included, and (3) for any account fees that vary with the size of
the account, a mean (or median) account size in a Fund during the periods is
reflected. The ending redeemable value (variable "ERV" in the formula) is
determined by assuming complete redemption of the hypothetical investment after
deduction of all nonrecurring charges at the end of the measuring period. In
addition, the Funds' average annual total return and aggregate total return
quotations will reflect the deduction of the maximum sales load charged in
connection with the purchase of Shares.
Based on the foregoing calculations, the average annual total returns
for the Shares of the International Fund for the one year period ended March 31,
1995, for the five-year period ended March 31, 1995, and for the period from
July 21, 1987 (commencement of operations) to March 31, 1995 were (6.33)%,
1.67%, and 4.60%, respectively. The average annual total returns for the Shares
of the Emerging Americas, Pacific/Asia and Pan European Funds for the one year
period ended March 31, 1995 and for the period from December 31, 1992
(commencement of operations) to March 31, 1995 were (33.61) and (10.10)%,
(0.38)% and (4.90)%, and 13.78% and 6.40%, respectively.
The Funds may also from time to time include in advertisements, sales
literature and communications to shareholders a total return figure that is not
calculated
-34-
<PAGE>
according to the formula set forth above in order to compare more accurately a
Fund's performance with other measures of investment return. For example, in
comparing a Fund's total return with data published by Lipper Analytical
Services, Inc., CDA Investment Technologies, Inc. or Weisenberger Investment
Company Service, or with the performance of an index, a Fund may calculate its
aggregate total return for the period of time specified in the advertisement,
sales literature or communication by assuming the investment of $10,000 in
Shares and assuming the reinvestment of each dividend or other distribution at
net asset value on the reinvestment date. Percentage increases are determined
by subtracting the initial value of the investment from the ending value and by
dividing the remainder by the beginning value. A Fund does not, for these
purposes, deduct from the initial value invested any amount representing sales
charges. A Fund will, however, disclose the maximum sales charge and will also
disclose that the performance data does not reflect sales charges and that
inclusion of sale charges would reduce the performance quoted.
The total return of Shares of a Fund may be compared to those of other
mutual funds with similar investment objectives and to other relevant indices or
to ratings prepared by independent services or other financial or industry
publications that monitor the performance of mutual funds. For example, the
total return of a Fund may be compared to data prepared by Lipper Analytical
Services, Inc., CDA Investment Technologies, Inc. and Weisenberger Investment
Company Service. Total return and yield data as reported in national financial
publications such as Money Magazine, Forbes, Barron's, The Wall Street Journal
----- -------- ------ -------- --- ---- ------ -------
and The New York Times, or in publications of a local or regional nature, may
--- --- ---- -----
also be used in comparing the performance of a Fund. Advertisements, sales
literature or reports to shareholders may from time to time also include a
discussion and analysis of each Fund's performance, including without
limitation, those factors, strategies and techniques that together with market
conditions and events, materially affected each Fund's performance.
The Funds may also from time to time include discussions or
illustrations of the effects of compounding in advertisements. "Compounding"
refers to the fact that, if dividends or other distributions of a Fund
investment are reinvested by being paid in additional Fund Shares, any future
income or capital appreciation of a Fund would increase the value, not only of
the original Fund investment, but also of the additional Fund Shares received
through reinvestment. As a result, the value of the Fund investment would
increase more quickly than if dividends or other distributions had been paid in
cash. The Funds may also include discussions or illustrations of the potential
investment goals of a prospective investor, investment management techniques,
policies or investment suitability of a Fund, economic conditions, the effects
of
-35-
<PAGE>
inflation and historical performance of various asset classes, including but not
limited to, stocks, bonds and Treasury bills. From time to time advertisements,
sales literature or communications to shareholders may summarize the substance
of information contained in shareholder reports (including the investment
composition of a Fund), as well as the views of the Investment Adviser as to
current market, economy, trade and interest rate trends, legislative, regulatory
and monetary developments, investment strategies and related matters believed to
be of relevance to a Fund. The Funds may also include in advertisements charts,
graphs or drawings which illustrate the potential risks and rewards of
investment in various investment vehicles, including but not limited to, stocks,
bonds, treasury bills and Shares of a Fund. In addition, advertisement, sales
literature or shareholder communications may include a discussion of certain
attributes or benefits to be derived by an investment in a Fund. Such
advertisements or communicators may include symbols, headlines or other material
which highlight or summarize the information discussed in more detail therein.
MISCELLANEOUS
-------------
As used in the Prospectuses, "assets belonging to a Fund" means the
consideration received upon the issuance of Shares in a Fund together with all
income, earnings, profits, and proceeds derived from the investment thereof,
including any proceeds from the sale of such investments, any funds or payments
derived from any reinvestment of such proceeds, and a portion of any general
assets of Master Fund not belonging to a particular portfolio of Master Fund.
In determining a Fund's net asset value, assets belonging to the Fund are
charged with the direct liabilities in respect of the Fund and with a share of
the general liabilities of Master Fund which are normally allocated in
proportion to the relative asset values of Master Fund's portfolios at the time
of allocation. Subject to the provisions of Master Fund's Charter,
determinations by the Board of Directors as to the direct and allocable
liabilities, and the allocable portion of any general assets with respect to a
particular Fund, are conclusive.
As of July 11, 1995, U.S. Trust held of record substantially all of
the Shares in the Funds as agent or custodian for its customers, but did not own
such Shares beneficially because it did not have discretion to vote or invest
such Shares.
-36-
<PAGE>
FINANCIAL STATEMENTS
--------------------
Master Fund's Annual Report to Shareholders for the fiscal year ended
March 31, 1995 (the "Annual Report") for the international equity portfolios
accompanies this Statement of Additional Information. The financial statements
in the Annual Report for the International, Emerging Americas, Pacific/Asia and
Pan European Funds (the "Financial Statements") are incorporated in this
Statement of Additional Information by reference. The Financial Statements
included in the Annual Report for the fiscal year ended March 31, 1995 have been
audited by Master Fund's independent auditors, Ernst & Young LLP, whose reports
thereon also appear in such Annual Report and are incorporated herein by
reference. The Financial Statements in such Annual Report have been
incorporated herein in reliance upon such report given upon the authority of
such firm as experts in accounting and auditing. Additional copies of the
Annual Report may be obtained at no charge by telephoning MFSC at the telephone
number appearing on the front page of this Statement of Additional Information.
-37-
<PAGE>
APPENDIX A
----------
Commercial Paper Ratings
------------------------
A Standard & Poor's commercial paper rating is a current assessment of
the likelihood of timely payment of debt considered short-term in the relevant
market. The following summarizes the rating categories used by Standard and
Poor's for commercial paper:
"A-1" - Issue's degree of safety regarding timely payment is strong.
Those issues determined to possess extremely strong safety characteristics are
denoted "A-1+."
"A-2" - Issue's capacity for timely payment is satisfactory. However,
the relative degree of safety is not as high as for issues designated "A-1."
"A-3" - Issue has an adequate capacity for timely payment. It is,
however, somewhat more vulnerable to the adverse effects of changes and
circumstances than an obligation carrying a higher designation.
"B" - Issue has only a speculative capacity for timely payment.
"C" - Issue has a doubtful capacity for payment.
"D" - Issue is in payment default.
Moody's commercial paper ratings are opinions of the ability of
issuers to repay punctually promissory obligations not having an original
maturity in excess of 9 months. The following summarizes the rating categories
used by Moody's for commercial paper:
"Prime-1" - Issuer or related supporting institutions are considered
to have a superior capacity for repayment of short-term promissory obligations.
Prime-1 repayment capacity will normally be evidenced by the following
characteristics: leading market positions in well established industries; high
rates of return on funds employed; conservative capitalization structures with
moderate reliance on debt and ample asset protection; broad margins in earning
coverage of fixed financial charges and high internal cash generation; and well
established access to a range of financial markets and assured sources of
alternate liquidity.
A-1
<PAGE>
"Prime-2" - Issuer or related supporting institutions are considered
to have a strong capacity for repayment of short-term promissory obligations.
This will normally be evidenced by many of the characteristics cited above but
to a lesser degree. Earnings trends and coverage ratios, while sound, will be
more subject to variation. Capitalization characteristics, while still
appropriate, may be more affected by external conditions. Ample alternative
liquidity is maintained.
"Prime-3" - Issuer or related supporting institutions have an
acceptable capacity for repayment of short-term promissory obligations. The
effects of industry characteristics and market composition may be more
pronounced. Variability in earnings and profitability may result in changes in
the level of debt protection measurements and the requirement for relatively
high financial leverage. Adequate alternate liquidity is maintained.
"Not Prime" - Issuer does not fall within any of the Prime rating
categories.
The three rating categories of Duff & Phelps for investment grade
commercial paper and short-term debt are "D-1," "D-2" and "D-3." Duff & Phelps
employs three designations, "D-1+," "D-1" and "D-1-," within the highest rating
category. The following summarizes the rating categories used by Duff & Phelps
for commercial paper:
"D-1+" - Debt possesses highest certainty of timely payment. Short-
term liquidity, including internal operating factors and/or access to
alternative sources of funds, is outstanding, and safety is just below risk-free
U.S. Treasury short-term obligations.
"D-1" - Debt possesses very high certainty of timely payment.
Liquidity factors are excellent and supported by good fundamental protection
factors. Risk factors are minor.
"D-1-" - Debt possesses high certainty of timely payment. Liquidity
factors are strong and supported by good fundamental protection factors. Risk
factors are very small.
"D-2" - Debt possesses good certainty of timely payment. Liquidity
factors and company fundamentals are sound. Although ongoing funding needs may
enlarge total financing requirements, access to capital markets is good. Risk
factors are small.
"D-3" - Debt possesses satisfactory liquidity, and other protection
factors qualify issue as investment grade. Risk
A-2
<PAGE>
factors are larger and subject to more variation. Nevertheless, timely payment
is expected.
"D-4" - Debt possesses speculative investment characteristics.
Liquidity is not sufficient to ensure against disruption in debt service.
Operating factors and market access may be subject to a high degree of
variation.
"D-5" - Issuer has failed to meet scheduled principal and/or interest
payments.
Fitch short-term ratings apply to debt obligations that are payable on
demand or have original maturities of up to three years. The following
summarizes the rating categories used by Fitch for short-term obligations:
"F-1+" - Securities possess exceptionally strong credit quality.
Issues assigned this rating are regarded as having the strongest degree of
assurance for timely payment.
"F-1" - Securities possess very strong credit quality. Issues
assigned this rating reflect an assurance of timely payment only slightly less
in degree than issues rated "F-1+."
"F-2" - Securities possess good credit quality. Issues assigned this
rating have a satisfactory degree of assurance for timely payment, but the
margin of safety is not as great as the "F-1+" and "F-1" categories.
"F-3" - Securities possess fair credit quality. Issues assigned this
rating have characteristics suggesting that the degree of assurance for timely
payment is adequate; however, near-term adverse changes could cause these
securities to be rated below investment grade.
"F-S" - Securities possess weak credit quality. Issues assigned this
rating have characteristics suggesting a minimal degree of assurance for timely
payment and are vulnerable to near-term adverse changes in financial and
economic conditions.
"D" - Securities are in actual or imminent payment default.
Fitch may also use the symbol "LOC" with its short-term ratings to
indicate that the rating is based upon a letter of credit issued by a commercial
bank.
Thomson BankWatch short-term ratings assess the likelihood of an
untimely or incomplete payment of principal or interest of unsubordinated
instruments having a maturity of one
A-3
<PAGE>
year or less which is issued by United States commercial banks, thrifts and non-
bank banks; non-United States banks; and broker-dealers. The following
summarizes the ratings used by Thomson BankWatch:
"TBW-1" - This designation represents Thomson BankWatch's highest
rating category and indicates a very high degree of likelihood that principal
and interest will be paid on a timely basis.
"TBW-2" - This designation indicates that while the degree of safety
regarding timely payment of principal and interest is strong, the relative
degree of safety is not as high as for issues rated "TBW-1."
"TBW-3" - This designation represents the lowest investment grade
category and indicates that while the debt is more susceptible to adverse
developments (both internal and external) than obligations with higher ratings,
capacity to service principal and interest in a timely fashion is considered
adequate.
"TBW-4" - This designation indicates that the debt is regarded as non-
investment grade and therefore speculative.
IBCA assesses the investment quality of unsecured debt with an
original maturity of less than one year which is issued by bank holding
companies and their principal bank subsidiaries. The following summarizes the
rating categories used by IBCA for short-term debt ratings:
"A1" - Obligations are supported by the highest capacity for timely
repayment. Where issues possess a particularly strong credit feature, a rating
of A1+ is assigned.
"A2" - Obligations are supported by a good capacity for timely
repayment.
"A3" - Obligations are supported by a satisfactory capacity for timely
repayment.
"B" - Obligations for which there is an uncertainty as to the capacity
to ensure timely repayment.
"C" - Obligations for which there is a high risk of default or which
are currently in default.
A-4
<PAGE>
Corporate and Municipal Long-Term Debt Ratings
----------------------------------------------
The following summarizes the ratings used by Standard & Poor's for
corporate and municipal debt:
"AAA" - This designation represents the highest rating assigned by
Standard & Poor's to a debt obligation and indicates an extremely strong
capacity to pay interest and repay principal.
"AA" - Debt is considered to have a very strong capacity to pay
interest and repay principal and differs from AAA issues only in small degree.
"A" - Debt is considered to have a strong capacity to pay interest and
repay principal although such issues are somewhat more susceptible to the
adverse effects of changes in circumstances and economic conditions than debt in
higher-rated categories.
"BBB" - Debt is regarded as having an adequate capacity to pay
interest and repay principal. Whereas such issues normally exhibit adequate
protection parameters, adverse economic conditions or changing circumstances are
more likely to lead to a weakened capacity to pay interest and repay principal
for debt in this category than in higher-rated categories.
"BB," "B," "CCC," "CC" and "C" - Debt is regarded, on balance, as
predominantly speculative with respect to capacity to pay interest and repay
principal in accordance with the terms of the obligation. "BB" indicates the
lowest degree of speculation and "C" the highest degree of speculation. While
such debt will likely have some quality and protective characteristics, these
are outweighed by large uncertainties or major risk exposures to adverse
conditions.
"BB" - Debt has less near-term vulnerability to default than other
speculative issues. However, it faces major ongoing uncertainties or exposure
to adverse business, financial or economic conditions which could lead to
inadequate capacity to meet timely interest and principal payments. The "BB"
rating category is also used for debt subordinated to senior debt that is
assigned an actual or implied "BBB-" rating.
"B" - Debt has a greater vulnerability to default but currently has
the capacity to meet interest payments and principal repayments. Adverse
business, financial or economic conditions will likely impair capacity or
willingness to pay interest and repay principal. The "B" rating category is
also used for debt subordinated to senior debt that is assigned an actual or
implied "BB" or "BB-" rating.
A-5
<PAGE>
"CCC" - Debt has a currently identifiable vulnerability to default,
and is dependent upon favorable business, financial and economic conditions to
meet timely payment of interest and repayment of principal. In the event of
adverse business, financial or economic conditions, it is not likely to have the
capacity to pay interest and repay principal. The "CCC" rating category is also
used for debt subordinated to senior debt that is assigned an actual or implied
"B" or "B-" rating.
"CC" - This rating is typically applied to debt subordinated to senior
debt that is assigned an actual or implied "CCC" rating.
"C" - This rating is typically applied to debt subordinated to senior
debt which is assigned an actual or implied "CCC-" debt rating. The "C" rating
may be used to cover a situation where a bankruptcy petition has been filed, but
debt service payments are continued.
"CI" - This rating is reserved for income bonds on which no interest
is being paid.
"D" - Debt is in payment default. This rating is used when interest
payments or principal payments are not made on the date due, even if the
applicable grace period has not expired, unless S & P believes such payments
will be made during such grace period. "D" rating is also used upon the filing
of a bankruptcy petition if debt service payments are jeopardized.
PLUS (+) OR MINUS (-) - The ratings from "AA" through "CCC" may be
modified by the addition of a plus or minus sign to show relative standing
within the major rating categories.
"r" - This rating is attached to highlight derivative, hybrid, and
certain other obligations that S & P believes may experience high volatility or
high variability in expected returns due to non-credit risks. Examples of such
obligations are: securities whose principal or interest return is indexed to
equities, commodities, or currencies; certain swaps and options; and interest
only and principal only mortgage securities.
The following summarizes the ratings used by Moody's for corporate and
municipal long-term debt:
"Aaa" - Bonds are judged to be of the best quality. They carry the
smallest degree of investment risk and are generally referred to as "gilt
edged." Interest payments are protected by a large or by an exceptionally
stable margin and principal is secure. While the various protective elements
are likely to change, such changes as can be visualized are most unlikely to
impair the fundamentally strong position of such issues.
A-6
<PAGE>
"Aa" - Bonds are judged to be of high quality by all standards.
Together with the "Aaa" group they comprise what are generally known as high
grade bonds. They are rated lower than the best bonds because margins of
protection may not be as large as in "Aaa" securities or fluctuation of
protective elements may be of greater amplitude or there may be other elements
present which make the long-term risks appear somewhat larger than in "Aaa"
securities.
"A" - Bonds possess many favorable investment attributes and are to be
considered as upper medium grade obligations. Factors giving security to
principal and interest are considered adequate but elements may be present which
suggest a susceptibility to impairment sometime in the future.
"Baa" - Bonds considered medium-grade obligations, i.e., they are
neither highly protected nor poorly secured. Interest payments and principal
security appear adequate for the present but certain protective elements may be
lacking or may be characteristically unreliable over any great length of time.
Such bonds lack outstanding investment characteristics and in fact have
speculative characteristics as well.
"Ba," "B," "Caa," "Ca," and "C" - Bonds that possess one of these
ratings provide questionable protection of interest and principal ("Ba"
indicates some speculative elements; "B" indicates a general lack of
characteristics of desirable investment; "Caa" represents a poor standing; "Ca"
represents obligations which are speculative in a high degree; and "C"
represents the lowest rated class of bonds). "Caa," "Ca" and "C" bonds may be in
default.
Con. (---) - Bonds for which the security depends upon the completion
of some act or the fulfillment of some condition are rated conditionally. These
are bonds secured by (a) earnings of projects under construction, (b) earnings
of projects unseasoned in operation experience, (c) rentals which begin when
facilities are completed, or (d) payments to which some other limiting condition
attaches. Parenthetical rating denotes probable credit stature upon completion
of construction or elimination of basis of condition.
Moody's applies numerical modifiers 1, 2 and 3 in each generic
classification from "Aa" to "B" in its bond rating system. The modifier 1
indicates that the issuer ranks in the higher end of its generic rating
category; the modifier 2 indicates a mid-range ranking; and the modifier 3
indicates that the issuer ranks at the lower end of its generic rating category.
A-7
<PAGE>
The following summarizes the long-term debt ratings used by Duff &
Phelps for corporate and municipal long-term debt:
"AAA" - Debt is considered to be of the highest credit quality. The
risk factors are negligible, being only slightly more than for risk-free U.S.
Treasury debt.
"AA" - Debt is considered of high credit quality. Protection factors
are strong. Risk is modest but may vary slightly from time to time because of
economic conditions.
"A" - Debt possesses protection factors which are average but
adequate. However, risk factors are more variable and greater in periods of
economic stress.
"BBB" - Debt possesses below average protection factors but such
protection factors are still considered sufficient for prudent investment.
Considerable variability in risk is present during economic cycles.
"BB," "B," "CCC," "DD," and "DP" - Debt that possesses one of these
ratings is considered to be below investment grade. Although below investment
grade, debt rated "BB" is deemed likely to meet obligations when due. Debt
rated "B" possesses the risk that obligations will not be met when due. Debt
rated "CCC" is well below investment grade and has considerable uncertainty as
to timely payment of principal, interest or preferred dividends. Debt rated
"DD" is a defaulted debt obligation, and the rating "DP" represents preferred
stock with dividend arrearages.
To provide more detailed indications of credit quality, the "AA," "A,"
"BBB," "BB" and "B" ratings may be modified by the addition of a plus (+) or
minus (-) sign to show relative standing within these major categories.
The following summarizes the highest four ratings used by Fitch for
corporate and municipal bonds:
"AAA" - Bonds considered to be investment grade and of the highest
credit quality. The obligor has an exceptionally strong ability to pay interest
and repay principal, which is unlikely to be affected by reasonably foreseeable
events.
"AA" - Bonds considered to be investment grade and of very high credit
quality. The obligor's ability to pay interest and repay principal is very
strong, although not quite as strong as bonds rated "AAA." Because bonds rated
in the "AAA" and "AA" categories are not significantly vulnerable to foreseeable
future developments, short-term debt of these issuers is generally rated "F-1+."
A-8
<PAGE>
"A" - Bonds considered to be investment grade and of high credit
quality. The obligor's ability to pay interest and repay principal is
considered to be strong, but may be more vulnerable to adverse changes in
economic conditions and circumstances than bonds with higher ratings.
"BBB" - Bonds considered to be investment grade and of satisfactory
credit quality. The obligor's ability to pay interest and repay principal is
considered to be adequate. Adverse changes in economic conditions and
circumstances, however, are more likely to have an adverse impact on these
bonds, and therefore, impair timely payment. The likelihood that the ratings of
these bonds will fall below investment grade is higher than for bonds with
higher ratings.
"BB," "B," "CCC," "CC," "C," "DDD," "DD," and "D" -Bonds that possess
one of these ratings are considered by Fitch to be speculative investments. The
ratings "BB" to "C" represent Fitch's assessment of the likelihood of timely
payment of principal and interest in accordance with the terms of obligation for
bond issues not in default. For defaulted bonds, the rating "DDD" to "D" is an
assessment of the ultimate recovery value through reorganization or liquidation.
To provide more detailed indications of credit quality, the Fitch
ratings from and including "AA" to "C" may be modified by the addition of a plus
(+) or minus (-) sign to show relative standing within these major rating
categories.
IBCA assesses the investment quality of unsecured debt with an
original maturity of more than one year which is issued by bank holding
companies and their principal bank subsidiaries. The following summarizes the
rating categories used by IBCA for long-term debt ratings:
"AAA" - Obligations for which there is the lowest expectation of
investment risk. Capacity for timely repayment of principal and interest is
substantial such that adverse changes in business, economic or financial
conditions are unlikely to increase investment risk substantially.
"AA" - Obligations for which there is a very low expectation of
investment risk. Capacity for timely repayment of principal and interest is
substantial. Adverse changes in business, economic or financial conditions may
increase investment risk albeit not very significantly.
"A" - Obligations for which there is a low expectation of investment
risk. Capacity for timely repayment of principal and interest is strong,
although adverse changes in business,
A-9
<PAGE>
economic or financial conditions may lead to increased investment risk.
"BBB" - Obligations for which there is currently a low expectation of
investment risk. Capacity for timely repayment of principal and interest is
adequate, although adverse changes in business, economic or financial conditions
are more likely to lead to increased investment risk than for obligations in
higher categories.
"BB," "B," "CCC," "CC," and "C" - Obligations are assigned one of
these ratings where it is considered that speculative characteristics are
present. "BB" represents the lowest degree of speculation and indicates a
possibility of investment risk developing. "C" represents the highest degree of
speculation and indicates that the obligations are currently in default.
IBCA may append a rating of plus (+) or minus (-) to a rating to
denote relative status within major rating categories.
Thomson BankWatch assesses the likelihood of an untimely repayment of
principal or interest over the term to maturity of long term debt and preferred
stock which are issued by United States commercial banks, thrifts and non-bank
banks; non-United States banks; and broker-dealers. The following summarizes
the rating categories used by Thomson BankWatch for long-term debt ratings:
"AAA" - This designation represents the highest category assigned by
Thomson BankWatch to long-term debt and indicates that the ability to repay
principal and interest on a timely basis is very high.
"AA" - This designation indicates a superior ability to repay
principal and interest on a timely basis with limited incremental risk versus
issues rated in the highest category.
"A" - This designation indicates that the ability to repay principal
and interest is strong. Issues rated "A" could be more vulnerable to adverse
developments (both internal and external) than obligations with higher ratings.
"BBB" - This designation represents Thomson BankWatch's lowest
investment grade category and indicates an acceptable capacity to repay
principal and interest. Issues rated "BBB" are, however, more vulnerable to
adverse developments (both internal and external) than obligations with higher
ratings.
"BB," "B," "CCC," and "CC," - These designations are assigned by
Thomson BankWatch to non-investment grade long-term
A-10
<PAGE>
debt. Such issues are regarded as having speculative characteristics regarding
the likelihood of timely payment of principal and interest. "BB" indicates the
lowest degree of speculation and "CC" the highest degree of speculation.
"D" - This designation indicates that the long-term debt is in
default.
PLUS (+) OR MINUS (-) - The ratings from "AAA" through "CC" may
include a plus or minus sign designation which indicates where within the
respective category the issue is placed.
Municipal Note Ratings
----------------------
A Standard and Poor's rating reflects the liquidity concerns and
market access risks unique to notes due in three years or less. The following
summarizes the ratings used by Standard & Poor's Ratings Group for municipal
notes:
"SP-1" - The issuers of these municipal notes exhibit very strong or
strong capacity to pay principal and interest. Those issues determined to
possess overwhelming safety characteristics are given a plus (+) designation.
"SP-2" - The issuers of these municipal notes exhibit satisfactory
capacity to pay principal and interest.
"SP-3" - The issuers of these municipal notes exhibit speculative
capacity to pay principal and interest.
Moody's ratings for state and municipal notes and other short-term
loans are designated Moody's Investment Grade ("MIG") and variable rate demand
obligations are designated Variable Moody's Investment Grade ("VMIG"). Such
ratings recognize the differences between short-term credit risk and long-term
risk. The following summarizes the ratings by Moody's Investors Service, Inc.
for short-term notes:
"MIG-1"/"VMIG-1" - Loans bearing this designation are of the best
quality, enjoying strong protection by established cash flows, superior
liquidity support or demonstrated broad-based access to the market for
refinancing.
"MIG-2"/"VMIG-2" - Loans bearing this designation are of high quality,
with margins of protection ample although not so large as in the preceding
group.
"MIG-3"/"VMIG-3" - Loans bearing this designation are of favorable
quality, with all security elements accounted for but lacking the undeniable
strength of the preceding grades.
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Liquidity and cash flow protection may be narrow and market access for
refinancing is likely to be less well established.
"MIG-4"/"VMIG-4" - Loans bearing this designation are of adequate
quality, carrying specific risk but having protection commonly regarded as
required of an investment security and not distinctly or predominantly
speculative.
"SG" - Loans bearing this designation are of speculative quality and
lack margins of protection.
Fitch and Duff & Phelps use the short-term ratings described under
Commercial Paper Ratings for municipal notes.
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