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PROSPECTUS
October 1, 1998
T. Rowe Price High Yield Fund
A bond fund for investors who can accept higher risk in order to earn a high
level of income.
(T. ROWE PRICE RAM LOGO)
These securities have not been approved or disapproved by the Securities and
Exchange Commission nor has the Commission passed upon the accuracy or adequacy
of this prospectus. Any representation to the contrary is a criminal offense.
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T. Rowe Price High Yield Fund, Inc.
Prospectus
October 1, 1998
<TABLE>
<CAPTION>
<S> <C> <C> <C>
1 ABOUT THE FUND
Fund, Market, and Risk Characteristics 1
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Other Information About the Fund 5
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Some Basics of Fixed Income Investing 6
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2 ABOUT YOUR ACCOUNT
Pricing Shares and Receiving 8
Sale Proceeds
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Distributions and Taxes 10
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Transaction Procedures and 12
Special Requirements
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3 MORE ABOUT THE FUND
Organization and Management 15
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Understanding Performance Information 16
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Investment Policies and Practices 18
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Financial Highlights 27
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4 INVESTING WITH T. ROWE PRICE
Account Requirements 29
and Transaction Information
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Opening a New Account 29
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Purchasing Additional Shares 31
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Exchanging and Redeeming 32
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Rights Reserved by the Fund 33
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Shareholder Services 34
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Discount Brokerage 36
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Investment Information 37
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</TABLE>
Founded in 1937 by the late Thomas Rowe Price, Jr., T. Rowe Price Associates,
Inc., and its affiliates managed over $141 billion for more than six million
individual and institutional investor accounts as of June 30, 1998.
Mutual fund shares are not deposits or obligations of, or guaranteed by, any
depository institution. Shares are not insured by the FDIC, Federal Reserve
Board, or any other agency, and are subject to investment risks, including
possible loss of the principal amount invested.
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ABOUT THE FUND
1
FUND, MARKET, AND RISK CHARACTERISTICS: WHAT TO EXPECT
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To help you decide whether this fund is appropriate for you, this section
reviews its investment objective, strategy, and potential risks.
What is the fund's objective?
The fund seeks high current income and, secondarily, capital appreciation.
What are the fund's principal investment strategies?
We will normally invest at least 80% of the fund's total assets in a widely
diversified portfolio of high-yield corporate bonds, often called "junk"
bonds, income-producing convertible securities and preferred stocks.
High-yield bonds are rated below investment-grade (BB and lower) and
generally provide high income in an effort to compensate investors for their
higher risk of default, that is, failure to make required interest or
principal payments. High-yield bond issuers include small or relatively new
companies lacking the history or capital to merit investment-grade status,
former blue chip companies downgraded because of financial problems,
companies electing to borrow heavily to finance or avoid a takeover or
buyout, and firms with heavy debt loads.
The fund may also invest in common stocks, warrants, private placements, bank
loans, hybrid instruments, foreign securities, futures and options, various
types of bonds such as asset-backed, pay-in-kind, and zero coupon, and other
securities.
The fund's dollar weighted average maturity generally is expected to be in
the 8 to 12 year range. In selecting investments for the fund, we rely
extensively on T. Rowe Price research analysts. When our outlook for the
economy is positive, we may purchase slightly lower-rated bonds in an effort
to secure additional income and appreciation potential. When we are less
positive, we may gravitate toward higher-rated junk bonds.
. For details about the fund's investment program, please see the Investment
Policies and Practices section.
What are the fund's principal risks?
This bond fund could have greater price declines than one that invests
primarily in high-quality bonds.
Like other bond funds, it is exposed to interest rate risk, which means that
its price is likely to fall when interest rates rise, as shown in Table 3 in
this section. Longer maturity bonds typically suffer greater declines than
those with shorter maturities.
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T. ROWE PRICE
Unlike high-quality bond funds, an equal if not more important source of risk
for the fund is credit risk, or the potential for price losses caused by
credit rating downgrades and defaults. Companies issuing high-yield bonds are
not as strong financially as those with higher credit ratings, so the bonds
are usually considered speculative investments. These companies are more
vulnerable to financial setbacks and recession than more creditworthy
companies which may impair their ability to make interest and principal
payments. Therefore, the fund's credit risk increases when the U.S. economy
slows or enters a recession.
The fund may be more vulnerable to interest rate risk if it is focusing on BB
rated bonds, since better-quality junk bonds follow the high-grade market to
some extent. But if its focus is bonds rated B and below, credit risk will
probably predominate.
The fund is subject to liquidity risk, which means that it may not be able to
sell bonds at desired prices and large purchases or sales of certain
high-yield bond issues can cause substantial price swings.
The fund is also subject to market risk. The entire junk bond market can
experience sudden and sharp price swings due to a variety of factors,
including changes in economic forecasts, stock market activity, large
sustained sales by major investors, a high-profile default, or just a change
in the market's psychology. This type of volatility is usually associated
more with stocks than bonds, but junk bond investors should be prepared for
it.
Shareholders are also exposed to foreign investing risk. There are special
risks associated with investments in foreign securities whether denominated
in U.S. dollars or foreign currencies. These risks include potentially
adverse political and economic developments overseas, greater volatility,
less liquidity and the possibility that foreign currencies will decline
against the dollar, lowering the value of securities denominated in those
currencies. Currency risk affects the fund to the extent that it holds
nondollar foreign bonds.
As with all mutual funds, there is no guarantee this fund will achieve its
goals.
Risk is also discussed later in this section.
. The fund's share price may decline, so when you sell your shares, you may
lose money. An investment in the fund is not a deposit of a bank and is not
insured or guaranteed by the Federal Deposit Insurance Corporation or any
other government agency.
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ABOUT THE FUND
How can I tell if the fund is appropriate for me?
If you are a long-term, risk-oriented investor seeking the highest level of
current income and some appreciation potential, the fund may be appropriate
but should not represent a significant portion of your assets. If you are
investing primarily for stability and liquidity, you should consider a money
market fund. This fund can be used for retirement plans, such as IRAs.
. The fund should not represent your complete investment program or be used
for short-term trading purposes.
How has the fund performed in the past?
The bar chart, which shows the fund's actual performance for each of the last
10 calendar years through December 31, 1997, indicates risk by illustrating
how much returns can differ from one year to the next.
The fund can also experience short-term performance swings, as shown below by
the best and worst calendar quarter returns during the years depicted in the
chart. Of course, the fund's past performance is no guarantee of its future
returns..
<TABLE>
High Yield Fund
<CAPTION>
Calendar Year Total Returns
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<S> <C>
1988 17.91%
1989 -1.46
1990 -10.96
1991 30.90
1992 14.73
1993 21.82
1994 -8.00
1995 15.77
1996 11.58
1997 14.47
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</TABLE>
Quarter Ended Total Return
Best Quarter 3/31/91 10.47%
Worst Quarter 9/30/90 -6.22%
The fund's return for the 6 months ended 6/30/98 was 5.31%.
In the following table, the fund's average annual total returns for the 1-,
5-, and 10-year periods through December 31, 1997 are compared with the First
Boston High Yield Index and the Lipper High Current Yield Funds Average. By
comparing the bar chart with Table 1, you can see that average returns smooth
out year-to-year variations.
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T. ROWE PRICE
<TABLE>
Table 1 Average Annual Total Returns
<CAPTION>
Periods ended December 31, 1997
---------------------------------- 1 year 5 years 10 years
<S> <C> <C> <C>
High Yield Fund 14.47% 10.63% 9.92%
First Boston High Yield Index 12.63% 11.84% 12.10%
Lipper High Yield Funds Average 12.96% 11.36% 10.66%
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</TABLE>
These figures include changes in principal value, reinvested dividends, and
capital gain distributions, if any.
What fees or expenses will I pay?
The fund is 100% no load. There are no fees or charges to buy fund shares,
reinvest dividends, or exchange into other T. Rowe Price funds. There are no
12b-1 marketing fees.
<TABLE>
Table 2 Fees and Expenses of the Fund
<CAPTION>
<C> <C> <S> <S> <S>
Annual fund operating expenses
Shareholder fees (fees paid (expenses that are deducted from fund
directly from your investment) assets)
Redemption fee (for Management fee 0.62%
shares held less than one 1%
year
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Other expenses 0.19%
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Total annual fund
operating 0.81%
expenses
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</TABLE>
The numbers in Table 2 provide an estimate of how much it will cost to
operate the fund for a year, based on 1998 fiscal year expenses.
Example. The following table gives you arough idea of how expense ratios may
translate into dollars and helps you to compare the cost of investing in this
fund with the cost of investing in other funds. Although your actual costs
may be higher or lower, the table shows expenses you would pay if operating
expenses remain the same, you invest $10,000, you earn a 5% annual return,
and you hold the investment for the following periods.
<TABLE>
<CAPTION>
<S> <S> <S> <S>
1 year 3 years 5 years 10 years
$83 $259 $450 $1,002
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</TABLE>
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ABOUT THE FUND
OTHER INFORMATION ABOUT THE FUND
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What are the fund's potential rewards?
The fund may be expected to generate significantly higher income than
higher-quality bond funds and to have greater potential for capital
appreciation. Because high-yield bonds can be more sensitive to changes in
economic growth than interest rates, the fund may outperform high-quality
bond funds when the outlook for the economy is positive.
How does the portfolio manager try to reduce risk?
Three approaches may mitigate but by no means eliminate risk: 1) rigorous
credit research by T. Rowe Price's high-yield bond specialists; 2) extensive
diversification, which limits the fund's exposure to any one industry or
issuer; and 3) variations in the amount of assets invested in other types of
securities.
Is the fund a substitute for a money market fund?
No. Money market funds, which have an average maturity under one year,
ordinarily generate lower income in return for stability of net asset value.
The fund's total return may be higher or lower than a money market fund's
and, as such, it should be viewed as a longer-term investment.
What are derivatives and can the fund invest in them?
A derivative is a financial instrument whose value is derived from an
underlying security, such as a stock or bond, or from a market benchmark such
as an interest rate index. Many types of investments representing a wide
range of potential risks and rewards are derivatives, including conventional
instruments such as callable bonds, futures, and options, as well as more
exotic investments such as stripped mortgage securities and structured notes.
Investment managers have used derivatives for many years.
We invest in derivatives only if the expected risks and rewards are
consistent with the fund's objective, policies, and overall risk profile
described in this prospectus. We use derivatives in situations where they may
enable the fund to increase yield, hedge against a decline in principal,
invest in other asset classes more efficiently and at a lower cost, or adjust
duration.
We will not invest in any high-risk, highly leveraged derivative that we
believe would cause the portfolio to be more volatile than a long-term high
yield bond.
Is there other information I can review before making a decision?
Investment Policies and Practices in Section 3 discusses the principal types
of portfolio securities that the fund may purchase as well as the types of
management practices that the fund may use.
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T. ROWE PRICE
SOME BASICS OF FIXED INCOME INVESTING
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Is a fund's yield fixed or will it vary?
It will vary. We calculate the yield every day by dividing a fund's net
income per share, expressed at annual rates, by the share price. Since income
and share price fluctuate, a fund's yield also varies.
Is yield the same as total return?
Not for bond funds. A fund's total return is the result of reinvested
distributions from income and capital gains and the change in share price for
a given period. Income is always a positive contributor to total return and
can either enhance a rise in share price or help offset a price decline.
What is credit quality and how does it affect yield?
Credit quality refers to a bond issuer's expected ability to make all
required interest and principal payments on time. Because highly rated
issuers represent less risk, they can borrow at lower interest rates than
less creditworthy issuers. Therefore, a fund investing in high-quality
securities should have a lower yield than an otherwise comparable fund
investing in lower-quality securities.
What is meant by a bond fund's maturity?
Every bond has a stated maturity date when the issuer must repay the bond's
entire principal value to the investor. However, many bonds are "callable,"
meaning their principal can be repaid earlier, on or after specified call
dates. Bonds are most likely to be called when interest rates are falling
because the issuer can refinance at a lower rate, just as a homeowner
refinances a mortgage. In that environment, a bond's "effective maturity" is
usually its nearest call date. For example, the rate at which homeowners pay
down their mortgage principal determines the effective maturity of
mortgage-backed bonds.
A bond mutual fund has no real maturity, but it does have a weighted average
maturity and an average effective maturity. This number is an average of the
stated or effective maturities of the underlying bonds, with each bond's
maturity "weighted" by the percentage of fund assets it represents. Funds
that target effective maturities normally use the effective, rather than
stated, maturities of the bonds in the portfolio when computing the average.
This provides additional flexibility in portfolio management but, all else
being equal, could result in higher volatility than a fund targeting a stated
maturity or maturity range.
What is meant by a bond fund's duration?
Duration is a calculation that seeks to measure the price sensitivity of a
bond or a bond fund to changes in interest rates. It measures this
sensitivity more accurately than maturity because it takes into account the
time value of cash
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ABOUT THE FUND
flows generated over the bond's life. Future interest and principal payments
are discounted to reflect their present value and then are multiplied by the
number of years they will be received to produce a value expressed in years -
the duration. Effective duration takes into account call features and sinking
fund payments that may shorten a bond's life.
Since duration can also be computed for bond funds, you can estimate the
effect of interest rates on share price by multiplying fund duration by an
expected change in interest rates. (T. Rowe Price shareholder bond fund
reports show duration.) For example, the price of a bond fund with a duration
of five years would be expected to fall approximately 5% if rates rose by one
percentage point.
Duration measures only sensitivity to interest rate changes-the dominant
source of risk for high-quality bond funds. It does not reflect risk from
other sources, such as bond defaults. Therefore, duration may not be as
significant an indicator of overall risk for a fund such as this one which
invests in noninvestment-grade (junk) bonds.
How is a bond's price affected by changes in interest rates?
When interest rates rise, a bond's price usually falls, and vice versa. In
general, the longer a bond's maturity, the greater the price increase or
decrease in response to a given change in rates, as shown in Table 3.
<TABLE>
Table 3 How Interest Rates May Affect Bond Prices
<CAPTION>
Price per $1,000 of bond face value if interest rates:
Bond maturity Coupon
Increase Decrease
1 point 2 points 1 point 2 points
<S> <C> <C> <C> <C> <C>
1 year 5.36% $990 $981 $1,010 $1,020
5 years 5.50 958 918 1,044 1,091
10 years 5.50 927 861 1,080 1,168
30 years 5.72 872 768 1,160 1,360
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</TABLE>
The table reflects yields on Treasury securities as of July 31, 1998. The table
may not be as representative of price changes for other types of bonds,
including mortgage-backed securities because of prepayments. This is an
illustration and does not represent expected yields or share price changes of
any T. Rowe Price fund.
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ABOUT YOUR ACCOUNT
2
PRICING SHARES AND RECEIVING SALE PROCEEDS
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Here are some procedures you should know when investing in a T. Rowe Price
fixed income fund.
How and when shares are priced
The share price (also called "net asset value" or NAV per share) for a fund
is calculated at 4 p.m. ET each day the New York Stock Exchange is open for
business. To calculate the NAV, the fund's assets are valued and totaled,
liabilities are subtracted, and the balance, called net assets, is divided by
the number of shares outstanding. Current market values are used to price
fund shares.
. The various ways you can buy, sell, and exchange shares are explained at the
end of this prospectus and on the New Account Form. These procedures and the
information you receive about them may differ for institutional and
employer-sponsored retirement accounts.
How your purchase, sale, or exchange price is determined
If we receive your request in correct form by 4 p.m. ET, your transaction
will be priced at that day's NAV. If we receive it after 4 p.m., it will be
priced at the next business day's NAV.
We cannot accept orders that request a particular day or price for your
transaction or any other special conditions.
Fund shares may be purchased through various third-party intermediaries
including banks, brokers, and investment advisers. Where authorized by a
fund, orders will be priced at the NAV next computed after receipt by the
intermediary. Consult your intermediary to determine when your orders will be
priced. The intermediary may charge a fee for its services.
Note: The time at which transactions and shares are priced and the time until
which orders are accepted may be changed in case of an emergency or if the
New York Stock Exchange closes at a time other than 4 p.m. ET.
How you can receive the proceeds from a sale
. When filling out the New Account Form, you may wish to give yourself the
widest range of options for receiving proceeds from a sale.
If your request is received by 4 p.m. ET in correct form, proceeds are
usually sent on the next business day. Proceeds can be sent to you by mail or
to your bank account by Automated Clearing House (ACH) transfer or bank wire.
Proceeds sent by ACH transfer should be credited the second day after the
sale. ACH is an automated method of initiating payments from, and receiving
payments in, your
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ABOUT YOUR ACCOUNT
financial institution account. The ACH system is supported by over 20,000
banks, savings banks, and credit unions. Proceeds sent by bank wire should be
credited to your account the next business day.
. Exception: Under certain circumstances and when deemed to be in the fund's
best interests, your proceeds may not be sent for up to five business days
after we receive your sale or exchange request. If you were exchanging into a
bond or money fund, your new investment would not begin to earn dividends
until the sixth business day.
. If for some reason we cannot accept your request to sell shares, we will
contact you.
Contingent Redemption Fee
The fund can experience substantial price fluctuations and is intended for
long-term investors. Short-term "market timers" who engage in frequent
purchases and redemptions can disrupt the fund's investment program and
create additional transaction costs that are borne by all shareholders. For
these reasons, the fund assesses a 1% fee on redemptions (including
exchanges) of fund shares held for less than one year.
Redemption fees are paid to the fund to help offset transaction costs and to
protect the fund's long-term shareholders. The fund will use the "first-in,
first-out" (FIFO) method to determine the one-year holding period. Under this
method, the date of the redemption or exchange will be compared to the
earliest purchase date of shares held in the account. If this holding period
is less than one year, the fee will be charged.
The fee does not apply to any shares purchased through reinvested
distributions (dividends and capital gains) or to shares held in retirement
plans such as 401(k), 403(b), 457, Keogh, profit sharing, SIMPLE IRA,
SEP-IRA, and money purchase pension accounts. The fee does apply to shares
held in IRA accounts and to shares purchased through automatic investment
plans (described under Shareholder Services). The fee may apply to shares in
retirement plans held in broker omnibus accounts.
In determining "one year," the fund will use the anniversary date of a
transaction. Thus, shares purchased on October 1, 1998, for example, will be
subject to the fee if they are redeemed on or prior to September 30, 1999. If
they are redeemed on or after October 1, 1999, they will not be subject to
the fee.
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T. ROWE PRICE
USEFUL INFORMATION ON DISTRIBUTIONS AND TAXES
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. All net investment income and realized capital gains are distributed to
shareholders.
Dividends and Other Distributions
Dividend and capital gain distributions are reinvested in additional fund
shares in your account unless you select another option on your New Account
Form. The advantage of reinvesting distributions arises from compounding;
that is, you receive income dividends and capital gain distributions on a
rising number of shares.
Distributions not reinvested are paid by check or transmitted to your bank
account via ACH. If the Post Office cannot deliver your check, or if your
check remains uncashed for six months, the fund reserves the right to
reinvest your distribution check in your account at the NAV on the business
day of the reinvestment and to reinvest all subsequent distributions in
shares of the fund. No interest will accrue on amounts represented by
uncashed distribution or redemption checks.
Income dividends
. Bond funds declare income dividends daily at 4 p.m. ET to shareholders of
record at that time provided payment has been received on the previous
business day.
. Dividends are paid on the first business day of each month.
. Fund shares will earn dividends through the date of redemption; also, shares
redeemed on a Friday or prior to a holiday will continue to earn dividends
until the next business day. Generally, if you redeem all of your shares at
any time during the month, you will also receive all dividends earned through
the date of redemption in the same check. When you redeem only a portion of
your shares, all dividends accrued on those shares will be reinvested, or
paid in cash, on the next dividend payment date.
A portion of the fund's dividends may be eligible for the 70% deduction for
dividends received by corporations.
Capital gains
. A capital gain or loss is the difference between the purchase and sale price
of a security.
. If a fund has net capital gains for the year (after subtracting any capital
losses), they are usually declared and paid in December to shareholders of
record on a specified date that month.
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ABOUT YOUR ACCOUNT
Tax Information
. You will be sent timely information for your tax filing needs.
You need to be aware of the possible tax consequences when:
. You sell fund shares, including an exchange from one fund to another.
. The fund makes a distribution to your account.
Taxes on fund redemptions
When you sell shares in any fund, you may realize a gain or loss. An exchange
from one fund to another is still a sale for tax purposes.
In January, you will be sent Form 1099-B indicating the date and amount of
each sale you made in the fund during the prior year. This information will
also be reported to the IRS. For new accounts or those opened by exchange in
1983 or later, we will provide the gain or loss on the shares you sold during
the year, based on the "average cost," single category method. This
information is not reported to the IRS, and you do not have to use it. You
may calculate the cost basis using other methods acceptable to the IRS, such
as "specific identification."
To help you maintain accurate records, we send you a confirmation immediately
following each transaction you make (except for systematic purchases and
redemptions) and a year-end statement detailing all your transactions in each
fund account during the year.
Taxes on fund distributions
. The following summary does not apply to retirement accounts, such as IRAs,
which are not subject to current tax.
In January, you will be sent Form 1099-DIV indicating the tax status of any
dividend and capital gain distributions made to you. This information will
also be reported to the IRS. Distributions made by a fund are generally
taxable to you for the year in which they were paid. You will be sent any
additional information you need to determine your taxes on fund
distributions, such as the portion of your dividend, if any, that may be
exempt from state income taxes.
The tax treatment of a capital gain distribution is determined by how long
the fund held the portfolio securities, not how long you held shares in the
fund. Short-term (one year or less) capital gain distributions are taxable at
the same rate as ordinary income. Reflecting recent changes in the tax code,
gains on securities held more than 12 months are taxed at a maximum rate of
20%. If you realized a loss on the sale or exchange of fund shares which you
held six months or less, your short-term loss will be reclassified to a
long-term loss to the extent you received a long-term capital gain
distribution during the period you held the shares.
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T. ROWE PRICE
Gains and losses from the sale of foreign currencies and the foreign currency
gain or loss resulting from the sale of a foreign debt security can increase
or decrease a fund's ordinary income dividend. Net foreign currency losses
may result in a fund's dividend being classified as a return of capital.
. Distributions are taxable whether reinvested in additional shares or
received in cash.
Tax effect of buying shares before a capital gain distribution
If you buy shares shortly before or on the "record date" - the date that
establishes you as the person to receive the upcoming distribution - you will
receive a portion of the money you just invested in the form of a taxable
distribution. Therefore, you may wish to find out a fund's record date before
investing. Of course, a fund's share price may, at any time, reflect
undistributed capital gains or income and unrealized appreciation, which may
result in future taxable distributions.
TRANSACTION PROCEDURES AND SPECIAL REQUIREMENTS
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. Following these procedures helps assure timely and accurate transactions.
Purchase Conditions
Nonpayment
If your payment is not received or you pay with a check or ACH transfer that
does not clear, your purchase will be canceled. You will be responsible for
any losses or expenses incurred by the fund or transfer agent, and the fund
can redeem shares you own in this or another identically registered T. Rowe
Price fund as reimbursement. The fund and its agents have the right to reject
or cancel any purchase, exchange, or redemption due to nonpayment.
U.S. dollars
All purchases must be paid for in U.S. dollars; checks must be drawn on U.S.
banks.
Sale (Redemption) Conditions
Holds on immediate redemptions
10-day hold
If you sell shares that you just purchased and paid for by check or ACH
transfer, the fund will process your redemption but will generally delay
sending you the proceeds for up to 10 calendar days to allow the check or
transfer to clear. If your redemption request was sent by mail or mailgram,
proceeds will be mailed no later than the seventh calendar day following
receipt unless the check or ACH transfer has not cleared. If, during the
clearing period, we receive a check drawn against your bond or money market
account, it will be returned marked
<PAGE>
ABOUT YOUR ACCOUNT
"uncollected." (The 10-day hold does not apply to the following: purchases
paid for by bank wire; cashier's, certified, or treasurer's checks; or
automatic purchases through your paycheck.)
Telephone, Tele*Access/(R)/, and personal computer transactions
Exchange and redemption services through telephone and Tele*Access are
established automatically when you sign the New Account Form unless you check
the box that states you do not want these services. Personal computer
transactions must be authorized separately. T. Rowe Price funds and their
agents use reasonable procedures (including shareholder identity
verification) to confirm that instructions given by telephone are genuine and
they are not liable for acting on these instructions. If these procedures are
not followed, it is the opinion of certain regulatory agencies that the funds
and their agents may be liable for any losses that may result from acting on
the instructions given. A confirmation is sent promptly after a transaction.
All telephone conversations are recorded.
Redemptions over $250,000
Large sales can adversely affect a portfolio manager's ability to implement a
fund's investment strategy by causing the premature sale of securities that
would otherwise be held. If, in any 90-day period, you redeem (sell) more
than $250,000, or your sale amounts to more than 1% of fund net assets, the
fund has the right to pay the difference between the redemption amount and
the lesser of the two previously mentioned figures with securities from the
fund.
Excessive Trading
. T. Rowe Price may bar excessive traders from purchasing shares.
Frequent trades, involving either substantial fund assets or a substantial
portion of your account or accounts controlled by you, can disrupt management
of the fund and raise its expenses.
. Trades placed directly with T. Rowe Price If you trade directly with T. Rowe
Price, you can make one purchase and sale involving the same fund within any
120-day period. For example, if you are in fund A, you can move substantial
assets from fund A to fund B and, within the next 120 days, sell your shares
in fund B to return to fund A or move to fund C. If you exceed this limit,
you are in violation of our excessive trading policy.
Two types of transactions are exempt from this policy: 1) trades solely in
money market funds (exchanges between a money fund and a nonmoney fund are
not exempt); and 2) systematic purchases or redemptions (see Shareholder
Services).
. Trades placed through intermediaries If you purchase fund shares through an
intermediary including a broker, bank, investment adviser, or other third
party and hold them for less than 60 calendar days, you are in violation of
our excessive trading policy.
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T. ROWE PRICE
. If you violate our excessive trading policy, you may be barred indefinitely
and without further notice from further purchases of T. Rowe Price funds.
Keeping Your Account Open
Due to the relatively high cost to a fund of maintaining small accounts, we
ask you to maintain an account balance of at least $1,000. If your balance is
below $1,000 for three months or longer, we have the right to close your
account after giving you 60 days in which to increase your balance.
Small Account Fee
Because of the disproportionately high costs of servicing accounts with low
balances, a $10 fee, paid to T. Rowe Price Services, the fund's transfer
agent, will automatically be deducted from nonretirement accounts with
balances falling below a minimum level. The valuation of accounts and the
deduction are expected to take place during the last five business days of
September. The fee will be deducted from accounts with balances below $2,000,
except for UGMA/ UTMA accounts, for which the limit is $500. The fee will be
waived for any investor whose aggregate T. Rowe Price mutual fund investments
total $25,000 or more. Accounts employing automatic investing (e.g., payroll
deduction, automatic purchase from a bank account, etc.) are also exempt from
the charge. The fee will not apply to IRAs and other retirement plan
accounts. (A separate custodial fee may apply to IRAs and other retirement
plan accounts.)
Signature Guarantees
. A signature guarantee is designed to protect you and the T. Rowe Price funds
from fraud by verifying your signature.
You may need to have your signature guaranteed in certain situations, such
as:
. Written requests 1) to redeem over $100,000, or 2) to wire redemption
proceeds.
. Remitting redemption proceeds to any person, address, or bank account not on
record.
. Transferring redemption proceeds to a T. Rowe Price fund account with a
different registration (name or ownership) from yours.
. Establishing certain services after the account is opened.
You can obtain a signature guarantee from most banks, savings institutions,
broker-dealers, and other guarantors acceptable to T. Rowe Price. We cannot
accept guarantees from notaries public or organizations that do not provide
reimbursement in the case of fraud.
<PAGE>
MORE ABOUT THE FUND
3
ORGANIZATION AND MANAGEMENT
----------------------------------------------------------
How is the fund organized?
The fund was incorporated in Maryland in 1984 and is a "diversified, open-end
investment company," or mutual fund. Mutual funds pool money received from
shareholders and invest it to try to achieve specified objectives.
. Shareholders benefit from T. Rowe Price's 61 years of investment management
experience.
What is meant by "shares"?
As with all mutual funds, investors purchase shares when they put money in a
fund. These shares are part of a fund's authorized capital stock, but share
certificates are not issued.
Each share and fractional share entitles the shareholder to:
. Receive a proportional interest in a fund's income and capital gain
distributions.
. Cast one vote per share on certain fund matters, including the election of
fund directors, changes in fundamental policies, or approval of changes in
the fund's management contract.
Do T. Rowe Price funds have annual shareholder meetings?
The fund is not required to hold annual meetings and, to avoid unnecessary
costs to fund shareholders, does not intend to do so except when certain
matters, such as a change in its fundamental policies, must be decided. In
addition, shareholders representing at least 10% of all eligible votes may
call a special meeting, if they wish, for the purpose of voting on the
removal of any fund director or trustee. If a meeting is held and you cannot
attend, you can vote by proxy. Before the meeting, the fund will send you
proxy materials that explain the issues to be decided and include a voting
card for you to mail back.
Who runs the fund?
General Oversight
The fund is governed by a Board of Directors that meets regularly to review
the fund's investments, performance, expenses, and other business affairs.
The Board elects the fund's officers. The policy of the fund is that the
majority of Board members are independent of T. Rowe Price Associates, Inc.
(T. Rowe Price).
. All decisions regarding the purchase and sale of fund investments are made
by T. Rowe Price - specifically by the fund's portfolio managers.
<PAGE>
T. ROWE PRICE
Portfolio Management
The fund has an Investment Advisory Committee with the following members:
Mark J. Vaselkiv, Chairman, Andrew M. Brooks, Kim Z. Golden, Paul A. Karpers,
Nathaniel S. Levy, Kevin P. Loome, Michael J. McGonigle, William T. Reynolds,
Thomas E. Tewksbury, and Thea N. Williams. The committee chairman has
day-to-day responsibility for managing the fund and works with the committee
in developing and executing the fund's investment program. Mr. Vaselkiv was
appointed chairman of the fund's committee in 1996. He joined T. Rowe Price
in 1988 and has been managing investments in the high-yield bond market since
that time.
The Management Fee
This fee has two parts - an "individual fund fee," which reflects a fund's
particular investment management costs, and a "group fee." The group fee,
which is designed to reflect the benefits of the shared resources of the T.
Rowe Price investment management complex, is calculated daily based on the
combined net assets of all T. Rowe Price funds (except the Spectrum Funds,
and any institutional, index, or private label mutual funds). The group fee
schedule (shown below) is graduated, declining as the asset total rises, so
shareholders benefit from the overall growth in mutual fund assets.
<TABLE>
Group Fee Schedule
<CAPTION>
<S> <C> <C> <C>
0.334% First $50 billion/a/
----------------------------------------
0.305% Next $30 billion
----------------------------------------
0.300% Thereafter
--------------------------------------------------------------------------------------------------------------------
</TABLE>
/a/ Represents a blended group fee rate containing various break points.
The fund's portion of the group fee is determined by the ratio of its daily
net assets to the daily net assets of all the T. Rowe Price funds described
previously. Based on combined T. Rowe Price funds' assets of over $86 billion
at June 30, 1998, the group fee was 0.32%. The individual fund fee was 0.30%.
UNDERSTANDING PERFORMANCE INFORMATION
----------------------------------------------------------
This section should help you understand the terms used to describe fund
performance. You will come across them in shareholder reports you receive
from us; in our newsletter, The Price Report; in Insights articles; in T.
Rowe Price advertisements; and in the media.
<PAGE>
MORE ABOUT THE FUND
Total Return
This tells you how much an investment in a fund has changed in value over a
given time period. It reflects any net increase or decrease in the share
price and assumes that all dividends and capital gains (if any) paid during
the period were reinvested in additional shares. Therefore, total return
numbers include the effect of compounding.
Advertisements for a fund may include cumulative or average annual total
return figures, which may be compared with various indices, other performance
measures, or other mutual funds.
Cumulative Total Return
This is the actual return of an investment for a specified period. A
cumulative return does not indicate how much the value of the investment may
have fluctuated during the period. For example, a fund could have a 10-year
positive cumulative return despite experiencing three negative years during
that time.
Average Annual Total Return
This is always hypothetical and should not be confused with actual
year-by-year results. It smooths out all the variations in annual performance
to tell you what constant year-by-year return would have produced the
investment's actual cumulative return. This gives you an idea of an
investment's annual contribution to your portfolio, provided you held it for
the entire period.
Yield
The current or "dividend" yield on a fund or any investment tells you the
relationship between the investment's current level of annual income and its
price on a particular day. The dividend yield reflects the actual income paid
to shareholders for a given period, annualized, and divided by the fund's net
asset value. For example, a fund providing $5 of annual income per share and
a price of $50 has a current yield of 10%. Yields can be calculated for any
time period.
The advertised or Securities and Exchange Commission (SEC) yield is found by
determining the net income per share (as defined by the SEC) earned by a fund
during a 30-day base period and dividing this amount by the per share price
on the last day of the base period. The SEC yield may differ from the
dividend yield.
<PAGE>
T. ROWE PRICE
INVESTMENT POLICIES AND PRACTICES
----------------------------------------------------------
This section takes a detailed look at some of the types of securities the
fund may hold in its portfolio and the various kinds of investment practices
that may be used in day-to-day portfolio management. The fund's investment
program is subject to further restrictions and risks described in the
Statement of Additional Information.
Shareholder approval is required to substantively change the fund's objective
and certain investment restrictions noted in the following section as
"fundamental policies." The managers follow certain "operating policies,"
which can be changed without shareholder approval. However, significant
changes are discussed with shareholders in fund reports. The fund adheres to
applicable investment restrictions and policies at the time it makes an
investment. A later change in circumstances will not require the sale of an
investment if it was proper at the time it was made.
The fund's holdings of certain kinds of investments cannot exceed maximum
percentages of total assets, which are set forth in this prospectus. For
instance, this fund is not permitted to invest more than 10% of total assets
in hybrid instruments. While these restrictions provide a useful level of
detail about the fund's investment program, investors should not view them as
an accurate gauge of the potential risk of such investments. For example, in
a given period, a 5% investment in hybrid instruments could have
significantly more of an impact on the fund's share price than its weighting
in the portfolio. The net effect of a particular investment depends on its
volatility and the size of its overall return in relation to the performance
of all the fund's other investments.
Changes in the fund's holdings, the fund's performance, and the contribution
of various investments are discussed in the shareholder reports sent to you.
. Fund managers have considerable leeway in choosing investment strategies and
selecting securities they believe will help the fund achieve its objective.
Types of Portfolio Securities
In seeking to meet its investment objective, the fund may invest in any type
of security or instrument (including certain potentially high-risk
derivatives described in this section) whose investment characteristics are
consistent with the fund's investment program. The following pages describe
the principal types of portfolio securities and investment management
practices of the fund.
Fundamental policy The fund will not purchase a security if, as a result,
with respect to 75% of its total assets, more than 5% of its total assets
would be invested in securities of a single issuer, or if more than 10% of
the outstanding
<PAGE>
MORE ABOUT THE FUND
voting securities of the issuer would be held by the fund. These limitations
do not apply to the fund's purchase of securities issued or guaranteed by the
U.S. government, its agencies, or instrumentalities.
Bonds
A bond is an interest-bearing security - an IOU - issued by companies or
governmental units. The issuer has a contractual obligation to pay interest
at a stated rate on specific dates and to repay principal (the bond's face
value) on a specified date. An issuer may have the right to redeem or "call"
a bond before maturity, and the investor may have to reinvest the proceeds at
lower market rates.
A bond's annual interest income, set by its coupon rate, is usually fixed for
the life of the bond. Its yield (income as a percent of current price) will
fluctuate to reflect changes in interest rate levels. A bond's price usually
rises when interest rates fall, and vice versa, so its yield stays current.
High-yield bond prices are less directly responsive to interest rate changes
than investment-grade issues and may not always follow this pattern.
Bonds may be unsecured (backed by the issuer's general creditworthiness only)
or secured (also backed by specified collateral). Most high-yield "junk"
bonds are unsecured.
Certain bonds have interest rates that are adjusted periodically. These
interest rate adjustments tend to minimize fluctuations in the bonds'
principal values. The maturity of those securities may be shortened under
certain specified conditions.
Bonds may be designated as senior or subordinated obligations. Senior
obligations generally have the first claim on a corporation's earnings and
assets and, in the event of liquidation, are paid before subordinated debt.
Some specific types of securities the fund may hold from time to time
include:
. Portfolio managers diversify fund assets to lower risk.
Zero Coupon Bonds and Pay-in-Kind Bonds
A zero coupon bond does not make cash interest payments during the life of
the bond. Instead, it is sold at a deep discount to face value, and the
interest consists of the gradual appreciation in price as the bond approaches
maturity. "Zeros" can be an attractive financing method for issuers with
near-term cash-flow problems or seeking to preserve liquidity. Pay-in-kind
(PIK) bonds pay interest in cash or additional securities, at the issuer's
option, for a specified period. Like zeros, they may help a corporation
economize on cash. PIK prices reflect the market value of the underlying debt
plus any accrued interest. Zeros and PIKs can be higher- or lower-quality
debt, and both are more volatile than coupon bonds. There is no limit on the
fund's investments in these securities.
<PAGE>
T. ROWE PRICE
The fund is required to distribute to shareholders income imputed to any zero
or PIK investments. Such distributions could reduce the fund's reserve
position and require the fund to sell securities and incur a gain or loss at
a time it may not otherwise want to in order to provide the cash necessary
for these distributions.
Hybrid Instruments
These instruments (a type of potentially high-risk derivative) can combine
the characteristics of securities, futures, and options. For example, the
principal amount or interest rate of a hybrid could be tied (positively or
negatively) to the price of some commodity, currency, or securities index or
another interest rate (each a "benchmark"). Hybrids can be used as an
efficient means of pursuing a variety of investment goals, including currency
hedging, duration management, and increased total return. Hybrids may not
bear interest or pay dividends. The value of a hybrid or its interest rate
may be a multiple of a benchmark and, as a result, may be leveraged and move
(up or down) more steeply and rapidly than the benchmark. These benchmarks
may be sensitive to economic and political events, such as commodity
shortages and currency devaluations, which cannot be readily foreseen by the
purchaser of a hybrid. Under certain conditions, the redemption value of a
hybrid could be zero. Thus, an investment in a hybrid may entail significant
market risks that are not associated with a similar investment in a
traditional, U.S. dollar-denominated bond that has a fixed principal amount
and pays a fixed rate or floating rate of interest. The purchase of hybrids
also exposes the fund to the credit risk of the issuer of the hybrid. These
risks may cause significant fluctuations in the net asset value of the fund.
. Hybrids can have volatile prices and limited liquidity, and their use by the
fund may not be successful.
Operating policy The fund may invest up to 10% of its total assets in hybrid
instruments.
Bond Ratings and High-Yield Bonds
Larger bond issues are evaluated by rating agencies such as Moody's and
Standard & Poor's on the basis of the issuer's ability to meet all required
interest and principal payments. The highest ratings are assigned to issuers
perceived to be the best credit risks. T. Rowe Price research analysts also
evaluate all portfolio holdings, including those rated by an outside agency.
Other things being equal, lower-rated bonds have higher yields due to greater
risk. High-yield bonds, also called "junk" bonds, are those rated below BBB.
Table 4 shows the rating scale used by the major rating agencies. T. Rowe
Price considers publicly available ratings but emphasizes its own credit
analysis when selecting investments.
<PAGE>
MORE ABOUT THE FUND
<TABLE>
Table 4 Ratings of Corporate Debt Securities
<CAPTION>
<S> <S> <C> <S> <S> <S> <S> <S> <S>
Moody's Standard
Investors & Poor's Fitch
Service, Inc. Corporation IBCA, Inc. Definition
--------------------------------------------------------------------------------------
Long Term Aaa AAA AAA Highest quality
--------------------------------------------------------------------------------------
Aa AA AA High quality
--------------------------------------------------------------------------------------
A A A Upper medium grade
--------------------------------------------------------------------------------------
Baa BBB BBB Medium grade
--------------------------------------------------------------------------------------
Ba BB BB Speculative
--------------------------------------------------------------------------------------
B B B Highly speculative
--------------------------------------------------------------------------------------
Caa CCC, CC CCC, CC Vulnerable to default
--------------------------------------------------------------------------------------
Ca C C Default is imminent
--------------------------------------------------------------------------------------
C D DDD, DD, D Probably in default
Moody's S&P Fitch
Commercial P-1 Superior quality A-1+ Extremely strong quality F-1+ Exceptionally
Paper A-1 Strong quality F-1 strong quality
Very strong
quality
--------------------------------------------------------------------------------------
P-2 Strong quality A-2 Satisfactory quality F-2 Good credit
quality
--------------------------------------------------------------------------------------
P-3 Acceptable quality A-3 Adequate quality F-3 Fair credit
B Speculative quality F-5 quality
C Doubtful quality Weak credit
quality
-----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
Credit Quality
Table 5 shows the average credit quality allocation of the fund's assets for
the fiscal year ended May 31, 1998. (Equities and reserves are excluded.)
Percentages are computed on a dollar-weighted basis and are an average of 12
monthly calculations.
<TABLE>
Table 5 Explanation of Quality
Ratings
<CAPTION>
<S> <C> <C> <S>
Standard &
Poor's
Rating
AAA 0.4% 0.0%
-------------------------------------
AA 0.0 0.0
-------------------------------------
A 0.0 0.0
-------------------------------------
BBB 0.2 0.0
-------------------------------------
BB 8.9 0.2
-------------------------------------
B 70.9 2.5
-------------------------------------
CCC 3.8 0.3
-------------------------------------
CC 0.6 0.6
-------------------------------------
C 0.0 0.0
-------------------------------------
D 0.0 0.0
-------------------------------------
Not Rated 3.6 0.0
-------------------------------------
88.4% 3.6%
- -------------------------------------------------------------------------
</TABLE>
<PAGE>
T. ROWE PRICE
Other types of securities and investments the fund may buy, but is not
limited to, include:
Common and Preferred Stocks
Stocks represent shares of ownership in a company. Generally, preferred stock
has a specified dividend and ranks after bonds and before common stocks in
its claim on income for dividend payments and on assets should the company be
liquidated. After other claims are satisfied, common stockholders participate
in company profits on a pro-rata basis; profits may be paid out in dividends
or reinvested in the company to help it grow. Increases and decreases in
earnings are usually reflected in a company's stock price, so common stocks
generally have the greatest appreciation and depreciation potential of all
corporate securities. While most preferred stocks pay a dividend, the fund
may purchase preferred stock where the issuer has omitted, or is in danger of
omitting, payment of its dividend. Such investments would be made primarily
for their capital appreciation potential.
Convertible Securities and Warrants
The fund may invest in debt or preferred equity securities convertible into,
or exchangeable for, equity securities. Traditionally, convertible securities
have paid dividends or interest at rates higher than common stocks but lower
than nonconvertible securities. They generally participate in the
appreciation or depreciation of the underlying stock into which they are
convertible, but to a lesser degree. In recent years, convertibles have been
developed which combine higher or lower current income with options and other
features. Warrants are options to buy a stated number of shares of common
stock at a specified price anytime during the life of the warrants
(generally, two or more years).
Operating policy The fund may invest up to 20% of total assets in equity
securities, including no more than 10% of net assets in warrants.
Notes, Loan Participations, and Assignments
The fund may invest in a company through the purchase or execution of a
privately negotiated note representing the equivalent of a loan to the
company. Larger loans to corporations or governments, including governments
of less developed countries (LDCs), may be shared or syndicated among several
lenders, usually banks. The fund could participate in such syndicates, or
could buy part of a loan, becoming a direct lender. These loans may often be
obligations of companies in financial distress or in default. These
investments involve special types of risk, including those of being a lender,
reduced liquidity, and in the case of LDC investments, increased credit risk
and volatility.
Operating policy The fund may not invest more than 15% of total assets in
loan participations and assignments.
<PAGE>
MORE ABOUT THE FUND
Deferrable Subordinated Securities
Recently, securities have been issued which have long maturities and are
deeply subordinated in the issuer's capital structure. They generally have
30-year maturities and permit the issuer to defer distributions for up to
five years. These characteristics give the issuer more financial flexibility
than is typically the case with traditional bonds. As a result, the
securities may be viewed as possessing certain "equity-like" features by
rating agencies and bank regulators. However, the securities are treated as
debt securities by market participants, and the fund intends to treat them as
such as well. These securities may offer a mandatory put or remarketing
option that creates an effective maturity date significantly shorter than the
stated one. The fund will invest in these securities to the extent their
yield, credit, and maturity characteristics are consistent with the fund's
investment objective and program.
Private Placements
These securities are sold directly to a small number of investors, usually
institutions. Unlike public offerings, such securities are not registered
with the SEC. Although certain of these securities may be readily sold, for
example, under Rule 144A, others may be illiquid, and their sale may involve
substantial delays and additional costs.
Operating policy The fund will not invest more than 15% of its net assets in
illiquid securities.
Trade Claims
This is an IOU arising from a business transaction, such as a sale of goods,
not from a loan. Such claims are typically bought at a discount to their face
value, with the size of the discount reflecting the probability of repayment.
They may be illiquid and very volatile in price.
Operating policy The fund may not invest more than 5% of its total assets in
trade claims.
Foreign Securities
The fund may invest in foreign securities. These include
nondollar-denominated securities traded outside of the U.S. and
dollar-denominated securities of foreign issuers traded in the U.S. (such as
ADRs). Such investments increase a portfolio's diversification and may
enhance return, but they also involve some special risks, such as exposure to
potentially adverse local political and economic developments;
nationalization and exchange controls; potentially lower liquidity and higher
volatility; possible problems arising from accounting, disclosure,
settlement, and regulatory practices that differ from U.S. standards; and the
chance that fluctuations in foreign exchange rates will decrease the
investment's value (favorable changes can increase its value). These risks
are heightened for investments in developing countries, and there is no limit
on the amount of the fund's foreign investments that may be made in such
countries.
<PAGE>
T. ROWE PRICE
. Foreign securities increase the fund's diversification and may enhance
return, but they involve special risks, especially from developing countries.
Operating policy The fund may invest up to 20% of its total assets (excluding
reserves) in non-U.S. dollar securities, and may invest without limit in U.S.
dollar-denominated bonds issued abroad.
Mortgage- and Asset-Backed Securities
These may take a variety of forms, including conventional mortgage
securities, collateralized mortgage obligations (CMOs), interest only
securities (IOs), and principal only securities (POs).
Operating policy The fund will not invest more than 5% of its total assets in
these securities.
Types of Management Practices
Reserve Position
The fund will hold a certain portion of its assets in money market reserves.
The fund's reserve position can consist of shares of one or more T. Rowe
Price internal money market funds as well as short-term, high-quality U.S.
and foreign dollar-denominated money market securities, including repurchase
agreements. For temporary, defensive purposes, the fund may invest without
limitation in money market reserves. The effect of taking such a position is
that the fund may not achieve its investment objective. The reserve position
provides flexibility in meeting redemptions, expenses, and the timing of new
investments and can serve as a short-term defense during periods of unusual
market volatility.
Fundamental policy If the fund's reserve position should rise to 35% or more
of total fund assets, the fund would normally invest more than 25% of its
reserves in bank-related securities. While this eventuality is unlikely, it
is explained here in accordance with SEC regulations concerning potential
asset concentration. Such concentration would increase the fund's exposure to
developments within the banking industry, including potential credit losses,
but T. Rowe Price believes these risks can be minimized by credit research
and the fund's overall asset diversification.
Borrowing Money and Transferring Assets
The fund can borrow money from banks (and to the extent permitted by the SEC,
other Price funds) as a temporary measure for emergency purposes, to
facilitate redemption requests, or for other purposes consistent with the
fund's investment objective and program. Such borrowings may be
collateralized with fund assets, subject to restrictions.
Fundamental policy Borrowings may not exceed 33/1//\\/3/\\% of total fund
assets.
<PAGE>
MORE ABOUT THE FUND
Operating policy The fund may not transfer as collateral any portfolio
securities except as necessary in connection with permissible borrowings or
investments, and then such transfers may not exceed 33/1//\\/3/\\% of the
fund's total assets. The fund may not purchase additional securities when
borrowings exceed 5% of total assets.
Futures and Options
Futures (a type of potentially high-risk derivative) are often used to manage
or hedge risk because they enable the investor to buy or sell an asset in the
future at an agreed-upon price. Options (another type of potentially
high-risk derivative) give the investor the right (where the investor
purchases the option), or the obligation (where the investor writes (sells)
the option), to buy or sell an asset at a predetermined price in the future.
The fund may buy and sell futures and options contracts for any number of
reasons, including: to manage its exposure to changes in interest rates, bond
prices, and foreign currencies; as an efficient means of adjusting its
overall exposure to certain markets; in an effort to enhance income; to
protect the value of portfolio securities; and to adjust portfolio duration.
The fund may purchase, sell, or write call and put options on securities,
financial indices, and foreign currencies.
Futures contracts and options may not always be successful hedges; their
prices can be highly volatile. Using them could lower the fund's total
return, and the potential loss from the use of futures can exceed the fund's
initial investment in such contracts.
Operating policies Futures: Initial margin deposits and premiums on options
used for non-hedging purposes will not equal more than 5% of the fund's net
asset value. Options on securities: The total market value of securities
against which the fund writes call or put options may not exceed 25% of its
total assets. The fund will not commit more than 5% of its total assets to
premiums when purchasing call or put options.
Managing Foreign Exchange Risk
Investors in foreign securities may "hedge" their exposure to potentially
unfavorable currency changes by purchasing a contract to exchange one
currency for another on some future date at a specified exchange rate. In
certain circumstances, a "proxy currency" may be substituted for the currency
in which the investment is denominated, a strategy known as "proxy hedging."
The fund may also use these contracts to create a synthetic bond - issued by
a U.S. company, for example, but with the dollar component transformed into a
foreign currency. If the fund were to engage in foreign currency
transactions, they would be used primarily to protect the fund's foreign
securities from adverse currency movements relative to the dollar. Such
transactions involve the risk that anticipated currency movements will not
occur, and the fund's total return could be reduced.
<PAGE>
T. ROWE PRICE
Operating policy The fund will not commit more than 20% of its total assets
to forward currency contracts.
Short Sales
The fund may sell a security short as a hedge against portfolio holdings. In
short sales, investors sell borrowed securities in hopes of buying them back
later at a lower price. However, if the price rises instead of falls, the
investor will lose money when repurchasing the security.
Operating policy The fund's short sales are limited to situations where the
fund owns a debt security of a company and sells short a different type of
security issued by the same company, such as common or preferred stock or a
senior or junior debt security. The total market value of all securities sold
short may not exceed 2% of the fund's net assets.
Lending of Portfolio Securities
Like other mutual funds, the fund may lend securities to broker-dealers,
other institutions, or other persons to earn additional income. The principal
risk is the potential insolvency of the broker-dealer or other borrower. In
this event, the fund could experience delays in recovering its securities and
possibly capital losses.
Fundamental policy The value of loaned securities may not exceed
33/1//\\/3/\\% of total fund assets.
Portfolio Turnover
The fund will not generally trade in securities for short-term profits, but,
when circumstances warrant, securities may be purchased and sold without
regard to the length of time held. A high turnover rate may increase
transaction costs and result in additional taxable gains. The fund's
portfolio turnover rates for the fiscal years ending May 31, 1998, 1997, and
1996, were 129.6%, 111.3%, and 100.1%, respectively.
Year 2000 Processing Issue
Many computer programs use two digits rather than four to identify the year.
These programs, if not adapted, will not correctly handle the change from
"99" to "00" on January 1, 2000, and will not be able to perform necessary
functions. The Year 2000 issue affects virtually all companies and
organizations.
T. Rowe Price has implemented steps intended to assure that its major
computer systems and processes are capable of Year 2000 processing. We are
working with third parties to assess the adequacy of their compliance efforts
and are developing contingency plans intended to assure that third-party
noncompliance will not materially affect T. Rowe Price's operations.
<PAGE>
MORE ABOUT THE FUND
Companies, organizations, governmental entities and markets in which T. Rowe
Price funds invest will be affected by the Year 2000 issue, but at this time
the funds cannot predict the degree of impact. To the extent the effect is
negative, the fund's returns could be adversely affected.
FINANCIAL HIGHLIGHTS
----------------------------------------------------------
Table 6, which provides information about the fund's financial history, is
based on a single share outstanding throughout each fiscal year. The table is
part of the fund's financial statements, which are included in its annual
report and are incorporated by reference into the Statement of Additional
Information (available upon request). The total returns in the table
represent the rate that an investor would have earned or lost on an
investment in the fund (assuming reinvestment of all dividends and
distributions). The financial statements in the annual report were audited by
the fund's independent accountants, PricewaterhouseCoopers LLP.
<PAGE>
T. ROWE PRICE
<TABLE>
Table 6 Financial Highlights
<CAPTION>
Year ended May 31
Three months
Year ended ended
2/28/94 5/31/94/ a/ 1995 1996 1997 1998
-------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <S>
Net asset value,
beginning of period $ 8.58 $ 9.15 $ 8.37 $ 8.16 $ 8.13 $ 8.43
Income From Investment Operations
Net investment income 0.81 0.18 0.75 0.73 0.75 0.77
--------------------------------------------------------------
Net gains or losses
on securities (both
realized and 0.57 (0.78) (0.20) (0.02) 0.30 0.41
unrealized)
--------------------------------------------------------------
Total from investment
operations 1.38 (0.60) 0.55 0.71 1.05 1.18
Less Distributions
Dividends (from net (0.81) (0.18) (0.76) (0.74) (0.75) (0.76)
investment income)
--------------------------------------------------------------
Distributions (from -- -- -- -- -- --
capital gains)
--------------------------------------------------------------
Returns of capital -- -- -- -- -- --
--------------------------------------------------------------
Total distributions (0.81) (0.18) (0.76) (0.74) (0.75) (0.76)
--------------------------------------------------------------
Net asset value, $ 9.15 $ 8.37 $ 8.16 $ 8.13 $ 8.43 $ 8.85
end of period
--------------------------------------------------------------
Total return 16.59% (6.52)% 7.09% 9.06% 13.49% 14.51%
Ratios/Supplemental Data
Net assets, end of $1,624 $1,241 $1,208 $1,229 $1,401 $1,725
period (in millions)
--------------------------------------------------------------
Ratio of expenses to 0.85% 0.85% /b/ 0.88% 0.85% 0.84% 0.81%
average net assets
--------------------------------------------------------------
Ratio of net
investment income to
average 8.99% 8.37% /b/ 9.27% 8.89% 9.15% 8.78%
net assets
--------------------------------------------------------------
Portfolio turnover 107.0% 62.5% /b/ 74.2% 100.1% 111.3% 129.6%
rate
--------------------------------------------------------------------------------------
</TABLE>
/a/ The fund's fiscal year-end was changed to May 31.
/b/ Annualized.
<PAGE>
INVESTING WITH T. ROWE PRICE
4
ACCOUNT REQUIREMENTS AND TRANSACTION INFORMATION
----------------------------------------------------------
Tax Identification Number
We must have your correct Social Security or corporate tax identification number
on a signed New Account Form or W-9 Form. Otherwise, federal law requires the
funds to withhold a percentage (currently 31%) of your dividends, capital gain
distributions, and redemptions, and may subject you to an IRS fine. If this
information is not received within 60 days after your account is established,
your account may be redeemed, priced at the NAV on the date of redemption.
Always verify your transactions by carefully reviewing the confirmation we send
you. Please report any discrepancies to Shareholder Services promptly.
Employer-Sponsored Retirement Plans and Institutional Accounts T. Rowe Price
Trust Company 1-800-492-7670
Transaction procedures in the following sections may not apply to
employer-sponsored retirement plans and institutional accounts. For procedures
regarding employer-sponsored retirement plans, please call T. Rowe Price Trust
Company or consult your plan administrator. For institutional account
procedures, please call your designated account manager or service
representative.
OPENING A NEW ACCOUNT
----------------------------------------------------------
$2,500 minimum initial investment; $1,000 for retirement plans or gifts or
transfers to minors (UGMA/UTMA) accounts
Account Registration
If you own other T. Rowe Price funds, be sure to register any new account just
like your existing accounts so you can exchange among them easily. (The name and
account type would have to be identical.)
By Mail
Please make your check payable to T. Rowe Price Funds (otherwise it will be
returned) and send your check, together with the New Account Form, to the
appropriate address in the next paragraph. We do not accept third-party checks
to open new accounts, except for IRA Rollover checks that are properly endorsed.
<PAGE>
T. ROWE PRICE
Regular Mail
T. Rowe Price Account Services P.O. Box 17300 Baltimore, MD 21298-9353
Mailgram, Express, Registered, or Certified Mail
T. Rowe Price Account Services 10090 Red Run Blvd. Owings Mills, MD 21117
By Wire
Call Investor Services for an account number and give the following wire
information to your bank:
PNC Bank, N.A. (Pittsburgh) ABA# 043000096 T. Rowe Price [fund name] Account#
1004397951 name of owner(s) and account number
Complete a New Account Form and mail it to one of the appropriate addresses
listed previously.
Note: No services will be established and IRS penalty withholding may occur
until a signed New Account Form is received. Also, retirement plans cannot be
opened by wire.
By Exchange
Call Shareholder Services or use Tele*Access or your personal computer (see
Automated Services under Shareholder Services). The new account will have the
same registration as the account from which you are exchanging. Services for the
new account may be carried over by telephone request if preauthorized on the
existing account. For limitations on exchanging, see explanation of Excessive
Trading under Transaction Procedures and Special Requirements.
In Person
Drop off your New Account Form at any location listed on the cover and obtain a
receipt.
<PAGE>
INVESTING WITH T. ROWE PRICE
PURCHASING ADDITIONAL SHARES
----------------------------------------------------------
$100 minimum purchase; $50 minimum for retirement plans, Automatic Asset
Builder, and gifts or transfers to minors (UGMA/UTMA) accounts
By ACH Transfer
Use Tele*Access or your personal computer or call Investor Services if you have
established electronic transfers using the ACH network.
By Wire
Call Shareholder Services or use the wire address in Opening a New Account.
By Mail
1. Make your check payable to T. Rowe Price Funds (otherwise it may be
returned).
2. Mail the check to us at the following address with either a fund reinvestment
slip or a note indicating the fund you want to buy and your fund account
number.
3. Remember to provide your account number and the fund name on the memo line of
your check.
Regular Mail
T. Rowe Price Funds Account Services P.O. Box 89000 Baltimore, MD 21289-1500
/(For mailgrams, express, registered, or certified mail, see previous /
/section.)/
By Automatic Asset Builder
Fill out the Automatic Asset Builder section on the New Account or Shareholder
Services Form.
<PAGE>
T. ROWE PRICE
EXCHANGING AND REDEEMING SHARES
----------------------------------------------------------
Exchange Service
You can move money from one account to an existing identically registered
account or open a new identically registered account. Remember, exchanges are
purchases and sales for tax purposes. (Exchanges into a state tax-free fund are
limited to investors living in states where the fund is registered.) Some of the
T. Rowe Price funds may impose a redemption fee of 0.5% to 2% on shares held for
less than six months or one year, as specified in the prospectus. The fee is
paid to the fund.
By Phone
Call Shareholder Services
If you find our phones busy during unusually volatile markets, please consider
placing your order by your personal computer, Tele*Access (if you have
previously authorized telephone services), mailgram, or express mail. For
exchange policies, please see Transaction Procedures and Special Requirements -
Excessive Trading.
Redemption proceeds can be mailed to your account address, sent by ACH transfer,
or wired to your bank (provided your bank information is already on file). For
charges, see Electronic Transfers - By Wire under Shareholder Services.
By Mail
For each account involved, provide the account name, number, fund name, and
exchange or redemption amount. For exchanges, be sure to indicate any fund you
are exchanging out of and the fund or funds you are exchanging into. Please mail
to the appropriate address below. T. Rowe Price requires the signatures of all
owners exactly as registered, and possibly a signature guarantee (see
Transaction Procedures and Special Requirements - Signature Guarantees).
Regular Mail
For nonretirement and IRA accounts
T. Rowe Price Account Services P.O. Box 89000 Baltimore, MD 21289-0220
<PAGE>
INVESTING WITH T. ROWE PRICE
For employer-sponsored retirement accounts
T. Rowe Price Trust Company P.O. Box 89000 Baltimore, MD 21289-0300
/(For mailgrams, express, registered, or certified mail, see Opening a / /New
Account.)/
Redemptions from employer-sponsored retirement accounts must be in writing;
please call T. Rowe Price Trust Company or your plan administrator for
instructions. IRA distributions may be requested in writing or by telephone;
please call Shareholder Services to obtain an IRA Distribution Form or an IRA
Shareholder Services Form to authorize the telephone redemption service.
RIGHTS RESERVED BY THE FUND
----------------------------------------------------------
The fund and its agents reserve the following rights: (1) to waive or lower
investment minimums; (2) to accept initial purchases by telephone or mailgram;
(3) to refuse any purchase or exchange order; (4) to cancel or rescind any
purchase or exchange order (including, but not limited to, orders deemed to
result in excessive trading, market timing, fraud, or 5% ownership) upon notice
to the shareholder within five business days of the trade or if the written
confirmation has not been received by the shareholder, whichever is sooner; (5)
to freeze any account and suspend account services when notice has been received
of a dispute between the registered or beneficial account owners or there is
reason to believe a fraudulent transaction may occur; (6) to otherwise modify
the conditions of purchase and any services at any time; or (7) to act on
instructions believed to be genuine. These actions will be taken when, in the
sole discretion of management, they are deemed to be in the best interest of the
fund.
In an effort to protect the fund from the possible adverse effects of a
substantial redemption in a large account, as a matter of general policy no
shareholder or group of related shareholders controlled by the same person or
group of persons will knowingly be
<PAGE>
T. ROWE PRICE
permitted to purchase in excess of 5% of the outstanding shares of the fund,
except upon approval of the fund's management.
SHAREHOLDER SERVICES
----------------------------------------------------------
Shareholder Services 1-800-225-5132 Investor Services 1-800-638-5660
Many services are available to you as a T. Rowe Price shareholder; some you
receive automatically, and others you must authorize on the New Account Form. By
signing up for services on the New Account Form rather than later on, you avoid
having to complete a separate form and obtain a signature guarantee. This
section reviews some of the principal services currently offered. Our Services
Guide, which we mail to all new shareholders, contains detailed descriptions of
these and other services.
Note: Corporate and other institutional accounts require an original or
certified resolution to establish services and to redeem by mail. For more
information, call Investor Services.
Retirement Plans
We offer a wide range of plans for individuals, institutions, and large and
small businesses: Traditional IRAs, Roth IRAs, SIMPLE IRAs, SEP-IRAs, Keoghs
(profit sharing, money purchase pension), 401(k), and 403(b)(7). For information
on IRAs, call Investor Services. For information on all other retirement plans,
including our no-load variable annuity, please call our Trust Company at
1-800-492-7670.
Automated Services Tele*Access 1-800-638-2587 24 hours, 7 days
Tele*Access
24-hour service via toll-free number enables you to (1) access information on
fund yields, prices, distributions, account balances, and your latest
transaction; (2) request checks, prospectuses, services forms, duplicate
statements, and tax forms; and (3) initiate purchase, redemption, and exchange
transactions in your accounts (see Electronic Transfers on the next page).
<PAGE>
INVESTING WITH T. ROWE PRICE
Web Address www.troweprice.com
After obtaining proper authorization, account transactions may also be conducted
through our Web site on the Internet. If you subscribe to America Online, you
can access our web site via keyword "T. Rowe Price" and conduct transactions in
your account.
Plan Account Line 1-800-401-3279
Plan Account Line
This 24-hour service is similar to Tele*Access but is designed specifically to
meet the needs of retirement plan investors.
Telephone and Walk-In Services
Buy, sell, or exchange shares by calling one of our service representatives or
by visiting one of our investor center locations whose addresses are listed on
the cover.
Electronic Transfers
By ACH
With no charges to pay, you can initiate a purchase or redemption for as little
as $100 or as much as $100,000 between your bank account and fund account using
the ACH network. Enter instructions via Tele*Access or your personal computer,
or call Shareholder Services.
By Wire
Electronic transfers can be conducted via bank wire. There is currently a $5 fee
for wire redemptions under $5,000, and your bank may charge for incoming or
outgoing wire transfers regardless of size.
Checkwriting
(Not available for equity funds, or the High Yield or Emerging Markets Bond
Funds) You may write an unlimited number of free checks on any money market
fund, and most bond funds, with a minimum of $500 per check. Keep in mind,
however, that a check results in a redemption; a check written on a bond fund
will create a taxable event which you and we must report to the IRS.
Automatic Investing
($50 minimum) You can invest automatically in several different ways, including:
Automatic Asset Builder
You instruct us to move $50 or more from your bank account, or you can instruct
your employer to send all or a portion of your paycheck to the fund or funds you
designate.
<PAGE>
T. ROWE PRICE
Automatic Exchange
You can set up systematic investments from one fund account into another, such
as from a money fund into a stock fund.
DISCOUNT BROKERAGE
----------------------------------------------------------
To open an account 1-800-638-5660 For existing discount brokerage investors
1-800-225-7720
This service gives you the opportunity to consolidate all of your investments
with one company. Investments available through our discount brokerage include
stocks, options, bonds, non-T. Rowe Price mutual funds, and others at
commission savings over full-service brokers. We also provide a wide range of
services, including:
Automated telephone and computer services
You can enter stock and option trades, access quotes, and review account
information around the clock by phone with Tele-Trader or via the Internet with
Internet-Trader. Any trades executed through Tele-Trader save you an additional
10% on commissions. You will save 20% on commissions for stock trades when you
trade through Internet-Trader. All trades are subject to a $35 minimum
commission except stock trades placed through Internet-Trader, which are subject
to a $29.95 minimum commission.
Investor information
A variety of informative reports, such as our Brokerage Insights series, S&P
Market Month newsletter, and select stock reports can help you better evaluate
economic trends and investment opportunities.
Dividend Reinvestment Service
Virtually all stocks held in customer accounts are eligible for this free
service.
/Discount Brokerage is a division of T. Rowe Price Investment / /Services, Inc.,
Member NASD/SIPC./
<PAGE>
INVESTING WITH T. ROWE PRICE
INVESTMENT INFORMATION
----------------------------------------------------------
To help shareholders monitor their current investments and make decisions that
accurately reflect their financial goals, T. Rowe Price offers a wide variety of
information in addition to account statements. Most of this information is also
available on our web site at www.troweprice.com.
Shareholder Reports
Fund managers' reviews of their strategies and results. If several members of a
household own the same fund, only one fund report is mailed to that address. To
receive additional copies, please call Shareholder Services or write to us at
100 East Pratt Street, Baltimore, Maryland 21202.
The T. Rowe Price Report
A quarterly investment newsletter discussing markets and financial strategies.
Performance Update
A quarterly review of all T. Rowe Price fund results.
Insights
Educational reports on investment strategies and financial markets.
Investment Guides
Asset Mix Worksheet, College Planning Kit, Diversifying Overseas: A T. Rowe
Price Guide to International Investing, Managing Your Retirement Distribution,
Personal Strategy Planner, Retirees Financial Guide, Retirement Planning Kit,
and Tax Considerations for Investors.
<PAGE>
To help you achieve your financial goals, T. Rowe Price offers a wide range of
stock, bond, and money market investments, as well as convenient services and
informative reports.
For Mutual Fund or Discount Brokerage Information
Investor Services
1-800-638-5660
For Existing Accounts
Shareholder Services
1-800-225-5132
For Yields, Prices, Account Information, or to Conduct Transactions
Tele*Access/(R)/
24 hours, 7 days
1-800-638-2587
Internet Address
www.troweprice.com
Plan Account Line
For retirement plan
investors
1-800-401-3279
Investor Centers
101 East Lombard St.
Baltimore, MD 21202
T. Rowe Price
Financial Center
10090 Red Run Blvd.
Owings Mills, MD 21117
Farragut Square
900 17th Street, N.W.
Washington, D.C. 20006
ARCO Tower
31st Floor
515 South Flower St.
Los Angeles, CA 90071
4200 West Cypress St.
10th Floor
Tampa, FL 33607
Headquarters
100 East Pratt St.
Baltimore, MD 21202
A Statement of Additional Information about the fund has been filed with the
Securities and Exchange Commission and incorporated by reference into this
prospectus. Further information about the fund's investments, including, a
review of market conditions and the manager's recent strategies and their impact
on performance, is available in the annual and semiannual shareholder reports.
To obtain free copies of any of these documents or for shareholder inquiries,
call 1-800-638-5660.
Fund reports and Statements of Additional Information are also available from
the Securities and Exchange Commission by calling 1-800-SEC-0330 or by writing
the SEC's Public Reference Section, Washington, D.C. 20549-6009 (you will be
charged a duplicating fee); by visiting the SEC's public reference room; or by
consulting the SEC's web site at www.sec.gov.
(LOGO)
This prospectus contains information you should know before investing. Please
keep it for future reference.
1940 Act File No. 811-4119
F57-040 10/1/98
<PAGE>
STATEMENT OF ADDITIONAL INFORMATION
The date of this Statement of Additional Information is October 1, 1998.
T. ROWE PRICE CORPORATE INCOME FUND, INC.
T. ROWE PRICE GNMA FUND
T. ROWE PRICE HIGH YIELD FUND, INC.
T. ROWE PRICE NEW INCOME FUND, INC.
T. ROWE PRICE PERSONAL STRATEGY FUNDS, INC.
T. Rowe Price Personal Strategy Balanced Fund
T. Rowe Price Personal Strategy Growth Fund
T. Rowe Price Personal Strategy Income Fund
T. ROWE PRICE PRIME RESERVE FUND, INC.
RESERVE INVESTMENT FUNDS, INC.
Government Reserve Investment Fund
Reserve Investment Fund
T. ROWE PRICE SHORT-TERM BOND FUND, INC.
T. ROWE PRICE SHORT-TERM U.S. GOVERNMENT FUND, INC.
and
T. ROWE PRICE U.S. TREASURY FUNDS, INC.
U.S. Treasury Intermediate Fund
U.S. Treasury Long-Term Fund
U.S. Treasury Money Fund
___________________________________________________________________
Mailing Address:
T. Rowe Price Investment Services, Inc.
100 East Pratt Street
Baltimore, Maryland 21202
1-800-638-5660
This Statement of Additional Information is not a prospectus but should be
read in conjunction with the appropriate Fund prospectus dated October 1,
1998, which may be obtained from T. Rowe Price Investment Services, Inc.
If you would like a prospectus for a Fund of which you are not a shareholder,
please call 1-800-638-5660. A prospectus with more complete information,
including management fees and expenses, will be sent to you. Please read it
carefully.
Government Reserve and Reserve Investment Funds are not available for direct
purchase by members of the public.
C22-043 10/1/98
<PAGE>
<TABLE>
<CAPTION>
TABLE OF CONTENTS
-----------------
Page Page
---- ----
<S> <C> <S> <C> <C>
Capital Stock 66 Management of the Funds 39
- ------------------------------ --------------------------------------------
Code of Ethics 54 Net Asset Value Per Share 61
- ------------------------------ --------------------------------------------
Custodian 53 Portfolio Management Practices 21
- ------------------------------ --------------------------------------------
Distributor for the 53 Portfolio Transactions 54
Funds
- ------------------------------ --------------------------------------------
Dividends and 62 Pricing of Securities 59
Distributions
- ------------------------------ --------------------------------------------
Federal Registration 67 Principal Holders of Securities 48
of Shares
- ------------------------------ --------------------------------------------
Independent 68 Ratings of Commercial Paper 69
Accountants
- ------------------------------ --------------------------------------------
Investment Management 49 Ratings of Corporate Debt Securities 70
Services
- ------------------------------ --------------------------------------------
Investment Objectives 2 Risk Factors 2
and Policies
- ------------------------------ --------------------------------------------
Investment Performance 64 Shareholder Services 54
- ------------------------------ --------------------------------------------
Investment Program 7 Tax Status 62
- ------------------------------ --------------------------------------------
Investment 36 Yield Information 63
Restrictions
- ------------------------------ --------------------------------------------
Legal Counsel 68
- ------------------------------ --------------------------------------------
</TABLE>
INVESTMENT OBJECTIVES AND POLICIES
-------------------------------------------------------------------------------
The following information supplements the discussion of each Fund's
investment objectives and policies discussed in the Funds' prospectus.
The Funds will not make a material change in their investment objectives
without obtaining shareholder approval. Unless otherwise specified, the
investment programs and restrictions of the Funds are not fundamental
policies. Each Fund's operating policies are subject to change by each Board
of Directors/ Trustees without shareholder approval. However, shareholders
will be notified of a material change in an operating policy. Each Fund's
fundamental policies may not be changed without the approval of at least a
majority of the outstanding shares of the Fund or, if it is less, 67% of the
shares represented at a meeting of shareholders at which the holders of 50%
or more of the shares are represented.
Throughout this Statement of Additional Information, "the Fund" is intended
to refer to each Fund listed on the cover page, unless otherwise indicated.
RISK FACTORS
-------------------------------------------------------------------------------
Reference is also made to the sections entitled "Types of Securities" and
"Portfolio Management Practices" for discussions of the risks associated with
the investments and practices described therein as they apply to the Fund.
All Funds
Debt Obligations
Yields on short-, intermediate-, and long-term securities are dependent on a
variety of factors, including the general conditions of the money and bond
markets, the size of a particular offering, the maturity of the obligation,
and the credit quality and rating of the issue. Debt securities with longer
maturities tend to have
<PAGE>
higher yields and are generally subject to potentially greater capital
appreciation and depreciation than obligations with shorter maturities and
lower yields. The market prices of debt securities usually vary, depending
upon available yields. An increase in interest rates will generally reduce
the value of portfolio debt securities, and a decline in interest rates will
generally increase the value of portfolio debt securities. The ability of the
Fund to achieve its investment objective is also dependent on the continuing
ability of the issuers of the debt securities in which the Fund invests to
meet their obligations for the payment of interest and principal when due.
Although the Fund seeks to reduce risk by portfolio diversification, credit
analysis, and attention to trends in the economy, industries and financial
markets, such efforts will not eliminate all risk. There can, of course, be
no assurance that the Fund will achieve its investment objective.
After purchase by the Fund, a debt security may cease to be rated or its
rating may be reduced below the minimum required for purchase by the Fund.
For the Government Reserve Investment; Prime Reserve; Reserve Investment; and
U.S. Treasury Money Funds, the procedures set forth in Rule 2a-7, under the
Investment Company Act of 1940 (the "1940 Act"), may require the prompt sale
of any such security. For the other Funds, neither event will require a sale
of such security by the Fund. However, T. Rowe Price will consider such event
in its determination of whether the Fund should continue to hold the
security. To the extent that the ratings given by Moody's Investors Service,
Inc. ("Moody's") or Standard & Poor's Corporation ("S&P") may change as a
result of changes in such organizations or their rating systems, the Fund
will attempt to use comparable ratings as standards for investments in
accordance with the investment policies contained in the prospectus. When
purchasing unrated securities, T. Rowe Price, under the supervision of the
Fund's Board of Directors/Trustees, determines whether the unrated security
is of a quality comparable to that which the Fund is allowed to purchase.
Government Reserve Investment, Prime Reserve, Reserve Investment, and U.S.
Treasury Money Funds
There can be no assurance that the Fund will achieve its investment objective
or be able to maintain its net asset value per share at $1.00. The price of
the Fund is not guaranteed or insured by the U.S. government and its yield is
not fixed. An increase in interest rates could reduce the value of the Fund's
portfolio investments, and a decline in interest rates could increase the
value.
All Funds except Government Reserve Investment, Prime Reserve, Reserve
Investment, and U.S. Treasury Money Funds
Because of its investment policy, the Fund may or may not be suitable or
appropriate for all investors. The Fund is not a money market fund and is not
an appropriate investment for those whose primary objective is principal
stability. The value of the portfolio securities of the Fund will fluctuate
based upon market conditions. Although the Fund seeks to reduce risk by
investing in a diversified portfolio, such diversification does not eliminate
all risk. There can, of course, be no assurance that the Fund will achieve
its investment objective.
Mortgage-backed securities differ from conventional bonds in that principal
is paid back over the life of the security rather than at maturity. As a
result, the holder of a mortgage-backed security (i.e., the Fund) receives
monthly scheduled payments of principal and interest, and may receive
unscheduled principal payments representing prepayments on the underlying
mortgages. The incidence of unscheduled principal prepayments is also likely
to increase in mortgage pools owned by the Fund when prevailing mortgage loan
rates fall below the mortgage rates of the securities underlying the
individual pool. The effect of such prepayments in a falling rate environment
is to (1) cause the Fund to reinvest principal payments at the then lower
prevailing interest rate, and (2) reduce the potential for capital
appreciation beyond the face amount of the security. Conversely, the Fund may
realize a gain on prepayments of mortgage pools trading at a discount. Such
prepayments will provide an early return of principal which may then be
reinvested at the then higher prevailing interest rate.
The market value of adjustable rate mortgage securities ("ARMs"), like other
U.S. government securities, will generally vary inversely with changes in
market interest rates, declining when interest rates rise and rising when
interest rates decline. Because of their periodic adjustment feature, ARMs
should be more sensitive to short-term interest rates than long-term rates.
They should also display less volatility than long-term
<PAGE>
mortgage-backed securities. Thus, while having less risk of a decline during
periods of rapidly rising rates, ARMs may also have less potential for
capital appreciation than other investments of comparable maturities.
Interest rate caps on mortgages underlying ARM securities may prevent income
on the ARM from increasing to prevailing interest rate levels and cause the
securities to decline in value. In addition, to the extent ARMs are purchased
at a premium, mortgage foreclosures and unscheduled principal prepayments may
result in some loss of the holders' principal investment to the extent of the
premium paid. On the other hand, if ARMs are purchased at a discount, both a
scheduled payment of principal and an unscheduled prepayment of principal
will increase current and total returns and will accelerate the recognition
of income which when distributed to shareholders will be taxable as ordinary
income.
Corporate Income, High Yield, New Income, Personal Strategy, and Short-Term
Bond Funds
Risk Factors of Foreign Investing There are special risks in foreign
investing. Certain of these risks are inherent in any mutual fund while
others relate more to the countries in which the Fund will invest. Many of
the risks are more pronounced for investments in developing or emerging
market countries, such as many of the countries of Asia, Latin America,
Eastern Europe, Russia, Africa and the Middle East. Although there is no
universally accepted definition, a developing country is generally considered
to be a country which is in the initial stages of its industrialization cycle
with a per capita gross national product of less than $8,000.
. Political and Economic Factors Individual foreign economies of certain
countries differ favorably or unfavorably from the United States' economy in
such respects as growth of gross national product, rate of inflation, capital
reinvestment, resource self-sufficiency and balance of payments position. The
internal politics of certain foreign countries are not as stable as in the
United States. For example, in 1991, the existing government in Thailand was
overthrown in a military coup. In 1992, there were two military coup attempts
in Venezuela and in 1992 the President of Brazil was impeached. In 1994-1995,
the Mexican peso plunged in value setting off a severe crisis in the Mexican
economy. Asia is still coming to terms with its own crisis and recessionary
conditions sparked off by widespread currency weakness in late 1997. In
addition, significant external political risks currently affect some foreign
countries. Both Taiwan and China still claim sovereignty of one another and
there is a demilitarized border and hostile relations between North and South
Korea.
Governments in certain foreign countries continue to participate to a
significant degree, through ownership interest or regulation, in their
respective economies. Action by these governments could have a significant
effect on market prices of securities and payment of dividends. The economies
of many foreign countries are heavily dependent upon international trade and
are accordingly affected by protective trade barriers and economic conditions
of their trading partners. The enactment by these trading partners of
protectionist trade legislation could have a significant adverse effect upon
the securities markets of such countries.
. Currency Fluctuations The Fund invests in securities denominated in various
currencies. Accordingly, a change in the value of any such currency against
the U.S. dollar will result in a corresponding change in the U. S. dollar
value of the Fund's assets denominated in that currency. Such changes will
also affect the Fund's income. Generally, when a given currency appreciates
against the dollar (the dollar weakens) the value of the Fund's securities
denominated in that currency will rise. When a given currency depreciates
against the dollar (the dollar strengthens) the value of the Fund's
securities denominated in that currency would be expected to decline.
. Investment and Repatriation of Restrictions Foreign investment in the
securities markets of certain foreign countries is restricted or controlled
in varying degrees. These restrictions limit at times and preclude investment
in certain of such countries and increase the cost and expenses of the Fund.
Investments by foreign investors are subject to a variety of restrictions in
many developing countries. These restrictions may take the form of prior
governmental approval, limits on the amount or type of securities held by
foreigners, and limits on the types of companies in which foreigners may
invest. Additional or different restrictions may be imposed at any time by
these or other countries in which the Funds invest. In addition, the
repatriation of both investment income and capital from several foreign
countries is restricted and controlled under certain regulations, including
in some cases the need for certain government consents. For example, capital
invested in Chile normally cannot be repatriated for one year.
<PAGE>
. Market Characteristics It is contemplated that most foreign securities will
be purchased in over-the-counter markets or on stock exchanges located in the
countries in which the respective principal offices of the issuers of the
various securities are located, if that is the best available market.
Investments in certain markets may be made through ADRs traded in the United
States. Foreign stock markets are generally not as developed or efficient as,
and more volatile than, those in the United States. While growing in volume,
they usually have substantially less volume than U.S. markets and the Fund's
portfolio securities may be less liquid and subject to more rapid and erratic
price movements than securities of comparable U.S. companies. Equity
securities may trade at price/earnings multiples higher than comparable
United States securities and such levels may not be sustainable. Commissions
on foreign stocks are generally higher than commissions on United States
exchanges, and while there is an increasing number of overseas stock markets
that have adopted a system of negotiated rates, a number are still subject to
an established schedule of minimum commission rates. There is generally less
government supervision and regulation of foreign stock exchanges, brokers,
and listed companies than in the United States. Moreover, settlement
practices for transactions in foreign markets may differ from those in United
States markets. Such differences include delays beyond periods customary in
the United States and practices, such as delivery of securities prior to
receipt of payment, which increase the likelihood of a "failed settlement."
Failed settlements can result in losses to the Fund.
. Investment Funds The Fund may invest in investment funds which have been
authorized by the governments of certain countries specifically to permit
foreign investment in securities of companies listed and traded on the stock
exchanges in these respective countries. The Fund's investment in these funds
is subject to the provisions of the 1940 Act. If the Fund invests in such
investment funds, the Fund's shareholders will bear not only their
proportionate share of the expenses of the Fund (including operating expenses
and the fees of the investment manager), but also will bear indirectly
similar expenses of the underlying investment funds. In addition, the
securities of these investment funds may trade at a premium over their net
asset value.
. Information and Supervision There is generally less publicly available
information about foreign companies comparable to reports and ratings that
are published about companies in the United States. Foreign companies are
also generally not subject to uniform accounting, auditing and financial
reporting standards, practices, and requirements comparable to those
applicable to United States companies. It also is often more difficult to
keep currently informed of corporate actions which affect the prices of
portfolio securities.
. Taxes The dividends and interest payable on certain of the Fund's foreign
portfolio securities may be subject to foreign withholding taxes, thus
reducing the net amount of income available for distribution to the Fund's
shareholders.
. Other With respect to certain foreign countries, especially developing and
emerging ones, there is the possibility of adverse changes in investment or
exchange control regulations, expropriation or confiscatory taxation,
limitations on the removal of Funds or other assets of the Funds, political
or social instability, or diplomatic developments which could affect
investments by U.S. persons in those countries.
. Eastern Europe and Russia Changes occurring in Eastern Europe and Russia
today could have long-term potential consequences. As restrictions fall, this
could result in rising standards of living, lower manufacturing costs,
growing consumer spending, and substantial economic growth. However,
investment in the countries of Eastern Europe and Russia is highly
speculative at this time. Political and economic reforms are too recent to
establish a definite trend away from centrally planned economies and
state-owned industries. In many of the countries of Eastern Europe and
Russia, there is no stock exchange or formal market for securities. Such
countries may also have government exchange controls, currencies with no
recognizable market value relative to the established currencies of western
market economies, little or no experience in trading in securities, no
financial reporting standards, a lack of a banking and securities
infrastructure to handle such trading, and a legal tradition which does not
recognize rights in private property. In addition, these countries may have
national policies which restrict investments in companies deemed sensitive to
the country's national interest. Further, the governments in such countries
may require governmental or quasi-governmental authorities to act as
custodian of the Fund's assets invested in such countries, and these
authorities may not qualify as a foreign custodian under the Investment
Company Act of 1940 and exemptive relief from such Act may be required. All
of these considerations are among the factors which could cause significant
risks and
<PAGE>
uncertainties to investment in Eastern Europe and Russia. The Fund will only
invest in a company located in, or a government of, Eastern Europe and
Russia, if it believes the potential return justifies the risk.
. Latin America
Inflation Most Latin American countries have experienced, at one time or
another, severe and persistent levels of inflation, including, in some cases,
hyperinflation. This has, in turn, led to high interest rates, extreme
measures by governments to keep inflation in check, and a generally
debilitating effect on economic growth. Although inflation in many countries
has lessened, there is no guarantee it will remain at lower levels.
Political Instability The political history of certain Latin American
countries has been characterized by political uncertainty, intervention by
the military in civilian and economic spheres, and political corruption. Such
developments, if they were to reoccur, could reverse favorable trends toward
market and economic reform, privatization, and removal of trade barriers, and
result in significant disruption in securities markets.
Foreign Currency Certain Latin American countries may have managed currencies
which are maintained at artificial levels to the U. S. dollar rather than at
levels determined by the market. This type of system can lead to sudden and
large adjustments in the currency which, in turn, can have a disruptive and
negative effect on foreign investors. For example, in late 1994 the value of
the Mexican peso lost more than one-third of its value relative to the
dollar. Certain Latin American countries also restrict the free conversion of
their currency into foreign currencies, including the U.S. dollar. There is
no significant foreign exchange market for many currencies and it would, as a
result, be difficult for the Fund to engage in foreign currency transactions
designed to protect the value of the Fund's interests in securities
denominated in such currencies.
Sovereign Debt A number of Latin American countries are among the largest
debtors of developing countries. There have been moratoria on, and
reschedulings of, repayment with respect to these debts. Such events can
restrict the flexibility of these debtor nations in the international markets
and result in the imposition of onerous conditions on their economies.
Corporate Income, High Yield, and Personal Strategy Funds
Special Risks of Investing in Junk Bonds The following special considerations
are additional risk factors associated with the Fund's investments in
lower-rated debt securities.
. Youth and Growth of the Lower-Rated Debt Securities Market The market for
lower-rated debt securities is relatively new and its growth has paralleled a
long economic expansion. Past experience may not, therefore, provide an
accurate indication of future performance of this market, particularly during
periods of economic recession. An economic downturn or increase in interest
rates is likely to have a greater negative effect on this market, the value
of lower-rated debt securities in the Fund's portfolio, the Fund's net asset
value and the ability of the bonds' issuers to repay principal and interest,
meet projected business goals and obtain additional financing than on
higher-rated securities. These circumstances also may result in a higher
incidence of defaults than with respect to higher-rated securities. An
investment in this Fund is more speculative than investment in shares of a
fund which invests only in higher-rated debt securities.
. Sensitivity to Interest Rate and Economic Changes Prices of lower-rated debt
securities may be more sensitive to adverse economic changes or corporate
developments than higher-rated investments. Debt securities with longer
maturities, which may have higher yields, may increase or decrease in value
more than debt securities with shorter maturities. Market prices of
lower-rated debt securities structured as zero coupon or pay-in-kind
securities are affected to a greater extent by interest rate changes and may
be more volatile than securities which pay interest periodically and in cash.
Where it deems it appropriate and in the best interests of Fund shareholders,
the Fund may incur additional expenses to seek recovery on a debt security on
which the issuer has defaulted and to pursue litigation to protect the
interests of security holders of its portfolio companies.
. Liquidity and Valuation Because the market for lower-rated securities may be
thinner and less active than for higher-rated securities, there may be market
price volatility for these securities and limited liquidity in the resale
market. Nonrated securities are usually not as attractive to as many buyers
as rated securities are, a factor which may make nonrated securities less
marketable. These factors may have the effect of limiting the
<PAGE>
availability of the securities for purchase by the Fund and may also limit
the ability of the Fund to sell such securities at their fair value either to
meet redemption requests or in response to changes in the economy or the
financial markets.
Adverse publicity and investor perceptions, whether or not based on
fundamental analysis, may decrease the values and liquidity of lower-rated
debt securities, especially in a thinly traded market. To the extent the Fund
owns or may acquire illiquid or restricted lower-rated securities, these
securities may involve special registration responsibilities, liabilities and
costs, and liquidity and valuation difficulties. Changes in values of debt
securities which the Fund owns will affect its net asset value per share. If
market quotations are not readily available for the Fund's lower-rated or
nonrated securities, these securities will be valued by a method that the
Fund's Board of Directors believes accurately reflects fair value. Judgment
plays a greater role in valuing lower-rated debt securities than with respect
to securities for which more external sources of quotations and last sale
information are available.
. Taxation Special tax considerations are associated with investing in
lower-rated debt securities structured as zero coupon or pay-in-kind
securities. The Fund accrues income on these securities prior to the receipt
of cash payments. The Fund must distribute substantially all of its income to
its shareholders to qualify for pass-through treatment under the tax laws and
may, therefore, have to dispose of its portfolio securities to satisfy
distribution requirements.
INVESTMENT PROGRAM
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Types of Securities
Set forth below is additional information about certain of the investments
described in the Fund's prospectus.
Debt Securities
Fixed income securities in which the Fund may invest include, but are not
limited to, those described below.
All Funds
. U.S. Government Obligations Bills, notes, bonds, and other debt securities
issued by the U.S. Treasury. These are direct obligations of the U.S.
government and differ mainly in the length of their maturities.
. U.S. Government Agency Securities Issued or guaranteed by U.S.
government-sponsored enterprises and federal agencies. These include
securities issued by the Federal National Mortgage Association, Government
National Mortgage Association, Federal Home Loan Bank, Federal Land Banks,
Farmers Home Administration, Banks for Cooperatives, Federal Intermediate
Credit Banks, Federal Financing Bank, Farm Credit Banks, the Small Business
Association, and the Tennessee Valley Authority. Some of these securities are
supported by the full faith and credit of the U.S. Treasury; the remainder
are supported only by the credit of the instrumentality, which may or may not
include the right of the issuer to borrow from the Treasury.
The GNMA, U.S. Treasury Money, Intermediate, and Long-Term Funds and GRIF may
only invest in these securities if they are supported by the full faith and
credit of the U.S. government.
All Funds except GNMA, Government Reserve Investment, U.S. Treasury Money,
Intermediate, and Long-Term Funds
. Bank Obligations Certificates of deposit, bankers' acceptances, and other
short-term debt obligations. Certificates of deposit are short-term
obligations of commercial banks. A bankers' acceptance is a time draft drawn
on a commercial bank by a borrower, usually in connection with international
commercial transactions. Certificates of deposit may have fixed or variable
rates. The Fund may invest in U.S. banks, foreign branches of U.S. banks,
U.S. branches of foreign banks, and foreign branches of foreign banks.
<PAGE>
. Corporate Debt Securities Outstanding nonconvertible corporate debt
securities (e.g., bonds and debentures) which have one year or less remaining
to maturity. Corporate notes may have fixed, variable, or floating rates.
. Commercial Paper Short-term promissory notes issued by corporations
primarily to finance short-term credit needs. Certain notes may have floating
or variable rates.
. Foreign Government Securities Issued or guaranteed by a foreign government,
province, instrumentality, political subdivision, or similar unit thereof.
. Savings and Loan Obligations Negotiable certificates of deposit and other
short-term debt obligations of savings and loan associations.
. Supranational Agencies Securities of certain supranational entities, such as
the International Development Bank.
All Funds except Government Reserve Investment, Prime Reserve, Reserve
Investment, and U.S. Treasury Money Funds
Mortgage-Related Securities
Mortgage-related securities in which the Fund may invest include, but are not
limited to, those described below. The GNMA, U.S. Treasury Intermediate and
U.S. Treasury Long-Term Funds may only invest in these securities to the
extent they are backed by the full faith and credit of the U.S. government.
. Mortgage-Backed Securities Mortgage-backed securities are securities
representing an interest in a pool of mortgages. The mortgages may be of a
variety of types, including adjustable rate, conventional 30-year fixed rate,
graduated payment, and 15-year. Principal and interest payments made on the
mortgages in the underlying mortgage pool are passed through to the Fund.
This is in contrast to traditional bonds where principal is normally paid
back at maturity in a lump sum. Unscheduled prepayments of principal shorten
the securities' weighted average life and may lower their total return. (When
a mortgage in the underlying mortgage pool is prepaid, an unscheduled
principal prepayment is passed through to the Fund. This principal is
returned to the Fund at par. As a result, if a mortgage security were trading
at a premium, its total return would be lowered by prepayments, and if a
mortgage security were trading at a discount, its total return would be
increased by prepayments.) The value of these securities also may change
because of changes in the market's perception of the creditworthiness of the
federal agency that issued them. In addition, the mortgage securities market
in general may be adversely affected by changes in governmental regulation or
tax policies.
. U.S. Government Agency Mortgage-Backed Securities These are obligations
issued or guaranteed by the United States government or one of its agencies
or instrumentalities, such as the Government National Mortgage Association
("Ginnie Mae" or "GNMA"), the Federal National Mortgage Association ("Fannie
Mae" or "FNMA") the Federal Home Loan Mortgage Corporation ("Freddie Mac" or
"FHLMC"), and the Federal Agricultural Mortgage Corporation ("Farmer Mac" or
"FAMC"). FNMA, FHLMC, and FAMC obligations are not backed by the full faith
and credit of the U.S. government as GNMA certificates are, but they are
supported by the instrumentality's right to borrow from the United States
Treasury. U.S. Government Agency Mortgage-Backed Certificates provide for the
pass-through to investors of their pro-rata share of monthly payments
(including any prepayments) made by the individual borrowers on the pooled
mortgage loans, net of any fees paid to the guarantor of such securities and
the servicer of the underlying mortgage loans. Each of GNMA, FNMA, FHLMC, and
FAMC guarantees timely distributions of interest to certificate holders. GNMA
and FNMA guarantee timely distributions of scheduled principal. FHLMC has in
the past guaranteed only the ultimate collection of principal of the
underlying mortgage loan; however, FHLMC now issues mortgage-backed
securities (FHLMC Gold PCS) which also guarantee timely payment of monthly
principal reductions.
. Ginnie Mae Certificates Ginnie Mae is a wholly owned corporate
instrumentality of the United States within the Department of Housing and
Urban Development. The National Housing Act of 1934, as amended (the "Housing
Act"), authorizes Ginnie Mae to guarantee the timely payment of the principal
of and interest on certificates that are based on and backed by a pool of
mortgage loans insured by the Federal Housing
<PAGE>
Administration under the Housing Act, or Title V of the Housing Act of 1949
("FHA Loans"), or guaranteed by the Department of Veterans Affairs under the
Servicemen's Readjustment Act of 1944, as amended ("VA Loans"), or by pools
of other eligible mortgage loans. The Housing Act provides that the full
faith and credit of the United States government is pledged to the payment of
all amounts that may be required to be paid under any guaranty. In order to
meet its obligations under such guaranty, Ginnie Mae is authorized to borrow
from the United States Treasury with no limitations as to amount.
. Fannie Mae Certificates Fannie Mae is a federally chartered and privately
owned corporation organized and existing under the Federal National Mortgage
Association Charter Act of 1938. FNMA Certificates represent a pro-rata
interest in a group of mortgage loans purchased by Fannie Mae. FNMA
guarantees the timely payment of principal and interest on the securities it
issues. The obligations of FNMA are not backed by the full faith and credit
of the U.S. government.
. Freddie Mac Certificates Freddie Mac is a corporate instrumentality of the
United States created pursuant to the Emergency Home Finance Act of 1970, as
amended (the "FHLMC Act"). Freddie Mac Certificates represent a pro-rata
interest in a group of mortgage loans (a "Freddie Mac Certificate group")
purchased by Freddie Mac. Freddie Mac guarantees timely payment of interest
and principal on certain securities it issues and timely payment of interest
and eventual payment of principal on other securities it issues. The
obligations of Freddie Mac are obligations solely of Freddie Mac and are not
backed by the full faith and credit of the U.S. government.
. Farmer Mac Certificates The Federal Agricultural Mortgage Corporation
("Farmer Mac") is a federally chartered instrumentality of the United States
established by Title VIII of the Farm Credit Act of 1971, as amended
("Charter Act"). Farmer Mac was chartered primarily to attract new capital
for financing of agricultural real estate by making a secondary market in
certain qualified agricultural real estate loans. Farmer Mac provides
guarantees of timely payment of principal and interest on securities
representing interests in, or obligations backed by, pools of mortgages
secured by first liens on agricultural real estate ("Farmer Mac
Certificates"). Similar to Fannie Mae and Freddie Mac, Farmer Mac
Certificates are not supported by the full faith and credit of the U.S.
government; rather, Farmer Mac may borrow from the U.S. Treasury to meet its
guaranty obligations.
As discussed above, prepayments on the underlying mortgages and their effect
upon the rate of return of a mortgage-backed security, is the principal
investment risk for a purchaser of such securities, like the Fund. Over time,
any pool of mortgages will experience prepayments due to a variety of
factors, including (1) sales of the underlying homes (including
foreclosures), (2) refinancings of the underlying mortgages, and (3)
increased amortization by the mortgagee. These factors, in turn, depend upon
general economic factors, such as level of interest rates and economic
growth. Thus, investors normally expect prepayment rates to increase during
periods of strong economic growth or declining interest rates, and to
decrease in recessions and rising interest rate environments. Accordingly,
the life of the mortgage-backed security is likely to be substantially
shorter than the stated maturity of the mortgages in the underlying pool.
Because of such variation in prepayment rates, it is not possible to predict
the life of a particular mortgage-backed security, but FHA statistics
indicate that 25- to 30-year single family dwelling mortgages have an average
life of approximately 12 years. The majority of Ginnie Mae Certificates are
backed by mortgages of this type, and, accordingly, the generally accepted
practice treats Ginnie Mae Certificates as 30-year securities which prepay in
full in the 12th year. FNMA and Freddie Mac Certificates may have differing
prepayment characteristics.
Fixed rate mortgage-backed securities bear a stated "coupon rate" which
represents the effective mortgage rate at the time of issuance, less certain
fees to GNMA, FNMA and FHLMC for providing the guarantee, and the issuer for
assembling the pool and for passing through monthly payments of interest and
principal.
Payments to holders of mortgage-backed securities consist of the monthly
distributions of interest and principal less the applicable fees. The actual
yield to be earned by a holder of mortgage-backed securities is calculated by
dividing interest payments by the purchase price paid for the mortgage-backed
securities (which may be at a premium or a discount from the face value of
the certificate).
<PAGE>
Monthly distributions of interest, as contrasted to semiannual distributions
which are common for other fixed interest investments, have the effect of
compounding and thereby raising the effective annual yield earned on
mortgage-backed securities. Because of the variation in the life of the pools
of mortgages which back various mortgage-backed securities, and because it is
impossible to anticipate the rate of interest at which future principal
payments may be reinvested, the actual yield earned from a portfolio of
mortgage-backed securities will differ significantly from the yield estimated
by using an assumption of a certain life for each mortgage-backed security
included in such a portfolio as described above.
. Collateralized Mortgage Obligations (CMOs) CMOs are bonds that are
collateralized by whole loan mortgages or mortgage pass-through securities.
The bonds issued in a CMO deal are divided into groups, and each group of
bonds is referred to as a "tranche." Under the traditional CMO structure, the
cash flows generated by the mortgages or mortgage pass-through securities in
the collateral pool are used to first pay interest and then pay principal to
the CMO bondholders. The bonds issued under a CMO structure are retired
sequentially as opposed to the pro-rata return of principal found in
traditional pass-through obligations. Subject to the various provisions of
individual CMO issues, the cash flow generated by the underlying collateral
(to the extent it exceeds the amount required to pay the stated interest) is
used to retire the bonds. Under the CMO structure, the repayment of principal
among the different tranches is prioritized in accordance with the terms of
the particular CMO issuance. The "fastest-pay" tranche of bonds, as specified
in the prospectus for the issuance, would initially receive all principal
payments. When that tranche of bonds is retired, the next tranche, or
tranches, in the sequence, as specified in the prospectus, receive all of the
principal payments until they are retired. The sequential retirement of bond
groups continues until the last tranche, or group of bonds, is retired.
Accordingly, the CMO structure allows the issuer to use cash flows of long
maturity, monthly-pay collateral to formulate securities with short,
intermediate and long final maturities and expected average lives.
In recent years, new types of CMO structures have evolved. These include
floating rate CMOs, planned amortization classes, accrual bonds and CMO
residuals. These newer structures affect the amount and timing of principal
and interest received by each tranche from the underlying collateral. Under
certain of these new structures, given classes of CMOs have priority over
others with respect to the receipt of prepayments on the mortgages.
Therefore, depending on the type of CMOs in which the Fund invests, the
investment may be subject to a greater or lesser risk of prepayment than
other types of mortgage-related securities.
The primary risk of any mortgage security is the uncertainty of the timing of
cash flows. For CMOs, the primary risk results from the rate of prepayments
on the underlying mortgages serving as collateral. An increase or decrease in
prepayment rates (resulting from a decrease or increase in mortgage interest
rates) will affect the yield, average life and price of CMOs. The prices of
certain CMOs, depending on their structure and the rate of prepayments, can
be volatile. Some CMOs may also not be as liquid as other securities.
. U.S. Government Agency Multiclass Pass-Through Securities Unlike CMOs, U.S.
Government Agency Multiclass Pass-Through Securities, which include FNMA
Guaranteed REMIC Pass-Through Certificates and FHLMC Multi-Class Mortgage
Participation Certificates, are ownership interests in a pool of Mortgage
Assets. Unless the context indicates otherwise, all references herein to CMOs
include multiclass pass-through securities.
. Multi-Class Residential Mortgage Securities Such securities represent
interests in pools of mortgage loans to residential home buyers made by
commercial banks, savings and loan associations or other financial
institutions. Unlike GNMA, FNMA and FHLMC securities, the payment of
principal and interest on Multi-Class Residential Mortgage Securities is not
guaranteed by the U.S. government or any of its agencies. Accordingly, yields
on Multi-Class Residential Mortgage Securities have been historically higher
than the yields on U.S. government mortgage securities. However, the risk of
loss due to default on such instruments is higher since they are not
guaranteed by the U.S. government or its agencies. Additionally, pools of
such securities may be divided into senior or subordinated segments. Although
subordinated mortgage securities may have a higher yield than senior mortgage
securities, the risk of loss of principal is greater because losses on the
underlying mortgage loans must be borne by persons holding subordinated
securities before those holding senior mortgage securities.
<PAGE>
. Privately Issued Mortgage-Backed Certificates These are pass-through
certificates issued by non-governmental issuers. Pools of conventional
residential mortgage loans created by such issuers generally offer a higher
rate of interest than government and government-related pools because there
are no direct or indirect government guarantees of payment. Timely payment of
interest and principal of these pools is, however, generally supported by
various forms of insurance or guarantees, including individual loan, title,
pool and hazard insurance. The insurance and guarantees are issued by
government entities, private insurance or the mortgage poolers. Such
insurance and guarantees and the creditworthiness of the issuers thereof will
be considered in determining whether a mortgage-related security meets the
Fund's quality standards. The Fund may buy mortgage-related securities
without insurance or guarantees if through an examination of the loan
experience and practices of the poolers, the investment manager determines
that the securities meet the Fund's quality standards.
. Stripped Mortgage-Backed Securities These instruments are a type of
potentially high-risk derivative. They represent interests in a pool of
mortgages, the cash flow of which has been separated into its interest and
principal components. "IOs" (interest only securities) receive the interest
portion of the cash flow while "POs" (principal only securities) receive the
principal portion. IOs and POs are usually structured as tranches of a CMO.
Stripped Mortgage-Backed Securities may be issued by U.S. government agencies
or by private issuers similar to those described above with respect to CMOs
and privately issued mortgage-backed certificates. As interest rates rise and
fall, the value of IOs tends to move in the same direction as interest rates.
The value of the other mortgage-backed securities described herein, like
other debt instruments, will tend to move in the opposite direction compared
to interest rates. Under the Internal Revenue Code of 1986, as amended (the
"Code"), POs may generate taxable income from the current accrual of original
issue discount, without a corresponding distribution of cash to the Fund.
The cash flows and yields on IO and PO classes are extremely sensitive to the
rate of principal payments (including prepayments) on the related underlying
mortgage assets. In the case of IOs, prepayments affect the amount, but not
the timing, of cash flows provided to the investor. In contrast, prepayments
on the mortgage pool affect the timing, but not the amount, of cash flows
received by investors in POs. For example, a rapid or slow rate of principal
payments may have a material adverse effect on the prices of IOs or POs,
respectively. If the underlying mortgage assets experience greater than
anticipated prepayments of principal, an investor may fail to fully recoup
its initial investment in an IO class of a stripped mortgage-backed security,
even if the IO class is rated AAA or Aaa or is derived from a full faith and
credit obligation. Conversely, if the underlying mortgage assets experience
slower than anticipated prepayments of principal, the price on a PO class
will be affected more severely than would be the case with a traditional
mortgage-backed security.
The staff of the Securities and Exchange Commission ("SEC") has advised the
Fund that it believes the Fund should treat IOs and POs, other than
government-issued IOs or POs backed by fixed rate mortgages, as illiquid
securities and, accordingly, limit its investments in such securities,
together with all other illiquid securities, to 15% of the Fund's net assets.
Under the staff's position, the determination of whether a particular
government-issued IO and PO backed by fixed rate mortgages may be made on a
case by case basis under guidelines and standards established by the Fund's
Board of Directors/Trustees. The Fund's Board of Directors/Trustees has
delegated to T. Rowe Price the authority to determine the liquidity of these
investments based on the following guidelines: the type of issuer; type of
collateral, including age and prepayment characteristics; rate of interest on
coupon relative to current market rates and the effect of the rate on the
potential for prepayments; complexity of the issue's structure, including the
number of tranches; size of the issue and the number of dealers who make a
market in the IO or PO. The Fund will treat nongovernment-issued IOs and POs
not backed by fixed or adjustable rate mortgages as illiquid unless and until
the SEC staff modifies its position.
. Adjustable Rate Mortgage Securities ("ARMs") ARMs, like fixed rate
mortgages, have a specified maturity date, and the principal amount of the
mortgage is repaid over the life of the mortgage. Unlike fixed rate
mortgages, the interest rate on ARMs is adjusted at regular intervals based
on a specified, published interest rate "index" such as a Treasury rate
index. The new rate is determined by adding a specific interest amount, the
"margin," to the interest rate of the index. Investment in ARM securities
allows the Fund to participate in
<PAGE>
changing interest rate levels through regular adjustments in the coupons of
the underlying mortgages, resulting in more variable current income and lower
price volatility than longer-term fixed rate mortgage securities. The ARM
securities in which the Fund expects to invest will generally adjust their
interest rates at regular intervals of one year or less. ARM securities are a
less effective means of locking in long-term rates than fixed rate mortgages
since the income from adjustable rate mortgages will increase during periods
of rising interest rates and decline during periods of falling rates.
. Characteristics of Adjustable Rate Mortgage Securities-Interest Rate Indices
The interest rates paid on adjustable rate securities are readjusted
periodically to an increment over some predetermined interest rate index.
Such readjustments occur at intervals ranging from one to 60 months. There
are three main categories of indexes: (1) those based on U.S. Treasury
securities; (2) those derived from a calculated measure such as a cost of
funds index ("COFI") or a moving average of mortgage rates; and (3) those
based on actively traded or prominently posted short-term, interest rates.
Commonly utilized indexes include the one-year, three-year and five-year
constant maturity Treasury rates, the three-month Treasury bill rate, the
180-day Treasury bill rate, rates on longer-term Treasury securities, the
11th District Federal Home Loan Bank Cost of Funds, the National Median Cost
of Funds, the one-month, three-month, six-month or one-year London Interbank
Offered Rate ("LIBOR"), the prime rate of a specific bank, or commercial
paper rates. Some indexes, such as the one-year constant maturity Treasury
rate, closely mirror changes in market interest rate levels. Others, such as
the 11th District Home Loan Bank Cost of Funds index, tend to lag behind
changes in market rate levels. The market value of the Fund's assets and of
the net asset value of the Fund's shares will be affected by the length of
the adjustment period, the degree of volatility in the applicable indexes and
the maximum increase or decrease of the interest rate adjustment on any one
adjustment date, in any one year and over the life of the securities. These
maximum increases and decreases are typically referred to as "caps" and
"floors," respectively.
A number of factors affect the performance of the COFI and may cause the COFI
to move in a manner different from indices based upon specific interest
rates, such as the One Year Treasury Index. Additionally, there can be no
assurance that the COFI will necessarily move in the same direction or at the
same rate as prevailing interest rates. Furthermore, any movement in the COFI
as compared to other indices based upon specific interest rates may be
affected by changes instituted by the FHLB of San Francisco in the method
used to calculate the COFI. To the extent that the COFI may reflect interest
changes on a more delayed basis than other indices, in a period of rising
interest rates, any increase may produce a higher yield later than would be
produced by such other indices, and in a period of declining interest rates,
the COFI may remain higher than other market interest rates which may result
in a higher level of principal prepayments on mortgage loans which adjust in
accordance with the COFI than mortgage loans which adjust in accordance with
other indices.
LIBOR, is the interest rate that the most creditworthy international banks
dealing in U.S. dollar-denominated deposits and loans charge each other for
large dollar-denominated loans. LIBOR is also usually the base rate for large
dollar-denominated loans in the international market. LIBOR is generally
quoted for loans having rate adjustments at one-, three-, six- or 12- month
intervals.
Caps and Floors ARMs will frequently have caps and floors which limit the
maximum amount by which the interest rate to the residential borrower may
move up or down, respectively, each adjustment period and over the life of
the loan. Interest rate caps on ARM securities may cause them to decrease in
value in an increasing interest rate environment. Such caps may also prevent
their income from increasing to levels commensurate with prevailing interest
rates. Conversely, interest rate floors on ARM securities may cause their
income to remain higher than prevailing interest rate levels and result in an
increase in the value of such securities. However, this increase may be
tempered by the acceleration of prepayments.
Mortgage securities generally have a maximum maturity of up to 30 years.
However due to the adjustable rate feature of ARM securities, their prices
are considered to have volatility characteristics which approximate the
average period of time until the next adjustment of the interest rate. As a
result, the principal volatility of ARM securities may be more comparable to
short- and intermediate-term securities than to longer-term fixed rate
mortgage securities. Prepayments however, will increase their principal
volatility. See also the discussion of Mortgage-Backed Securities. Several
characteristics of ARMs may make them more susceptible to
<PAGE>
prepayments than other Mortgage-Backed Securities. An adjustable rate
mortgage has greater incentives to refinance with a fixed rate mortgage
during favorable interest rate environments, in order to avoid interest rate
risk. Also, homes financed with adjustable rate mortgages may be sold more
frequently because of the prevalence of first-time home buyers in the
adjustable rate mortgage market. Also, delinquency and foreclosure rates are
higher in this market since many buyers use adjustable rate mortgages to
purchase homes that they could not otherwise finance on a fixed rate basis.
Significant increases in the index rates for the adjustable rate mortgages
may also result in increased delinquency and default rates, which in turn,
may affect prepayment rates on the ARMs.
. Other Mortgage Related Securities The Fund expects that governmental,
government-related or private entities may create mortgage loan pools
offering pass-through investments in addition to those described above. The
mortgages underlying these securities may be alternative mortgage
instruments, that is, mortgage instruments whose principal or interest
payments may vary or whose terms to maturity may differ from customary
long-term fixed rate mortgages. As new types of mortgage-related securities
are developed and offered to investors, the investment manager will,
consistent with the Fund's objective, policies and quality standards,
consider making investments in such new types of securities.
All Funds except GNMA, Government Reserve Investment, U.S. Treasury Money,
Intermediate, and Long-Term Funds
Asset-Backed Securities
The credit quality of most asset-backed securities depends primarily on the
credit quality of the assets underlying such securities, how well the entity
issuing the security is insulated from the credit risk of the originator or
any other affiliated entities and the amount and quality of any credit
support provided to the securities. The rate of principal payment on
asset-backed securities generally depends on the rate of principal payments
received on the underlying assets which in turn may be affected by a variety
of economic and other factors. As a result, the yield on any asset-backed
security is difficult to predict with precision and actual yield to maturity
may be more or less than the anticipated yield to maturity. Asset-backed
securities may be classified as pass-through certificates or collateralized
obligations.
Pass-through certificates are asset-backed securities which represent an
undivided fractional ownership interest in an underlying pool of assets.
Pass-through certificates usually provide for payments of principal and
interest received to be passed through to their holders, usually after
deduction for certain costs and expenses incurred in administering the pool.
Because pass-through certificates represent an ownership interest in the
underlying assets, the holders thereof bear directly the risk of any defaults
by the obligors on the underlying assets not covered by any credit support.
See "Types of Credit Support."
Asset-backed securities issued in the form of debt instruments, also known as
collateralized obligations, are generally issued as the debt of a special
purpose entity organized solely for the purpose of owning such assets and
issuing such debt. Such assets are most often trade, credit card or
automobile receivables. The assets collateralizing such asset-backed
securities are pledged to a trustee or custodian for the benefit of the
holders thereof. Such issuers generally hold no assets other than those
underlying the asset-backed securities and any credit support provided. As a
result, although payments on such asset-backed securities are obligations of
the issuers, in the event of defaults on the underlying assets not covered by
any credit support (see "Types of Credit Support"), the issuing entities are
unlikely to have sufficient assets to satisfy their obligations on the
related asset-backed securities.
. Methods of Allocating Cash Flows While many asset-backed securities are
issued with only one class of security, many asset-backed securities are
issued in more than one class, each with different payment terms. Multiple
class asset-backed securities are issued for two main reasons. First,
multiple classes may be used as a method of providing credit support. This is
accomplished typically through creation of one or more classes whose right to
payments on the asset-backed security is made subordinate to the right to
such payments of the remaining class or classes. See "Types of Credit
Support." Second, multiple classes may permit the
<PAGE>
issuance of securities with payment terms, interest rates or other
characteristics differing both from those of each other and from those of the
underlying assets. Examples include so-called "strips" (asset-backed
securities entitling the holder to disproportionate interests with respect to
the allocation of interest and principal of the assets backing the security),
and securities with class or classes having characteristics which mimic the
characteristics of non-asset-backed securities, such as floating interest
rates (i.e., interest rates which adjust as a specified benchmark changes) or
scheduled amortization of principal.
Asset-backed securities in which the payment streams on the underlying assets
are allocated in a manner different than those described above may be issued
in the future. The Fund may invest in such asset-backed securities if such
investment is otherwise consistent with its investment objectives and
policies and with the investment restrictions of the Fund.
. Types of Credit Support Asset-backed securities are often backed by a pool
of assets representing the obligations of a number of different parties. To
lessen the effect of failures by obligors on underlying assets to make
payments, such securities may contain elements of credit support. Such credit
support falls into two classes: liquidity protection and protection against
ultimate default by an obligor on the underlying assets. Liquidity protection
refers to the provision of advances, generally by the entity administering
the pool of assets, to ensure that scheduled payments on the underlying pool
are made in a timely fashion. Protection against ultimate default ensures
ultimate payment of the obligations on at least a portion of the assets in
the pool. Such protection may be provided through guarantees, insurance
policies or letters of credit obtained from third parties "external credit
enhancement", through various means of structuring the transaction "internal
credit enhancement" or through a combination of such approaches. Examples of
asset-backed securities with credit support arising out of the structure of
the transaction include "senior-subordinated securities" (multiple class
asset-backed securities with certain classes subordinate to other classes as
to the payment of principal thereon, with the result that defaults on the
underlying assets are borne first by the holders of the subordinated class)
and asset-backed securities that have "reserve funds" (where cash or
investments, sometimes funded from a portion of the initial payments on the
underlying assets, are held in reserve against future losses) or that have
been "over collateralized" (where the scheduled payments on, or the principal
amount of, the underlying assets substantially exceeds that required to make
payment of the asset-backed securities and pay any servicing or other fees).
The degree of credit support provided on each issue is based generally on
historical information respecting the level of credit risk associated with
such payments. Depending upon the type of assets securitized, historical
information on credit risk and prepayment rates may be limited or even
unavailable. Delinquency or loss in excess of that anticipated could
adversely affect the return on an investment in an asset-backed security.
. Automobile Receivable Securities The Fund may invest in asset-backed
securities which are backed by receivables from motor vehicle installment
sales contracts or installment loans secured by motor vehicles ("Automobile
Receivable Securities"). Since installment sales contracts for motor vehicles
or installment loans related thereto ("Automobile Contracts") typically have
shorter durations and lower incidences of prepayment, Automobile Receivable
Securities generally will exhibit a shorter average life and are less
susceptible to prepayment risk.
Most entities that issue Automobile Receivable Securities create an
enforceable interest in their respective Automobile Contracts only by filing
a financing statement and by having the servicer of the Automobile Contracts,
which is usually the originator of the Automobile Contracts, take custody
thereof. In such circumstances, if the servicer of the Automobile Contracts
were to sell the same Automobile Contracts to another party, in violation of
its obligation not to do so, there is a risk that such party could acquire an
interest in the Automobile Contracts superior to that of the holders of
Automobile Receivable Securities. Also, although most Automobile Contracts
grant a security interest in the motor vehicle being financed, in most states
the security interest in a motor vehicle must be noted on the certificate of
title to create an enforceable security interest against competing claims of
other parties. Due to the large number of vehicles involved, however, the
certificate of title to each vehicle financed, pursuant to the Automobile
Contracts underlying the Automobile Receivable Security, usually is not
amended to reflect the assignment of the seller's security interest for the
benefit of the holders of the Automobile Receivable Securities. Therefore,
there is the
<PAGE>
possibility that recoveries on repossessed collateral may not, in some cases,
be available to support payments on the securities. In addition, various
state and federal securities laws give the motor vehicle owner the right to
assert against the holder of the owner's Automobile Contract certain defenses
such owner would have against the seller of the motor vehicle. The assertion
of such defenses could reduce payments on the Automobile Receivable
Securities.
. Credit Card Receivable Securities The Fund may invest in asset-backed
securities backed by receivables from revolving credit card agreements
("Credit Card Receivable Securities"). Credit balances on revolving credit
card agreements ("Accounts") are generally paid down more rapidly than are
Automobile Contracts. Most of the Credit Card Receivable Securities issued
publicly to date have been Pass-Through Certificates. In order to lengthen
the maturity of Credit Card Receivable Securities, most such securities
provide for a fixed period during which only interest payments on the
underlying Accounts are passed through to the security holder and principal
payments received on such Accounts are used to fund the transfer to the pool
of assets supporting the related Credit Card Receivable Securities of
additional credit card charges made on an Account. The initial fixed period
usually may be shortened upon the occurrence of specified events which signal
a potential deterioration in the quality of the assets backing the security,
such as the imposition of a cap on interest rates. The ability of the issuer
to extend the life of an issue of Credit Card Receivable Securities thus
depends upon the continued generation of additional principal amounts in the
underlying account during the initial period and the non-occurrence of
specified events. An acceleration in cardholders' payment rates or any other
event which shortens the period during which additional credit card charges
on an Account may be transferred to the pool of assets supporting the related
Credit Card Receivable Security could shorten the weighted average life and
yield of the Credit Card Receivable Security.
Credit cardholders are entitled to the protection of a number of state and
federal consumer credit laws, many of which give such holder the right to set
off certain amounts against balances owed on the credit card, thereby
reducing amounts paid on Accounts. In addition, unlike most other
asset-backed securities, Accounts are unsecured obligations of the
cardholder.
. Other Assets Asset-backed securities backed by assets other than those
described above, including, but not limited to, small-business loans and
accounts receivable, equipment leases, commercial real estate loans, boat
loans and manufacturing housing loans. The Fund may invest in such securities
in the future if such investment is otherwise consistent with its investment
objective and policies.
There are, of course, other types of securities that are, or may become
available, which are similar to the foregoing and the Funds may invest in
these securities.
High Yield Fund
Collateralized Bond or Loan Obligations
Collateralized Bond Obligations ("CBOs") are bonds collateralized by
corporate bonds and Collateralized Loan Obligations ("CLOs") are bonds
collateralized by bank loans. CBOs and CLOs are structured into tranches, and
payments are allocated such that each tranche has a predictable cash flow
stream and average life. CBOs are fairly recent entrants to the fixed income
market. Most CBOs issue to date have been collateralized by high yield bonds
or loans, with heavy credit enhancement.
Loan Participations and Assignments
Loan participations and assignments (collectively "participations") will
typically be participating interests in loans made by a syndicate of banks,
represented by an agent bank which has negotiated and structured the loan, to
corporate borrowers to finance internal growth, mergers, acquisitions, stock
repurchases, leveraged buy-outs and other corporate activities. Such loans
may also have been made to governmental borrowers, especially governments of
developing countries which is referred to as Loans to Developing Countries
debt ("LDC debt"). LDC debt will involve the risk that the governmental
entity responsible for the repayment of the debt may be unable or unwilling
to do so when due. The loans underlying such participations may be secured or
unsecured, and the Fund may invest in loans collateralized by mortgages on
real property or which have no collateral. The loan participations themselves
may extend for the entire term of the loan or
<PAGE>
may extend only for short "strips" that correspond to a quarterly or monthly
floating rate interest period on the underlying loan. Thus, a term or
revolving credit that extends for several years may be subdivided into
shorter periods.
The loan participations in which the Fund will invest will also vary in legal
structure. Occasionally, lenders assign to another institution both the
lender's rights and obligations under a credit agreement. Since this type of
assignment relieves the original lender of its obligations, it is called a
novation. More typically, a lender assigns only its right to receive payments
of principal and interest under a promissory note, credit agreement or
similar document. A true assignment shifts to the assignee the direct
debtor-creditor relationship with the underlying borrower. Alternatively, a
lender may assign only part of its rights to receive payments pursuant to the
underlying instrument or loan agreement. Such partial assignments, which are
more accurately characterized as "participating interests," do not shift the
debtor-creditor relationship to the assignee, who must rely on the original
lending institution to collect sums due and to otherwise enforce its rights
against the agent bank which administers the loan or against the underlying
borrower.
There may not be a recognizable, liquid public market for loan
participations. To the extent this is the case, the Fund would consider the
loan participation as illiquid and subject to the Fund's restriction on
investing no more than 15% of its net assets in illiquid securities.
Where required by applicable SEC positions, the Fund will treat both the
corporate borrower and the bank selling the participation interest as an
issuer for purposes of its fundamental investment restriction on
diversification.
Various service fees received by the Fund from loan participations, may be
treated as non-interest income depending on the nature of the fee
(commitment, takedown, commission, service or loan origination). To the
extent the service fees are not interest income, they will not qualify as
income under Section 851(b) of the Code. Thus the sum of such fees plus any
other non-qualifying income earned by the Fund cannot exceed 10% of total
income.
Trade Claims
Trade claims are non-securitized rights of payment arising from obligations
other than borrowed funds. Trade claims typically arise when, in the ordinary
course of business, vendors and suppliers extend credit to a company by
offering payment terms. Generally, when a company files for bankruptcy
protection, payments on these trade claims cease and the claims are subject
to compromise along with the other debts of the company. Trade claims
typically are bought and sold at a discount reflecting the degree of
uncertainty with respect to the timing and extent of recovery. In addition to
the risks otherwise associated with low-quality obligations, trade claims
have other risks, including the possibility that the amount of the claim may
be disputed by the obligor.
Over the last few years a market for the trade claims of bankrupt companies
has developed. Many vendors are either unwilling or lack the resources to
hold their claim through the extended bankruptcy process with an uncertain
outcome and timing. Some vendors are also aggressive in establishing reserves
against these receivables, so that the sale of the claim at a discount may
not result in the recognition of a loss.
Trade claims can represent an attractive investment opportunity because these
claims typically are priced at a discount to comparable public securities.
This discount is a reflection of both a less liquid market, a smaller
universe of potential buyers and the risks peculiar to trade claim investing.
It is not unusual for trade claims to be priced at a discount to public
securities that have an equal or lower priority claim.
As noted above, investing in trade claims does carry some unique risks which
include:
. Establishing the Amount of the Claim Frequently, the supplier's estimate of
its receivable will differ from the customer's estimate of its payable.
Resolution of these differences can result in a reduction in the amount of
the claim. This risk can be reduced by only purchasing scheduled claims
(claims already listed as liabilities by the debtor) and seeking
representations from the seller.
<PAGE>
. Defenses to Claims The debtor has a variety of defenses that can be asserted
under the bankruptcy code against any claim. Trade claims are subject to
these defenses, the most common of which for trade claims relates to
preference payments. (Preference payments are all payments made by the debtor
during the 90 days prior to the filing. These payments are presumed to have
benefited the receiving creditor at the expense of the other creditors. The
receiving creditor may be required to return the payment unless it can show
the payments were received in the ordinary course of business.) While none of
these defenses can result in any additional liability of the purchaser of the
trade claim, they can reduce or wipe out the entire purchased claim. This
risk can be reduced by seeking representations and indemnification from the
seller.
. Documentation/Indemnification Each trade claim purchased requires
documentation that must be negotiated between the buyer and seller. This
documentation is extremely important since it can protect the purchaser from
losses such as those described above. Legal expenses in negotiating a
purchase agreement can be fairly high. Additionally, it is important to note
that the value of an indemnification depends on the seller's credit.
. Volatile Pricing Due to Illiquid Market There are only a handful of brokers
for trade claims and the quoted price of these claims can be volatile.
Generally, it is expected that Trade Claims would be considered illiquid
investments.
. No Current Yield/Ultimate Recovery Trade claims are almost never entitled to
earn interest. As a result, the return on such an investment is very
sensitive to the length of the bankruptcy, which is uncertain. Although not
unique to trade claims, it is worth noting that the ultimate recovery on the
claim is uncertain and there is no way to calculate a conventional yield to
maturity on this investment. Additionally, the exit for this investment is a
plan of reorganization which may include the distribution of new securities.
These securities may be as illiquid as the original trade claim investment.
. Tax Issue Although the issue is not free from doubt, it is likely that Trade
Claims would be treated as non-securities investments. As a result, any gains
would be considered "non-qualifying" under the Code. The Fund may have up to
10% of its gross income (including capital gains) derived from non-qualifying
sources.
High Yield and Personal Strategy Funds
Zero Coupon and Pay-in-Kind Bonds
A zero coupon security has no cash coupon payments. Instead, the issuer sells
the security at a substantial discount from its maturity value. The interest
received by the investor from holding this security to maturity is the
difference between the maturity value and the purchase price. The advantage
to the investor is that reinvestment risk of the income received during the
life of the bond is eliminated. However, zero-coupon bonds, like other bonds,
retain interest rate and credit risk and usually display more price
volatility than those securities that pay a cash coupon.
Pay-in-Kind ("PIK") Instruments are securities that pay interest in either
cash or additional securities, at the issuer's option, for a specified
period. PIKs, like zero coupon bonds, are designed to give an issuer
flexibility in managing cash flow. PIK bonds can be either senior or
subordinated debt and trade flat (i.e., without accrued interest). The price
of PIK bonds is expected to reflect the market value of the underlying debt
plus an amount representing accrued interest since the last payment. PIK's
are usually less volatile than zero coupon bonds, but more volatile than cash
pay securities.
For federal income tax purposes, these types of bonds will require the
recognition of gross income each year even though no cash may be paid to the
Fund until the maturity or call date of the bond. The Fund will nonetheless
be required to distribute substantially all of this gross income each year to
comply with the Internal Revenue Code, and such distributions could reduce
the amount of cash available for investment by the Fund.
High Yield, New Income, and Personal Strategy Funds
Warrants
The Fund may acquire warrants. Warrants are pure speculation in that they
have no voting rights, pay no dividends, and have no rights with respect to
the assets of the corporation issuing them. Warrants basically
<PAGE>
are options to purchase equity securities at a specific price valid for a
specific period of time. They do not represent ownership of the securities,
but only the right to buy them. Warrants differ from call options in that
warrants are issued by the issuer of the security which may be purchased on
their exercise, whereas call options may be written or issued by anyone. The
prices of warrants do not necessarily move parallel to the prices of the
underlying securities.
Corporate Income, High Yield, New Income, Personal Strategy, Short-Term Bond,
and Short-Term U.S. Government Funds
Hybrid Instruments
Hybrid Instruments (a type of potentially high-risk derivative) have been
developed and combine the elements of futures contracts or options with those
of debt, preferred equity, or a depository instrument (hereinafter "Hybrid
Instruments"). Generally, a Hybrid Instrument will be a debt security,
preferred stock, depository share, trust certificate, certificate of deposit,
or other evidence of indebtedness on which a portion of or all interest
payments, and/or the principal or stated amount payable at maturity,
redemption, or retirement, is determined by reference to prices, changes in
prices, or differences between prices, of securities, currencies,
intangibles, goods, articles, or commodities (collectively "Underlying
Assets") or by another objective index, economic factor, or other measure,
such as interest rates, currency exchange rates, commodity indices, and
securities indices (collectively "Benchmarks"). Thus, Hybrid Instruments may
take a variety of forms, including, but not limited to, debt instruments with
interest or principal payments or redemption terms determined by reference to
the value of a currency or commodity or securities index at a future point in
time, preferred stock with dividend rates determined by reference to the
value of a currency, or convertible securities with the conversion terms
related to a particular commodity.
Hybrid Instruments can be an efficient means of creating exposure to a
particular market, or segment of a market, with the objective of enhancing
total return. For example, a Fund may wish to take advantage of expected
declines in interest rates in several European countries, but avoid the
transaction costs associated with buying and currency-hedging the foreign
bond positions. One solution would be to purchase a U.S. dollar-denominated
Hybrid Instrument whose redemption price is linked to the average three-year
interest rate in a designated group of countries. The redemption price
formula would provide for payoffs of greater than par if the average interest
rate was lower than a specified level, and payoffs of less than par if rates
were above the specified level. Furthermore, the Fund could limit the
downside risk of the security by establishing a minimum redemption price so
that the principal paid at maturity could not be below a predetermined
minimum level if interest rates were to rise significantly. The purpose of
this arrangement, known as a structured security with an embedded put option,
would be to give the Fund the desired European bond exposure while avoiding
currency risk, limiting downside market risk, and lowering transactions
costs. Of course, there is no guarantee that the strategy will be successful,
and the Fund could lose money if, for example, interest rates do not move as
anticipated or credit problems develop with the issuer of the Hybrid.
The risks of investing in Hybrid Instruments reflect a combination of the
risks of investing in securities, options, futures and currencies. Thus, an
investment in a Hybrid Instrument may entail significant risks that are not
associated with a similar investment in a traditional debt instrument that
has a fixed principal amount, is denominated in U.S. dollars, or bears
interest either at a fixed rate or a floating rate determined by reference to
a common, nationally published benchmark. The risks of a particular Hybrid
Instrument will, of course, depend upon the terms of the instrument, but may
include, without limitation, the possibility of significant changes in the
Benchmarks or the prices of Underlying Assets to which the instrument is
linked. Such risks generally depend upon factors which are unrelated to the
operations or credit quality of the issuer of the Hybrid Instrument and which
may not be readily foreseen by the purchaser, such as economic and political
events, the supply and demand for the Underlying Assets, and interest rate
movements. In recent years, various Benchmarks and prices for Underlying
Assets have been highly volatile, and such volatility may be expected in the
future. Reference is also made to the discussion of futures, options, and
forward contracts herein for a discussion of the risks associated with such
investments.
<PAGE>
Hybrid Instruments are potentially more volatile and carry greater market
risks than traditional debt instruments. Depending on the structure of the
particular Hybrid Instrument, changes in a Benchmark may be magnified by the
terms of the Hybrid Instrument and have an even more dramatic and substantial
effect upon the value of the Hybrid Instrument. Also, the prices of the
Hybrid Instrument and the Benchmark or Underlying Asset may not move in the
same direction or at the same time.
Hybrid Instruments may bear interest or pay preferred dividends at below
market (or even relatively nominal) rates. Alternatively, Hybrid Instruments
may bear interest at above market rates but bear an increased risk of
principal loss (or gain). The latter scenario may result if "leverage" is
used to structure the Hybrid Instrument. Leverage risk occurs when the Hybrid
Instrument is structured so that a given change in a Benchmark or Underlying
Asset is multiplied to produce a greater value change in the Hybrid
Instrument, thereby magnifying the risk of loss as well as the potential for
gain.
Hybrid Instruments may also carry liquidity risk since the instruments are
often "customized" to meet the portfolio needs of a particular investor, and
therefore, the number of investors that are willing and able to buy such
instruments in the secondary market may be smaller than that for more
traditional debt securities. In addition, because the purchase and sale of
Hybrid Instruments could take place in an over-the-counter market without the
guarantee of a central clearing organization or in a transaction between the
Fund and the issuer of the Hybrid Instrument, the creditworthiness of the
counter party of issuer of the Hybrid Instrument would be an additional risk
factor which the Fund would have to consider and monitor. Hybrid Instruments
also may not be subject to regulation of the Commodities Futures Trading
Commission ("CFTC"), which generally regulates the trading of commodity
futures by U.S. persons, the SEC, which regulates the offer and sale of
securities by and to U.S. persons, or any other governmental regulatory
authority.
The various risks discussed above, particularly the market risk of such
instruments, may in turn cause significant fluctuations in the net asset
value of the Fund. Accordingly, the Fund will limit its investments in Hybrid
Instruments to 10% of total assets. However, because of their volatility, it
is possible that the Fund's investment in Hybrid Instruments will account for
more than 10% of the Fund's return (positive or negative).
All Funds
When-Issued Securities and Forward Commitment Contracts
The price of such securities, which may be expressed in yield terms, is fixed
at the time the commitment to purchase is made, but delivery and payment take
place at a later date. Normally, the settlement date occurs within 90 days of
the purchase for When-Issueds, but may be substantially longer for Forwards.
During the period between purchase and settlement, no payment is made by the
Fund to the issuer and no interest accrues to the Fund. The purchase of these
securities will result in a loss if their value declines prior to the
settlement date. This could occur, for example, if interest rates increase
prior to settlement. The longer the period between purchase and settlement,
the greater the risks are. At the time the Fund makes the commitment to
purchase these securities, it will record the transaction and reflect the
value of the security in determining its net asset value. The Fund will cover
these securities by maintaining cash, liquid, high-grade debt securities, or
other suitable cover as permitted by the SEC with its custodian bank equal in
value to commitments for them during the time between the purchase and the
settlement. Therefore, the longer this period, the longer the period during
which alternative investment options are not available to the Fund (to the
extent of the securities used for cover). Such securities either will mature
or, if necessary, be sold on or before the settlement date.
To the extent the Fund remains fully or almost fully invested (in securities
with a remaining maturity of more than one year) at the same time it
purchases these securities, there will be greater fluctuations in the Fund's
net asset value than if the Fund did not purchase them.
Additional Adjustable Rate Securities
Certain securities may be issued with adjustable interest rates that are
reset periodically by predetermined formulas or indexes in order to minimize
movements in the principal value of the investment. Such securities may have
long-term maturities, but may be treated as a short-term investment under
certain conditions.
<PAGE>
Generally, as interest rates decrease or increase, the potential for capital
appreciation or depreciation on these securities is less than for fixed-rate
obligations. These securities may take the following forms:
Variable Rate Securities Variable rate instruments are those whose terms
provide for the adjustment of their interest rates on set dates and which,
upon such adjustment, can reasonably be expected to have a market value that
approximates it par value. A variable rate instrument, the principal amount
of which is scheduled to be paid in 397 days or less, is deemed to have a
maturity equal to the period remaining until the next readjustment of the
interest rate. A variable rate instrument which is subject to a demand
feature entitles the purchaser to receive the principal amount of the
underlying security or securities, either (i) upon notice of no more than 30
days or (ii) at specified intervals not exceeding 397 days and upon no more
than 30 days' notice, is deemed to have a maturity equal to the longer of the
period remaining until the next readjustment of the interest rate or the
period remaining until the principal amount can be recovered through demand.
Floating Rate Securities Floating rate instruments are those whose terms
provide for the adjustment of their interest rates whenever a specified
interest rate changes and which, at any time, can reasonably be expected to
have a market value that approximates its par value. The maturity of a
floating rate instrument is deemed to be the period remaining until the date
(noted on the face of the instrument) on which the principal amount must be
paid, or in the case of an instrument called for redemption, the date on
which the redemption payment must be made. Floating rate instruments with
demand features are deemed to have a maturity equal to the period remaining
until the principal amount can be recovered through demand.
Put Option Bonds Long-term obligations with maturities longer than one year
may provide purchasers an optional or mandatory tender of the security at par
value at predetermined intervals, often ranging from one month to several
years (e.g., a 30-year bond with a five-year tender period). These
instruments are deemed to have a maturity equal to the period remaining to
the put date.
Corporate Income, High Yield, New Income, Personal Strategy, Prime Reserve,
Reserve Investment, Short-Term Bond, and Short-Term U.S. Government Funds
Illiquid or Restricted Securities
Restricted securities may be sold only in privately negotiated 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
is 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. Restricted securities will be
priced at fair value as determined in accordance with procedures prescribed
by the Fund's Board of Directors/Trustees. If, through the appreciation of
illiquid securities or the depreciation of liquid securities, the Fund should
be in a position where more than 15% (10% for Government Reserve Investment;
Prime Reserve; Reserve Investment; and U.S. Treasury Money Funds) of the
value of its net assets is invested in illiquid assets, including restricted
securities, the Fund will take appropriate steps to protect liquidity.
Notwithstanding the above, the Fund may purchase securities which, while
privately placed, are eligible for purchase and sale under Rule 144A under
the 1933 Act. This rule permits certain qualified institutional buyers, such
as the Fund, to trade in privately placed securities even though such
securities are not registered under the 1933 Act. T. Rowe Price, under the
supervision of the Fund's Board of Directors/Trustees, will consider whether
securities purchased under Rule 144A are illiquid and thus subject to the
Fund's restriction of investing no more than 15% (10% for Government Reserve
Investment; Prime Reserve; Reserve Investment; and U.S. Treasury Money Funds)
of its net assets in illiquid securities. A determination of whether a Rule
144A security is liquid or not is a question of fact. In making this
determination, T. Rowe Price will consider the trading markets for the
specific security taking into account the unregistered nature of a Rule 144A
security. In addition, T. Rowe Price could consider the (1) frequency of
trades and quotes, (2) number of dealers and potential purchases, (3) dealer
undertakings to make a market, and (4) the nature of the security and of
marketplace trades (e.g., the time needed to dispose of the security, the
method of
<PAGE>
soliciting offers, and the mechanics of transfer). The liquidity of Rule 144A
securities would be monitored and, if as a result of changed conditions it is
determined that a Rule 144A security is no longer liquid, the Fund's holdings
of illiquid securities would be reviewed to determine what, if any, steps are
required to assure that the Fund does not invest more than 15% (10% for
Government Reserve Investment; Prime Reserve; Reserve Investment; and U.S.
Treasury Money Funds) of its net assets in illiquid securities. Investing in
Rule 144A securities could have the effect of increasing the amount of the
Fund's assets invested in illiquid securities if qualified institutional
buyers are unwilling to purchase such securities.
New Income and Short-Term Bond Funds
Industry Concentration
When the market for corporate debt securities is dominated by issues in the
gas utility, gas transmission utility, electric utility, telephone utility,
or petroleum industry, the Fund will as a matter of Fundamental policy
concentrate 25% or more, but not more than 50%, of its assets, in any one
such industry, if the Fund has cash for such investment (i.e., the Fund will
not sell portfolio securities to raise cash) and, if in T. Rowe Price's
judgment, the return available and the marketability, quality, and
availability of the debt securities of such industry justifies such
concentration in light of the Fund's investment objectives. Domination would
exist with respect to any one such industry, when, in the preceding 30-day
period, more than 25% of all new-issue corporate debt offerings (within the
four highest grades of Moody's or S&P's and with maturities of 10 years or
less) of $25,000,000 or more consisted of issues in such industry. Although
the Fund will normally purchase corporate debt securities in the secondary
market as opposed to new offerings, T. Rowe Price believes that the new
issue-based dominance standard, as defined above, is appropriate because it
is easily determined and represents an accurate correlation to the secondary
market. Investors should understand that concentration in any industry may
result in increased risk. Investments in any of these industries may be
affected by environmental conditions, energy conservation programs, fuel
shortages, difficulty in obtaining adequate return on capital in financing
operations and large construction programs, and the ability of the capital
markets to absorb debt issues. In addition, it is possible that the public
service commissions which have jurisdiction over these industries may not
grant future increases in rates sufficient to offset increases in operating
expenses. These industries also face numerous legislative and regulatory
uncertainties at both federal and state government levels. Management
believes that any risk to the Fund which might result from concentration in
any industry will be minimized by the Fund's practice of diversifying its
investments in other respects. The Fund's policy with respect to industry
concentration is a Fundamental policy. (For investment restriction on
industry concentration, see "Investment Restrictions").
PORTFOLIO MANAGEMENT PRACTICES
-------------------------------------------------------------------------------
Lending of Portfolio Securities
Securities loans are made to broker-dealers or institutional investors or
other persons, pursuant to agreements requiring that the loans be
continuously secured by collateral at least equal at all times to the value
of the securities lent, marked to market on a daily basis. The collateral
received will consist of cash, U.S. government securities, letters of credit
or such other collateral as may be permitted under its investment program.
While the securities are being lent, the Fund will continue to receive the
equivalent of the interest or dividends paid by the issuer on the securities,
as well as interest on the investment of the collateral or a fee from the
borrower. The Fund has a right to call each loan and obtain the securities,
within such period of time which coincides with the normal settlement period
for purchases and sales of such securities in the respective markets. The
Fund will not have the right to vote on securities while they are being lent,
but it will call a loan in anticipation of any important vote. The risks in
lending portfolio securities, as with other extensions of secured credit,
consist of possible delay in receiving additional collateral or in the
recovery of the securities or possible loss of rights in the collateral
should the borrower fail financially. Loans will only be
<PAGE>
made to firms deemed by T. Rowe Price to be of good standing and will not be
made unless, in the judgment of T. Rowe Price, the consideration to be earned
from such loans would justify the risk.
Other Lending/Borrowing
Subject to approval by the SEC, the Fund may make loans to, or borrow funds
from, other mutual funds sponsored or advised by T. Rowe Price or Rowe
Price-Fleming International, Inc. ("Price-Fleming"), (collectively, "Price
Funds").
Repurchase Agreements
The Fund may enter into a repurchase agreement through which an investor
(such as the Fund) purchases a security (known as the "underlying security")
from a well-established securities dealer or a bank that is a member of the
Federal Reserve System. Any such dealer or bank will be on T. Rowe Price's
approved list. At that time, the bank or securities dealer agrees to
repurchase the underlying security at the same price, plus specified
interest. Repurchase agreements are generally for a short period of time,
often less than a week. Repurchase agreements which do not provide for
payment within seven days will be treated as illiquid securities. The Fund
will only enter into repurchase agreements where (i) (A) Prime Reserve, U.S.
Treasury Money, Government Reserve Investment, and Reserve Investment
Funds--the underlying securities are either U.S. government securities or
securities that, at the time the repurchase agreement is entered into, are
rated in the highest rating category by the requisite number of NRSROs (as
required by Rule 2a-7 under the 1940 Act) and otherwise are of the type
(excluding maturity limitations) which the Fund's investment guidelines would
allow it to purchase directly, (B) GNMA, High Yield, New Income, Personal
Strategy, Short-Term Bond, Short-Term U.S. Government, and U.S. Treasury
Intermediate and Long-Term Funds--the underlying securities are of the type
(excluding maturity limitations) which the Fund's investment guidelines would
allow it to purchase directly; (ii) the market value of the underlying
security, including interest accrued, will be equal to or exceed the value of
the repurchase agreement; and (iii) payment for the underlying security is
made only upon physical delivery or evidence of book-entry transfer to the
account of the custodian or a bank acting as agent. In the event of a
bankruptcy or other default of a seller of a repurchase agreement, the Fund
could experience both delays in liquidating the underlying security and
losses, including: (a) possible decline in the value of the underlying
security during the period while the Fund seeks to enforce its rights
thereto; (b) possible subnormal levels of income and lack of access to income
during this period; and (c) expenses of enforcing its rights.
Reverse Repurchase Agreements
Although the Fund has no current intention of engaging in reverse repurchase
agreements, the Fund reserves the right to do so. Reverse repurchase
agreements are ordinary repurchase agreements in which a Fund is the seller
of, rather than the investor in, securities, and agrees to repurchase them at
an agreed upon time and price. Use of a reverse repurchase agreement may be
preferable to a regular sale and later repurchase of the securities because
it avoids certain market risks and transaction costs. A reverse repurchase
agreement may be viewed as a type of borrowing by the Fund, subject to
Investment Restriction (1). (See "Investment Restrictions").
Money Market Reserves
It is expected that the Fund will invest its cash reserves primarily in one
or more money market funds established for the exclusive use of the T. Rowe
Price family of mutual funds and other clients of T. Rowe Price and
Price-Fleming. Currently, two such money market funds are in
operation-Reserve Investment Fund ("RIF") and Government Reserve Investment
Fund ("GRF"), each a series of the Reserve Investment Funds, Inc. (The Prime
Reserve and U.S. Treasury Money Funds will not purchase shares of either
Fund, and the GNMA and U.S. Treasury Intermediate and U.S. Treasury Long-Term
Funds can only purchase shares of GRF.) Additional series may be created in
the future. These funds were created and operate under an Exemptive Order
issued by the Securities and Exchange Commission (Investment Company Act
Release No. IC-22770, July 29, 1997).
<PAGE>
Both funds must comply with the requirements of Rule 2a-7 under the 1940 Act
governing money market funds. The RIF invests at least 95% of its total
assets in prime money market instruments receiving the highest credit rating.
The GRF invests primarily in a portfolio of U.S. government-backed
securities, primarily U.S. Treasuries, and repurchase agreements thereon.
The RIF and GRF provide a very efficient means of managing the cash reserves
of the Fund. While neither RIF or GRF pay an advisory fee to the Investment
Manager, they will incur other expenses. However, the RIF and GRF are
expected by T. Rowe Price to operate at very low expense ratios. The Fund
will only invest in RIF or GRF to the extent it is consistent with its
objective and program.
Neither fund is insured or guaranteed by the U.S. government, and there is no
assurance they will maintain a stable net asset value of $1.00 per share.
High Yield Fund
Short Sales
The Fund may make short sales for hedging purposes to protect the Fund
against companies whose credit is deteriorating. Short sales are transactions
in which the Fund sells a security it does not own in anticipation of a
decline in the market value of that security. The Fund's short sales would be
limited to situations where the Fund owns a debt security of a company and
would sell short the common or preferred stock or another debt security at a
different level of the capital structure of the same company. No securities
will be sold short if, after the effect is given to any such short sale, the
total market value of all securities sold short would exceed 2% of the value
of the Fund's net assets.
To complete a short sale transaction, the Fund must borrow the security to
make delivery to the buyer. The Fund then is obligated to replace the
security borrowed by purchasing it at the market price at the time of
replacement. The price at such time may be more or less than the price at
which the security was sold by the Fund. Until the security is replaced, the
Fund is required to pay to the lender amounts equal to any dividends or
interest which accrue during the period of the loan. To borrow the security,
the Fund also may be required to pay a premium, which would increase the cost
of the security sold. The proceeds of the short sale will be retained by the
broker, to the extent necessary to meet margin requirements, until the short
position is closed out.
Until the Fund replaces a borrowed security in connection with a short sale,
the Fund will: (a) maintain daily a segregated account, containing cash, U.S.
government securities or other suitable cover as permitted by the SEC, at
such a level that (i) the amount deposited in the account plus the amount
deposited with the broker as collateral will equal the current value of the
security sold short and (ii) the amount deposited in the segregated account
plus the amount deposited with the broker as collateral will not be less than
the market value of the security at the time its was sold short; or (b)
otherwise cover its short position.
The Fund will incur a loss as a result of the short sale if the price of the
security sold short increases between the date of the short sale and the date
on which the Fund replaces the borrowed security. The Fund will realize a
gain if the security sold short declines in price between those dates. This
result is the opposite of what one would expect from a cash purchase of a
long position in a security. The amount of any gain will be decreased, and
the amount of any loss increased, by the amount of any premium, dividends or
interest the Fund may be required to pay in connection with a short sale. Any
gain or loss on the security sold short would be separate from a gain or loss
on the Fund security being hedged by the short sale.
The Taxpayer Relief Act of 1997 requires a mutual fund to recognize gain upon
entering into a constructive sale of stock, a partnership interest, or
certain debt positions occurring after August 5, 1997. A constructive sale is
deemed to occur if the Fund enters into a short sale, an offsetting notional
principal contract, or a futures or forward contract which is substantially
identical to the appreciated position. Some of the transactions in which the
Fund is permitted to invest may cause certain appreciated positions in
securities held by the Fund to qualify as a "constructive sale," in which
case it would be treated as sold and the resulting gain subjected to tax or,
in the case of a mutual fund, distributed to shareholders. If this were to
occur, the Fund would be required to distribute such gains even though it
would receive no cash until the later sale of
<PAGE>
the security. Such distributions could reduce the amount of cash available
for investment by the Fund. Because these rules do not apply to "straight"
debt transactions, it is not anticipated that they will have a significant
impact on the Fund; however, the effect cannot be determined until the
issuance of clarifying regulations.
All Funds except Government Reserve Investment, Prime Reserve, Reserve
Investment, and U.S. Treasury Money Funds
Options
Options are a type of potentially high-risk derivative.
Writing Covered Call Options
The Fund may write (sell) American or European style "covered" call options
and purchase options to close out options previously written by the Fund. In
writing covered call options, the Fund expects to generate additional premium
income which should serve to enhance the Fund's total return and reduce the
effect of any price decline of the security or currency involved in the
option. Covered call options will generally be written on securities or
currencies which, in T. Rowe Price's opinion, are not expected to have any
major price increases or moves in the near future but which, over the long
term, are deemed to be attractive investments for the Fund.
A call option gives the holder (buyer) the "right to purchase" a security or
currency at a specified price (the exercise price) at expiration of the
option (European style) or at any time until a certain date (the expiration
date) (American style). So long as the obligation of the writer of a call
option continues, he may be assigned an exercise notice by the broker-dealer
through whom such option was sold, requiring him to deliver the underlying
security or currency against payment of the exercise price. This obligation
terminates upon the expiration of the call option, or such earlier time at
which the writer effects a closing purchase transaction by repurchasing an
option identical to that previously sold. To secure his obligation to deliver
the underlying security or currency in the case of a call option, a writer is
required to deposit in escrow the underlying security or currency or other
assets in accordance with the rules of a clearing corporation.
The Fund will write only covered call options. This means that the Fund will
own the security or currency subject to the option or an option to purchase
the same underlying security or currency, having an exercise price equal to
or less than the exercise price of the "covered" option, or will establish
and maintain with its custodian for the term of the option, an account
consisting of cash, U.S. government securities, other liquid high-grade debt
obligations, or other suitable cover as permitted by the SEC having a value
equal to the fluctuating market value of the optioned securities or
currencies.
Portfolio securities or currencies on which call options may be written will
be purchased solely on the basis of investment considerations consistent with
the Fund's investment objective. The writing of covered call options is a
conservative investment technique believed to involve relatively little risk
(in contrast to the writing of naked or uncovered options, which the Fund
will not do), but capable of enhancing the Fund's total return. When writing
a covered call option, a Fund, in return for the premium, gives up the
opportunity for profit from a price increase in the underlying security or
currency above the exercise price, but conversely retains the risk of loss
should the price of the security or currency decline. Unlike one who owns
securities or currencies not subject to an option, the Fund has no control
over when it may be required to sell the underlying securities or currencies,
since it may be assigned an exercise notice at any time prior to the
expiration of its obligation as a writer. If a call option which the Fund has
written expires, the Fund will realize a gain in the amount of the premium;
however, such gain may be offset by a decline in the market value of the
underlying security or currency during the option period. If the call option
is exercised, the Fund will realize a gain or loss from the sale of the
underlying security or currency. The Fund does not consider a security or
currency covered by a call to be "pledged" as that term is used in the Fund's
policy which limits the pledging or mortgaging of its assets.
The premium received is the market value of an option. The premium the Fund
will receive from writing a call option will reflect, among other things, the
current market price of the underlying security or currency,
<PAGE>
the relationship of the exercise price to such market price, the historical
price volatility of the underlying security or currency, and the length of
the option period. Once the decision to write a call option has been made, T.
Rowe Price, in determining whether a particular call option should be written
on a particular security or currency, will consider the reasonableness of the
anticipated premium and the likelihood that a liquid secondary market will
exist for those options. The premium received by the Fund for writing covered
call options will be recorded as a liability of the Fund. This liability will
be adjusted daily to the option's current market value, which will be the
latest sale price at the time at which the net asset value per share of the
Fund is computed (close of the New York Stock Exchange), or, in the absence
of such sale, the latest asked price. The option will be terminated upon
expiration of the option, the purchase of an identical option in a closing
transaction, or delivery of the underlying security or currency upon the
exercise of the option.
Closing transactions will be effected in order to realize a profit on an
outstanding call option, to prevent an underlying security or currency from
being called, or, to permit the sale of the underlying security or currency.
Furthermore, effecting a closing transaction will permit the Fund to write
another call option on the underlying security or currency with either a
different exercise price or expiration date or both. If the Fund desires to
sell a particular security or currency from its portfolio on which it has
written a call option, or purchased a put option, it will seek to effect a
closing transaction prior to, or concurrently with, the sale of the security
or currency. There is, of course, no assurance that the Fund will be able to
effect such closing transactions at favorable prices. If the Fund cannot
enter into such a transaction, it may be required to hold a security or
currency that it might otherwise have sold. When the Fund writes a covered
call option, it runs the risk of not being able to participate in the
appreciation of the underlying securities or currencies above the exercise
price, as well as the risk of being required to hold on to securities or
currencies that are depreciating in value. This could result in higher
transaction costs. The Fund will pay transaction costs in connection with the
writing of options to close out previously written options. Such transaction
costs are normally higher than those applicable to purchases and sales of
portfolio securities.
Call options written by the Fund will normally have expiration dates of less
than nine months from the date written. The exercise price of the options may
be below, equal to, or above the current market values of the underlying
securities or currencies at the time the options are written. From time to
time, the Fund may purchase an underlying security or currency for delivery
in accordance with an exercise notice of a call option assigned to it, rather
than delivering such security or currency from its portfolio. In such cases,
additional costs may be incurred.
The Fund will realize a profit or loss from a closing purchase transaction if
the cost of the transaction is less or more than the premium received from
the writing of the option. Because increases in the market price of a call
option will generally reflect increases in the market price of the underlying
security or currency, any loss resulting from the repurchase of a call option
is likely to be offset in whole or in part by appreciation of the underlying
security or currency owned by the Fund.
The Fund will not write a covered call option if, as a result, the aggregate
market value of all portfolio securities or currencies covering written call
or put options exceeds 25% of the market value of the Fund's net assets. In
calculating the 25% limit, the Fund will offset, against the value of assets
covering written calls and puts, the value of purchased calls and puts on
identical securities or currencies with identical maturity dates.
Writing Covered Put Options
The Fund may write American or European style covered put options and
purchase options to close out options previously written by the Fund. A put
option gives the purchaser of the option the right to sell, and the writer
(seller) has the obligation to buy, the underlying security or currency at
the exercise price during the option period (American style) or at the
expiration of the option (European style). So long as the obligation of the
writer continues, he may be assigned an exercise notice by the broker-dealer
through whom such option was sold, requiring him to make payment to the
exercise price against delivery of the underlying security or currency. The
operation of put options in other respects, including their related risks and
rewards, is substantially identical to that of call options.
<PAGE>
The Fund would write put options only on a covered basis, which means that
the Fund would maintain in a segregated account cash, U.S. government
securities, other liquid high-grade debt obligations, or other suitable cover
as determined by the SEC, in an amount not less than the exercise price or
the Fund will own an option to sell the underlying security or currency
subject to the option having an exercise price equal to or greater than the
exercise price of the "covered" option at all times while the put option is
outstanding. (The rules of a clearing corporation currently require that such
assets be deposited in escrow to secure payment of the exercise price.)
The Fund would generally write covered put options in circumstances where T.
Rowe Price wishes to purchase the underlying security or currency for the
Fund's portfolio at a price lower than the current market price of the
security or currency. In such event the Fund would write a put option at an
exercise price which, reduced by the premium received on the option, reflects
the lower price it is willing to pay. Since the Fund would also receive
interest on debt securities or currencies maintained to cover the exercise
price of the option, this technique could be used to enhance current return
during periods of market uncertainty. The risk in such a transaction would be
that the market price of the underlying security or currency would decline
below the exercise price less the premiums received. Such a decline could be
substantial and result in a significant loss to the Fund. In addition, the
Fund, because it does not own the specific securities or currencies which it
may be required to purchase in exercise of the put, cannot benefit from
appreciation, if any, with respect to such specific securities or currencies.
The Fund will not write a covered put option if, as a result, the aggregate
market value of all portfolio securities or currencies covering put or call
options exceeds 25% of the market value of the Fund's net assets. In
calculating the 25% limit, the Fund will offset, against the value of assets
covering written puts and calls, the value of purchased puts and calls on
identical securities or currencies with identical maturity dates.
Purchasing Put Options
The Fund may purchase American or European style put options. As the holder
of a put option, the Fund has the right to sell the underlying security or
currency at the exercise price at any time during the option period (American
style) or at the expiration of the option (European style). The Fund may
enter into closing sale transactions with respect to such options, exercise
them or permit them to expire. The Fund may purchase put options for
defensive purposes in order to protect against an anticipated decline in the
value of its securities or currencies. An example of such use of put options
is provided next.
The Fund may purchase a put option on an underlying security or currency (a
"protective put") owned by the Fund as a defensive technique in order to
protect against an anticipated decline in the value of the security or
currency. Such hedge protection is provided only during the life of the put
option when the Fund, as the holder of the put option, is able to sell the
underlying security or currency at the put exercise price regardless of any
decline in the underlying security's market price or currency's exchange
value. For example, a put option may be purchased in order to protect
unrealized appreciation of a security or currency where T. Rowe Price deems
it desirable to continue to hold the security or currency because of tax
considerations. The premium paid for the put option and any transaction costs
would reduce any capital gain otherwise available for distribution when the
security or currency is eventually sold.
The Fund may also purchase put options at a time when the Fund does not own
the underlying security or currency. By purchasing put options on a security
or currency it does not own, the Fund seeks to benefit from a decline in the
market price of the underlying security or currency. If the put option is not
sold when it has remaining value, and if the market price of the underlying
security or currency remains equal to or greater than the exercise price
during the life of the put option, the Fund will lose its entire investment
in the put option. In order for the purchase of a put option to be
profitable, the market price of the underlying security or currency must
decline sufficiently below the exercise price to cover the premium and
transaction costs, unless the put option is sold in a closing sale
transaction.
The Fund will not commit more than 5% of its assets to premiums when
purchasing put and call options. The premium paid by the Fund when purchasing
a put option will be recorded as an asset of the Fund. This asset will be
adjusted daily to the option's current market value, which will be the latest
sale price at the time
<PAGE>
at which the net asset value per share of the Fund is computed (close of New
York Stock Exchange), or, in the absence of such sale, the latest bid price.
This asset will be terminated upon expiration of the option, the selling
(writing) of an identical option in a closing transaction, or the delivery of
the underlying security or currency upon the exercise of the option.
Purchasing Call Options
The Fund may purchase American or European style call options. As the holder
of a call option, the Fund has the right to purchase the underlying security
or currency at the exercise price at any time during the option period
(American style) or at the expiration of the option (European style). The
Fund may enter into closing sale transactions with respect to such options,
exercise them or permit them to expire. The Fund may purchase call options
for the purpose of increasing its current return or avoiding tax consequences
which could reduce its current return. The Fund may also purchase call
options in order to acquire the underlying securities or currencies. Examples
of such uses of call options are provided next.
Call options may be purchased by the Fund for the purpose of acquiring the
underlying securities or currencies for its portfolio. Utilized in this
fashion, the purchase of call options enables the Fund to acquire the
securities or currencies at the exercise price of the call option plus the
premium paid. At times the net cost of acquiring securities or currencies in
this manner may be less than the cost of acquiring the securities or
currencies directly. This technique may also be useful to the Fund in
purchasing a large block of securities or currencies that would be more
difficult to acquire by direct market purchases. So long as it holds such a
call option rather than the underlying security or currency itself, the Fund
is partially protected from any unexpected decline in the market price of the
underlying security or currency and in such event could allow the call option
to expire, incurring a loss only to the extent of the premium paid for the
option.
The Fund will not commit more than 5% of its assets to premiums when
purchasing call and put options. The Fund may also purchase call options on
underlying securities or currencies it owns in order to protect unrealized
gains on call options previously written by it. A call option would be
purchased for this purpose where tax considerations make it inadvisable to
realize such gains through a closing purchase transaction. Call options may
also be purchased at times to avoid realizing losses.
Dealer (Over-the-Counter) Options
The Fund may engage in transactions involving dealer options. Certain risks
are specific to dealer options. While the Fund would look to a clearing
corporation to exercise exchange-traded options, if the Fund were to purchase
a dealer option, it would rely on the dealer from whom it purchased the
option to perform if the option were exercised. Failure by the dealer to do
so would result in the loss of the premium paid by the Fund as well as loss
of the expected benefit of the transaction.
Exchange-traded options generally have a continuous liquid market while
dealer options have none. Consequently, the Fund will generally be able to
realize the value of a dealer option it has purchased only by exercising it
or reselling it to the dealer who issued it. Similarly, when the Fund writes
a dealer option, it generally will be able to close out the option prior to
its expiration only by entering into a closing purchase transaction with the
dealer to which the Fund originally wrote the option. While the Fund will
seek to enter into dealer options only with dealers who will agree to and
which are expected to be capable of entering into closing transactions with
the Fund, there can be no assurance that the Fund will be able to liquidate a
dealer option at a favorable price at any time prior to expiration. Until the
Fund, as a covered dealer call option writer, is able to effect a closing
purchase transaction, it will not be able to liquidate securities (or other
assets) or currencies used as cover until the option expires or is exercised.
In the event of insolvency of the contra party, the Fund may be unable to
liquidate a dealer option. With respect to options written by the Fund, the
inability to enter into a closing transaction may result in material losses
to the Fund. For example, since the Fund must maintain a secured position
with respect to any call option on a security it writes, the Fund may not
sell the assets which it has segregated to secure the position while it is
obligated under the option. This requirement may impair a Fund's ability to
sell portfolio securities or currencies at a time when such sale might be
advantageous.
<PAGE>
The Staff of the SEC has taken the position that purchased dealer options and
the assets used to secure the written dealer options are illiquid securities.
The Fund may treat the cover used for written OTC options as liquid if the
dealer agrees that the Fund may repurchase the OTC option it has written for
a maximum price to be calculated by a predetermined formula. In such cases,
the OTC option would be considered illiquid only to the extent the maximum
repurchase price under the formula exceeds the intrinsic value of the option.
High Yield Fund
Spread Option Transactions
The Fund may purchase from and sell to securities dealers covered spread
options. Such covered spread options are not presently exchange listed or
traded. The purchase of a spread option gives the Fund the right to put, or
sell, a security that it owns at a fixed dollar spread or fixed yield spread
in relationship to another security that the Fund does not own, but which is
used as a benchmark. The risk to the Fund in purchasing covered spread
options is the cost of the premium paid for the spread options and any
transaction costs. In addition, there is no assurance that closing
transactions will be available. The purchase of spread options will be used
to protect the Fund against adverse changes in prevailing credit quality
spreads, i.e., the yield spread between high-quality and lower-quality
securities. Such protection is only provided during the life of the spread
option. The security covering the spread option will be maintained in a
segregated account by the Fund's custodian. The Fund does not consider a
security covered by a spread option to be "pledged" as that term is used in
the Fund's policy limiting the pledging or mortgaging of its assets. The Fund
may also buy and sell uncovered spread options. Such options would be used
for the same purposes and be subject to similar risks as covered spread
options. However, in an uncovered spread option, the Fund would not own
either of the securities involved in the spread.
All Funds except Government Reserve Investment, Prime Reserve, Reserve
Investment, and U.S. Treasury Money Funds
Futures Contracts
Futures contracts are a type of potentially high-risk derivative.
Transactions in Futures
The Fund may enter into futures contracts including stock index, interest
rate, and currency futures ("futures" or "futures contracts").
Stock index futures contracts may be used to provide a hedge for a portion of
the Fund's portfolio, as a cash management tool, or as an efficient way for
T. Rowe Price to implement either an increase or decrease in portfolio market
exposure in response to changing market conditions. The Fund may purchase or
sell futures contracts with respect to any stock index. Nevertheless, to
hedge the Fund's portfolio successfully, the Fund must sell futures contacts
with respect to indices or subindices whose movements will have a significant
correlation with movements in the prices of the Fund's portfolio securities.
Interest rate or currency futures contracts may be used as a hedge against
changes in prevailing levels of interest rates or currency exchange rates in
order to establish more definitely the effective return on securities or
currencies held or intended to be acquired by the Fund. In this regard, the
Fund could sell interest rate or currency futures as an offset against the
effect of expected increases in interest rates or currency exchange rates and
purchase such futures as an offset against the effect of expected declines in
interest rates or currency exchange rates.
The Fund will enter into futures contracts which are traded on national or
foreign futures exchanges, and are standardized as to maturity date and
underlying financial instrument. Futures exchanges and trading in the United
States are regulated under the Commodity Exchange Act by the CFTC. Futures
are traded in London, at the London International Financial Futures Exchange,
in Paris, at the MATIF, and in Tokyo, at the Tokyo Stock Exchange. Although
techniques other than the sale and purchase of futures contracts could be
used for the above-referenced purposes, futures contracts offer an effective
and relatively low cost means of implementing the Fund's objectives in these
areas.
<PAGE>
Regulatory Limitations
The Fund will engage in futures contracts and options thereon only for bona
fide hedging, yield enhancement, and risk management purposes, in each case
in accordance with rules and regulations of the CFTC.
The Fund may not purchase or sell futures contracts or related options if,
with respect to positions which do not qualify as bona fide hedging under
applicable CFTC rules, the sum of the amounts of initial margin deposits and
premium paid on those positions would exceed 5% of the net asset value of the
Fund after taking into account unrealized profits and unrealized losses on
any such contracts it has entered into; provided, however, that in the case
of an option that is in-the-money at the time of purchase, the in-the-money
amount may be excluded in calculating the 5% limitation. For purposes of this
policy, options on futures contracts and foreign currency options traded on a
commodities exchange will be considered "related options." This policy may be
modified by the Board of Directors/Trustees without a shareholder vote and
does not limit the percentage of the Fund's assets at risk to 5%.
In instances involving the purchase of futures contracts or the writing of
call or put options thereon by the Fund, an amount of cash, U.S. government
securities, other liquid, high-grade debt obligations, or other suitable
cover as permitted by the SEC, equal to the market value of the futures
contracts and options thereon (less any related margin deposits), will be
identified by the Fund to cover the position, or alternative cover (such as
owning an offsetting position) will be employed. Assets used as cover or held
in an identified account cannot be sold while the position in the
corresponding option or future is open, unless they are replaced with similar
assets. As a result, the commitment of a large portion of a Fund's assets to
cover or identified accounts could impede portfolio management or the Fund's
ability to meet redemption requests or other current obligations.
If the CFTC or other regulatory authorities adopt different (including less
stringent) or additional restrictions, the Fund would comply with such new
restrictions.
Trading in Futures Contracts
A futures contract provides for the future sale by one party and purchase by
another party of a specified amount of a specific financial instrument (e.g.,
units of a debt security) for a specified price, date, time and place
designated at the time the contract is made. Brokerage fees are incurred when
a futures contract is bought or sold and margin deposits must be maintained.
Entering into a contract to buy is commonly referred to as buying or
purchasing a contract or holding a long position. Entering into a contract to
sell is commonly referred to as selling a contract or holding a short
position.
Unlike when the Fund purchases or sells a security, no price would be paid or
received by the Fund upon the purchase or sale of a futures contract. Upon
entering into a futures contract, and to maintain the Fund's open positions
in futures contracts, the Fund would be required to deposit with its
custodian in a segregated account in the name of the futures broker an amount
of cash, U.S. government securities, suitable money market instruments,
liquid, high-grade debt securities, or other suitable cover as determined by
the SEC, known as "initial margin." The margin required for a particular
futures contract is set by the exchange on which the contract is traded, and
may be significantly modified from time to time by the exchange during the
term of the contract. Futures contracts are customarily purchased and sold on
margins that may range upward from less than 5% of the value of the contract
being traded.
If the price of an open futures contract changes (by increase in the case of
a sale or by decrease in the case of a purchase) so that the loss on the
futures contract reaches a point at which the margin on deposit does not
satisfy margin requirements, the broker will require an increase in the
margin. However, if the value of a position increases because of favorable
price changes in the futures contract so that the margin deposit exceeds the
required margin, the broker will pay the excess to the Fund.
These subsequent payments, called "variation margin," to and from the futures
broker, are made on a daily basis as the price of the underlying assets
fluctuate, making the long and short positions in the futures contract more
or less valuable, a process known as "marking to market." The Fund expects to
earn interest income on its margin deposits.
<PAGE>
Although certain futures contracts, by their terms, require actual future
delivery of and payment for the underlying instruments, in practice most
futures contracts are usually closed out before the delivery date. Closing
out an open futures contract purchase or sale is effected by entering into an
offsetting futures contract sale or purchase, respectively, for the same
aggregate amount of the identical securities and the same delivery date. If
the offsetting purchase price is less than the original sale price, the Fund
realizes a gain; if it is more, the Fund realizes a loss. Conversely, if the
offsetting sale price is more than the original purchase price, the Fund
realizes a gain; if it is less, the Fund realizes a loss. The transaction
costs must also be included in these calculations. There can be no assurance,
however, that the Fund will be able to enter into an offsetting transaction
with respect to a particular futures contract at a particular time. If the
Fund is not able to enter into an offsetting transaction, the Fund will
continue to be required to maintain the margin deposits on the futures
contract.
As an example of an offsetting transaction in which the underlying instrument
is not delivered, the contractual obligations arising from the sale of one
contract of September Treasury Bills on an exchange may be fulfilled at any
time before delivery of the contract is required (i.e., on a specified date
in September, the "delivery month") by the purchase of one contract of
September Treasury Bills on the same exchange. In such instance, the
difference between the price at which the futures contract was sold and the
price paid for the offsetting purchase, after allowance for transaction
costs, represents the profit or loss to the Fund.
For example, the S&P's 500 Stock Index is made up of 500 selected common
stocks, most of which are listed on the New York Stock Exchange. The S&P 500
Index assigns relative weightings to the common stocks included in the Index,
and the Index fluctuates with changes in the market values of those common
stocks. In the case of futures contracts on the S&P 500 Index, the contracts
are to buy or sell 250 units. Thus, if the value of the S&P 500 Index were
$150, one contract would be worth $37,500 (250 units x $150). The stock index
futures contract specifies that no delivery of the actual stocks making up
the index will take place. Instead, settlement in cash occurs. Over the life
of the contract, the gain or loss realized by the Fund will equal the
difference between the purchase (or sale) price of the contract and the price
at which the contract is terminated. For example, if the Fund enters into a
futures contract to buy 250 units of the S&P 500 Index at a specified future
date at a contract price of $150 and the S&P 500 Index is at $154 on that
future date, the Fund will gain $1,000 (250 units x gain of $4). If the Fund
enters into a futures contract to sell 250 units of the stock index at a
specified future date at a contract price of $150 and the S&P 500 Index is at
$152 on that future date, the Fund will lose $500 (250 units x loss of $2).
Special Risks of Transactions in Futures Contracts
. Volatility and Leverage The prices of futures contracts are volatile and are
influenced, among other things, by actual and anticipated changes in the
market and interest rates, which in turn are affected by fiscal and monetary
policies and national and international political and economic events.
Most United States 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 futures 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.
Margin deposits required on futures trading are low. 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, if the
contract were closed out. Thus, a purchase or sale of a
<PAGE>
futures contract may result in losses in excess of the amount invested in the
futures contract. However, the Fund would presumably have sustained
comparable losses if, instead of the futures contract, it had invested in the
underlying financial instrument and sold it after decline. Furthermore, in
the case of a futures contract purchase, in order to be certain that the Fund
has sufficient assets to satisfy its obligations under a futures contract,
the Fund earmarks to the futures contract money market instruments equal in
value to the current value of the underlying instrument less the margin
deposit.
. Liquidity The Fund may elect to close some or all of its futures positions
at any time prior to their expiration. The Fund would do so to reduce
exposure represented by long futures positions or short futures positions.
The Fund may close its positions by taking opposite positions which would
operate to terminate the Fund's position in the futures contracts. Final
determinations of variation margin would then be made, additional cash would
be required to be paid by or released to the Fund, and the Fund would realize
a loss or a gain.
Futures contracts may be closed out only on the exchange or board of trade
where the contracts were initially traded. Although the Fund intends to
purchase or sell futures contracts only on exchanges or boards of trade where
there appears to be an active market, there is no assurance that a liquid
market on an exchange or board of trade will exist for any particular
contract at any particular time. In such event, it might not be possible to
close a futures contract, and in the event of adverse price movements, the
Fund would continue to be required to make daily cash payments of variation
margin. However, in the event futures contracts have been used to hedge the
underlying instruments, the Fund would continue to hold the underlying
instruments subject to the hedge until the futures contracts could be
terminated. In such circumstances, an increase in the price of underlying
instruments, if any, might partially or completely offset losses on the
futures contract. However, as described next, there is no guarantee that the
price of the underlying instruments will, in fact, correlate with the price
movements in the futures contract and thus provide an offset to losses on a
futures contract.
. Hedging Risk A decision of whether, when, and how to hedge involves skill
and judgment, and even a well-conceived hedge may be unsuccessful to some
degree because of unexpected market behavior, market or interest rate trends.
There are several risks in connection with the use by the Fund of futures
contracts as a hedging device. One risk arises because of the imperfect
correlation between movements in the prices of the futures contracts and
movements in the prices of the underlying instruments which are the subject
of the hedge. T. Rowe Price will, however, attempt to reduce this risk by
entering into futures contracts whose movements, in its judgment, will have a
significant correlation with movements in the prices of the Fund's underlying
instruments sought to be hedged.
Successful use of futures contracts by the Fund for hedging purposes is also
subject to T. Rowe Price's ability to correctly predict movements in the
direction of the market. It is possible that, when the Fund has sold futures
to hedge its portfolio against a decline in the market, the index, indices,
or instruments underlying futures might advance and the value of the
underlying instruments held in the Fund's portfolio might decline. If this
were to occur, the Fund would lose money on the futures and also would
experience a decline in value in its underlying instruments. However, while
this might occur to a certain degree, T. Rowe Price believes that over time
the value of the Fund's portfolio will tend to move in the same direction as
the market indices used to hedge the portfolio. It is also possible that, if
the Fund were to hedge against the possibility of a decline in the market
(adversely affecting the underlying instruments held in its portfolio) and
prices instead increased, the Fund would lose part or all of the benefit of
increased value of those underlying instruments that it has hedged, because
it would have offsetting losses in its futures positions. In addition, in
such situations, if the Fund had insufficient cash, it might have to sell
underlying instruments to meet daily variation margin requirements. Such
sales of underlying instruments might be, but would not necessarily be, at
increased prices (which would reflect the rising market). The Fund might have
to sell underlying instruments at a time when it would be disadvantageous to
do so.
In addition to the possibility that there might be an imperfect correlation,
or no correlation at all, between price movements in the futures contracts
and the portion of the portfolio being hedged, the price movements of futures
contracts might not correlate perfectly with price movements in the
underlying instruments due to certain market distortions. First, all
participants in the futures market are subject to margin deposit and
<PAGE>
maintenance requirements. Rather than meeting additional margin deposit
requirements, investors might close futures contracts through offsetting
transactions, which could distort the normal relationship between the
underlying instruments and futures markets. Second, the margin requirements
in the futures market are less onerous than margin requirements in the
securities markets and, as a result, the futures market might attract more
speculators than the securities markets do. Increased participation by
speculators in the futures market might also cause temporary price
distortions. Due to the possibility of price distortion in the futures market
and also because of imperfect correlation between price movements in the
underlying instruments and movements in the prices of futures contracts, even
a correct forecast of general market trends by T. Rowe Price might not result
in a successful hedging transaction over a very short time period.
Options on Futures Contracts
The Fund may purchase and sell options on the same types of futures in which
it may invest.
Options (another type of potentially high-risk derivative) on futures are
similar to options on underlying instruments except that options on futures
give the purchaser the right, in return for the premium paid, to assume a
position in a futures contract (a long position if the option is a call and a
short position if the option is a put), rather than to purchase or sell the
futures contract, at a specified exercise price at any time during the period
of the option. Upon exercise of the option, the delivery of the futures
position by the writer of the option to the holder of the option will be
accompanied by the delivery of the accumulated balance in the writer's
futures margin account which represents the amount by which the market price
of the futures contract, at exercise, exceeds (in the case of a call) or is
less than (in the case of a put) the exercise price of the option on the
futures contract. Purchasers of options who fail to exercise their options
prior to the exercise date suffer a loss of the premium paid.
As an alternative to writing or purchasing call and put options on interest
rate futures, the Fund may write or purchase call and put options on
financial indices. Such options would be used in a manner similar to the use
of options on futures contracts. From time to time, a single order to
purchase or sell futures contracts (or options thereon) may be made on behalf
of the Fund and other T. Rowe Price Funds. Such aggregated orders would be
allocated among the Funds and the other T. Rowe Price Funds in a fair and
nondiscriminatory manner.
Special Risks of Transactions in Options on Futures Contracts
The risks described under "Special Risks in Transactions on Futures
Contracts" are substantially the same as the risks of using options on
futures. In addition, where the Fund seeks to close out an option position by
writing or buying an offsetting option covering the same index, underlying
instrument or contract and having the same exercise price and expiration
date, its ability to establish and close out positions on such options will
be subject to the maintenance of a liquid secondary market. Reasons for the
absence of a liquid secondary market on an exchange include the following:
(i) there may be insufficient trading interest in certain options; (ii)
restrictions may be imposed by an exchange on opening transactions or closing
transactions or both; (iii) trading halts, suspensions or other restrictions
may be imposed with respect to particular classes or series of options, or
underlying instruments; (iv) unusual or unforeseen circumstances may
interrupt normal operations on an exchange; (v) the facilities of an exchange
or a clearing corporation may not at all times be adequate to handle current
trading volume; or (vi) one or more exchanges could, for economic or other
reasons, decide or be compelled at some future date to discontinue the
trading of options (or a particular class or series of options), in which
event the secondary market on that exchange (or in the class or series of
options) would cease to exist, although outstanding options on the exchange
that had been issued by a clearing corporation as a result of trades on that
exchange would continue to be exercisable in accordance with their terms.
There is no assurance that higher than anticipated trading activity or other
unforeseen events might not, at times, render certain of the facilities of
any of the clearing corporations inadequate, and thereby result in the
institution by an exchange of special procedures which may interfere with the
timely execution of customers' orders.
<PAGE>
Additional Futures and Options Contracts
Although the Fund has no current intention of engaging in futures or options
transactions other than those described above, it reserves the right to do
so. Such futures and options trading might involve risks which differ from
those involved in the futures and options described above.
Foreign Futures and Options
Participation in foreign futures and foreign options transactions involves
the execution and clearing of trades on or subject to the rules of a foreign
board of trade. Neither the National Futures Association nor any domestic
exchange regulates activities of any foreign boards of trade, including the
execution, delivery and clearing of transactions, or has the power to compel
enforcement of the rules of a foreign board of trade or any applicable
foreign law. This is true even if the exchange is formally linked to a
domestic market so that a position taken on the market may be liquidated by a
transaction on another market. Moreover, such laws or regulations will vary
depending on the foreign country in which the foreign futures or foreign
options transaction occurs. For these reasons, when the Fund trades foreign
futures or foreign options contracts, it may not be afforded certain of the
protective measures provided by the Commodity Exchange Act, the CFTC's
regulations and the rules of the National Futures Association and any
domestic exchange, including the right to use reparations proceedings before
the CFTC and arbitration proceedings provided by the National Futures
Association or any domestic futures exchange. In particular, funds received
from the Fund for foreign futures or foreign options transactions may not be
provided the same protections as funds received in respect of transactions on
United States futures exchanges. In addition, the price of any foreign
futures or foreign options contract and, therefore, the potential profit and
loss thereon may be affected by any variance in the foreign exchange rate
between the time the Fund's order is placed and the time it is liquidated,
offset or exercised.
U.S. Treasury Intermediate and Long-Term Funds
Limitations on Futures and Options for Intermediate and Long-Term Funds
The Funds will not purchase a futures contract or option theron if, with
respect to positions in futures or options on futures which do not represent
bona fide hedging, the aggregate initial margin and premiums on such
positions would exceed 5% of the Fund's net asset value. In addition, neither
of the Funds will enter into a futures transaction if it would be obligated
to purchase or deliver under outstanding open futures contracts amounts which
would exceed 15% of the Fund's total assets.
A Fund will not write a covered call option if, as a result, the aggregate
market value of all portfolio securities covering call options or subject to
delivery under put options exceeds 15% of the market value of the Fund's
total assets.
A Fund will not write a covered put option if, as a result, the aggregate
market value of all portfolio securities subject to such put options or
covering call options exceeds 15% of the market value of the Fund's total
assets.
The Funds have no current intention of investing in futures and options.
However, they reserve the right to do so in the future and could be subject
to the following limitations: a Fund may invest up to 15% of its total assets
in premiums on put options and 15% of its total assets in premiums on call
options. The total amount of a Fund's total assets invested in futures and
options will not exceed 15% of the Fund's total assets.
Corporate Income, High Yield, New Income, Personal Strategy, and Short-Term
Bond Funds
Foreign Currency Transactions
A forward foreign currency exchange contract involves an obligation to
purchase or sell a specific currency at a future date, which may be any fixed
number of days from the date of the contract agreed upon by the parties, at a
price set at the time of the contract. These contracts are principally traded
in the interbank market conducted directly between currency traders (usually
large, commercial banks) and their customers. A forward contract generally
has no deposit requirement, and no commissions are charged at any stage for
trades.
<PAGE>
The Fund may enter into forward contracts for a variety of purposes in
connection with the management of the foreign securities portion of its
portfolio. The Fund's use of such contracts would include, but not be limited
to, the following:
First, when the Fund enters into a contract for the purchase or sale of a
security denominated in a foreign currency, it may desire to "lock in" the
U.S. dollar price of the security. By entering into a forward contract for
the purchase or sale, for a fixed amount of dollars, of the amount of foreign
currency involved in the underlying security transactions, the Fund will be
able to protect itself against a possible loss resulting from an adverse
change in the relationship between the U.S. dollar and the subject foreign
currency during the period between the date the security is purchased or sold
and the date on which payment is made or received.
Second, when T. Rowe Price believes that one currency may experience a
substantial movement against another currency, including the U.S. dollar, it
may enter into a forward contract to sell or buy the amount of the former
foreign currency, approximating the value of some or all of the Fund's
portfolio securities denominated in such foreign currency. Alternatively,
where appropriate, the Fund may hedge all or part of its foreign currency
exposure through the use of a basket of currencies or a proxy currency where
such currency or currencies act as an effective proxy for other currencies.
In such a case, the Fund may enter into a forward contract where the amount
of the foreign currency to be sold exceeds the value of the securities
denominated in such currency. The use of this basket hedging technique may be
more efficient and economical than entering into separate forward contracts
for each currency held in the Fund. The precise matching of the forward
contract amounts and the value of the securities involved will not generally
be possible since the future value of such securities in foreign currencies
will change as a consequence of market movements in the value of those
securities between the date the forward contract is entered into and the date
it matures. The projection of short-term currency market movement is
extremely difficult, and the successful execution of a short-term hedging
strategy is highly uncertain. Under normal circumstances, consideration of
the prospect for currency parties will be incorporated into the longer term
investment decisions made with regard to overall diversification strategies.
However, T. Rowe Price believes that it is important to have the flexibility
to enter into such forward contracts when it determines that the best
interests of the Fund will be served.
Third, the Fund may use forward contracts when the Fund wishes to hedge out
of the dollar into a foreign currency in order to create a synthetic bond or
money market instrument-the security would be issued in U.S. dollars but the
dollar component would be transformed into a foreign currency through a
forward contract.
The Fund may enter into forward contacts for any other purpose consistent
with the Fund's investment objective and program. However, the Fund will not
enter into a forward contract, or maintain exposure to any such contract(s),
if the amount of foreign currency required to be delivered thereunder would
exceed the Fund's holdings of liquid, high-grade debt securities, currency
available for cover of the forward contract(s) or other suitable cover as
permitted by the SEC. In determining the amount to be delivered under a
contract, the Fund may net offsetting positions.
At the maturity of a forward contract, the Fund may sell the portfolio
security and make delivery of the foreign currency, or it may retain the
security and either extend the maturity of the forward contract (by "rolling"
that contract forward) or may initiate a new forward contract.
If the Fund retains the portfolio security and engages in an offsetting
transaction, the Fund will incur a gain or a loss (as described below) to the
extent that there has been movement in forward contract prices. If the Fund
engages in an offsetting transaction, it may subsequently enter into a new
forward contract to sell the foreign currency. Should forward prices decline
during the period between the Fund's entering into a forward contract for the
sale of a foreign currency and the date it enters into an offsetting contract
for the purchase of the foreign 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 of the price of the currency it has
agreed to purchase exceeds the price of the currency it has agreed to sell.
<PAGE>
The Fund's dealing in forward foreign currency exchange contracts will
generally be limited to the transactions described above. However, the Fund
reserves the right to enter into forward foreign currency contracts for
different purposes and under different circumstances. Of course, the Fund is
not required to enter into forward contracts with regard to its foreign
currency-denominated securities and will not do so unless deemed appropriate
by T. Rowe Price. It also should be realized that this method of hedging
against a decline in the value of a currency does not eliminate fluctuations
in the underlying prices of the securities. It simply establishes a rate of
exchange at a future date. Additionally, although such contracts tend to
minimize the risk of loss due to a decline in the value of the hedged
currency, at the same time, they tend to limit any potential gain which might
result from an increase in the value of that currency.
Although the Fund values its assets daily in terms of U.S. dollars, it does
not intend to convert its holdings of foreign currencies into U.S. dollars on
a daily basis. It will do so from time to time, and investors should be aware
of the costs of currency conversion. Although foreign exchange dealers do not
charge a fee for conversion, they do realize a profit based on the difference
(the "spread") between the prices at which they are buying and selling
various currencies. Thus, a dealer may offer to sell a foreign currency to
the Fund at one rate, while offering a lesser rate of exchange should the
Fund desire to resell that currency to the dealer.
Federal Tax Treatment of Options, Futures Contracts, and Forward Foreign
Exchange Contracts
The Fund may enter into certain options, futures, and forward foreign
exchange contracts, including options and futures on currencies, which will
be treated as Section 1256 contracts or straddles.
Transactions that are considered Section 1256 contracts will be considered to
have been closed at the end of the Fund's fiscal year and any gains or losses
will be recognized for tax purposes at that time. Such gains or losses from
the normal closing or settlement of such transactions will be characterized
as 60% long-term capital gain (taxable at a maximum rate of 20%) or loss and
40% short-term capital gain or loss regardless of the holding period of the
instrument (ordinary income or loss for foreign exchange contracts). The Fund
will be required to distribute net gains on such transactions to shareholders
even though it may not have closed the transaction and received cash to pay
such distributions.
Options, futures and forward foreign exchange contracts, including options
and futures on currencies, which offset a foreign dollar denominated bond or
currency position may be considered straddles for tax purposes, in which case
a loss on any position in a straddle will be subject to deferral to the
extent of unrealized gain in an offsetting position. The holding period of
the securities or currencies comprising the straddle will be deemed not to
begin until the straddle is terminated. The holding period of the security
offsetting an "in-the-money qualified covered call" option on an equity
security will not include the period of time the option is outstanding.
Losses on written covered calls and purchased puts on securities, excluding
certain "qualified covered call" options on equity securities, may be
long-term capital losses, if the security covering the option was held for
more than 12 months prior to the writing of the option.
In order for the Fund to continue to qualify for federal income tax treatment
as a regulated investment company, at least 90% of its gross income for a
taxable year must be derived from qualifying income, i.e., dividends,
interest, income derived from loans of securities, and gains from the sale of
securities or currencies. Tax regulations could be issued limiting the extent
that net gain realized from option, futures or foreign forward exchange
contracts on currencies is qualifying income for purposes of the 90%
requirement.
As a result of the "Taxpayer Relief Act of 1997," entering into certain
options, futures contracts, or forward contracts may result in the
"constructive sale" of offsetting stocks or debt securities of the Fund. See
"Portfolio Management Practices-Short Sales" for further discussion.
<PAGE>
INVESTMENT RESTRICTIONS
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Fundamental policies may not be changed without the approval of the lesser of
(1) 67% of the Fund's shares present at a meeting of shareholders if the
holders of more than 50% of the outstanding shares are present in person or
by proxy or (2) more than 50% of a Fund's outstanding shares. Other
restrictions in the form of operating policies are subject to change by the
Fund's Board of Directors/Trustees without shareholder approval. Any
investment restriction which involves a maximum percentage of securities or
assets shall not be considered to be violated unless an excess over the
percentage occurs immediately after, and is caused by, an acquisition of
securities or assets of, or borrowings by, the Fund. Calculation of the
Fund's total assets for compliance with any of the following fundamental or
operating policies or any other investment restrictions set forth in the
Fund's prospectus or Statement of Additional Information will not include
cash collateral held in connection with securities lending activities.
Fundamental Policies
As a matter of fundamental policy, the Fund may not:
(1) Borrowing Borrow money except that the Fund may (i) borrow for
non-leveraging, temporary or emergency purposes; and (ii) engage in
reverse repurchase agreements and make other investments or engage in
other transactions, which may involve a borrowing, in a manner consistent
with the Fund's investment objective and program, provided that the
combination of (i) and (ii) shall not exceed 33/1//\\/3/\\% of the value
of the Fund's total assets (including the amount borrowed) less
liabilities (other than borrowings) or such other percentage permitted by
law. Any borrowings which come to exceed this amount will be reduced in
accordance with applicable law. The Fund may borrow from banks, other
Price Funds, or other persons to the extent permitted by applicable law;
(2) Commodities Purchase or sell physical commodities; except that the Fund
(other than the Prime Reserve, U.S. Treasury Money, Government Reserve
Investment, and Reserve Investment Funds) may enter into futures
contracts and options thereon;
(3) (a)
Industry Concentration (All Funds except High Yield, New Income, Prime
Reserve, Reserve Investment, and Short-Term Bond Funds) Purchase the
securities of any issuer if, as a result, more than 25% of the value of
the Fund's total assets would be invested in the securities of issuers
having their principal business activities in the same industry;
(b)
Industry Concentration (High Yield Fund) Purchase the securities of any
issuer if, as a result, more than 25% of the value of the Fund's total
assets would be invested in the securities of issuers having their
principal business activities in the same industry; provided, however,
that the Fund will normally concentrate 25% or more of its assets in
securities of the banking industry when the Fund's position in issues
maturing in one year or less equals 35% or more of the Fund's total
assets;
(c) Industry Concentration (New Income Fund) Purchase the securities of
any issuer if, as a result, more than 25% of the value of the Fund's
total assets would be invested in the securities of issuers having their
principal business activities in the same industry; provided, however,
that the Fund will invest more than 25% of its total assets, but not more
than 50%, in any one of the gas utility, gas transmission utility,
electric utility, telephone utility, and petroleum industries under
certain circumstances, and further provided that this limitation does not
apply to securities of the banking industry including, but not limited
to, certificates of deposit and bankers' acceptances;
(d)
Industry Concentration (Prime Reserve and Reserve Investment Funds)
Purchase the securities of any issuer if, as a result, more than 25% of
the value of the Fund's total assets would be invested in the securities
of issuers having their principal business activities in the same
industry; provided, however, that this limitation does not apply to
securities of the banking industry including, but not limited to,
certificates of deposit and bankers' acceptances; and
(e)
Industry Concentration (Short-Term Bond Fund) Purchase the securities of
any issuer if, as a result, more than 25% of the value of the Fund's
total assets would be invested in the securities of issuers
<PAGE>
having their principal business activities in the same industry;
provided, however, that the Fund will normally invest more than 25% of
its total assets in the securities of the banking industry including, but
not limited to, bank certificates of deposit and bankers' acceptances
when the Fund's position in issues maturing in one year or less equals
35% or more of the Fund's total assets; provided, further, that the Fund
will invest more than 25% of its total assets, but not more than 50%, in
any one of the gas utility, gas transmission utility, electric utility,
telephone utility, and petroleum industries under certain circumstances;
(4) Loans Make loans, although the Fund may (i) lend portfolio securities and
participate in an interfund lending program with other Price Funds
provided that no such loan may be made if, as a result, the aggregate of
such loans would exceed 33/1//\\/3/\\% of the value of the Fund's total
assets; (ii) purchase money market securities and enter into repurchase
agreements; and (iii) acquire publicly distributed or privately placed
debt securities and purchase debt;
(5) Percent Limit on Assets Invested in Any One Issuer Purchase a security
if, as a result, with respect to 75% of the value of its total assets,
more than 5% of the value of the Fund's total assets would be invested in
the securities of a single issuer, except securities issued or guaranteed
by the U.S. government or any of its agencies or instrumentalities;
(6) Percent Limit on Share Ownership of Any One Issuer Purchase a security
if, as a result, with respect to 75% of the value of the Fund's total
assets, more than 10% of the outstanding voting securities of any issuer
would be held by the Fund (other than obligations issued or guaranteed by
the U.S. government, its agencies or instrumentalities);
(7) Real Estate Purchase or sell real estate, including limited partnership
interests therein, unless acquired as a result of ownership of securities
or other instruments (but this shall not prevent the Fund from investing
in securities or other instruments backed by real estate or securities of
companies engaged in the real estate business);
(8) Senior Securities Issue senior securities except in compliance with the
1940 Act; or
(9) Underwriting Underwrite securities issued by other persons, except to the
extent that the Fund may be deemed to be an underwriter within the
meaning of the Securities Act of 1933 in connection with the purchase and
sale of its portfolio securities in the ordinary course of pursuing its
investment program.
NOTES
The following Notes should be read in connection with the above-described
fundamental policies. The Notes are not fundamental policies.
With respect to investment restrictions (1) and (4), the Fund will not
borrow from or lend to any other Price Fund (defined as any other mutual
fund managed by or for which T. Rowe Price or Price-Fleming acts as
adviser) unless each Fund applies for and receives an exemptive order
from the SEC or the SEC issues rules permitting such transactions. There
is no assurance the SEC would grant any order requested by the Fund or
promulgate any rules allowing the transactions.
With respect to investment restriction (1), the Government Reserve
Investment, Prime Reserve, Reserve Investment, and U.S. Treasury Money
Funds have no current intention of engaging in any borrowing
transactions.
With respect to investment restriction (2), the Fund does not consider
currency contracts or hybrid investments to be commodities.
For purposes of investment restriction (3), U.S., state or local
governments, or related agencies or instrumentalities, are not considered
an industry. Industries are determined by reference to the
classifications of industries set forth in the Fund's semiannual and
annual reports. It is the position of the Staff of the SEC that foreign
governments are industries for purposes of this restriction.
<PAGE>
For purposes of investment restriction (4), the Fund will consider the
acquisition of a debt security to include the execution of a note or
other evidence of an extension of credit with a term of more than nine
months.
For purposes of investment restriction (5), the Fund will consider a
repurchase agreement fully collateralized with U.S. government securities
to be U.S. government securities.
Operating Policies
As a matter of operating policy, the Fund may not:
(1) Borrowing Purchase additional securities when money borrowed exceeds 5%
of its total assets;
(2) Control of Portfolio Companies Invest in companies for the purpose of
exercising management or control;
(3) (a)
Equity Securities (All Funds except High Yield and New Income Funds)
Purchase any equity security or security convertible into an equity
security except as set forth in its prospectus and operating policy on
investment companies;
(b)
Equity Securities (High Yield Fund) Invest more than 20% of the Fund's
total assets in equity securities (including up to 5% in warrants);
(c)
Equity Securities (New Income Fund) Invest more than 25% of the Fund's
total assets in equity securities;
(4) Futures Contracts Purchase a futures contract or an option thereon, if,
with respect to positions in futures or options on futures which do not
represent bona fide hedging, the aggregate initial margin and premiums on
such options would exceed 5% of the Fund's net asset value;
(5) Illiquid Securities Purchase illiquid securities if, as a result, more
than 15% (10% for the Government Reserve Investment, Prime Reserve,
Reserve Investment, and U.S. Treasury Money Funds) of its net assets
would be invested in such securities;
(6) Investment Companies Purchase securities of open-end or closed-end
investment companies except (i) in compliance with the 1940 Act; (ii)
securities of the Reserve Investment or Government Reserve Investment
Funds; or (iii) in the case of the Government Reserve Investment, Prime
Reserve, Reserve Investment, and U.S. Treasury Money Funds, only
securities of other money market funds;
(7) Margin Purchase securities on margin, except (i) for use of short-term
credit necessary for clearance of purchases of portfolio securities and
(ii) it may make margin deposits in connection with futures contracts or
other permissible investments;
(8) Mortgaging Mortgage, pledge, hypothecate or, in any manner, transfer any
security owned by the Fund as security for indebtedness except as may be
necessary in connection with permissible borrowings or investments and
then such mortgaging, pledging or hypothecating may not exceed
33/1//\\/3/\\% of the Fund's total assets at the time of borrowing or
investment;
(9) Oil and Gas Programs Purchase participations or other direct interests
in, or enter into leases with respect to oil, gas, or other mineral
exploration or development programs if, as a result thereof, more than 5%
of the value of the total assets of the Fund would be invested in such
programs;
(10) Options, etc. Invest in puts, calls, straddles, spreads, or any
combination thereof, except to the extent permitted by the prospectus and
Statement of Additional Information;
(11) (a) Short Sales (All Funds except High Yield Fund) Effect short sales of
securities;
(b)
Short Sales (High Yield Fund) Effect short sales of securities, other
than as set forth in its prospectus and Statement of Additional
Information; or
<PAGE>
(12) Warrants Invest in warrants if, as a result thereof, more than 10% of
the value of the net assets of the Fund would be invested in warrants.
Personal Strategy Funds
Notwithstanding anything in the above fundamental and operating restrictions
to the contrary, the Fund may invest all of its assets in a single investment
company or a series thereof in connection with a "master-feeder" arrangement.
Such an investment would be made where the Fund (a "Feeder"), and one or more
other Funds with the same investment objective and program as the Fund,
sought to accomplish its investment objective and program by investing all of
its assets in the shares of another investment company (the "Master"). The
Master would, in turn, have the same investment objective and program as the
Fund. The Fund would invest in this manner in an effort to achieve the
economies of scale associated with having a Master fund make investments in
portfolio companies on behalf of a number of Feeder funds.
MANAGEMENT OF THE FUNDS
-------------------------------------------------------------------------------
The officers and directors/trustees of the Fund are listed below. Unless
otherwise noted, the address of each is 100 East Pratt Street, Baltimore,
Maryland 21202. Except as indicated, each has been an employee of T. Rowe
Price for more than five years. In the list below, the Fund's
directors/trustees who are considered "interested persons" of T. Rowe Price
as defined under Section 2(a)(19) of the Investment Company Act of 1940 are
noted with an asterisk (*). These directors/trustees are referred to as
inside directors by virtue of their officership, directorship, and/or
employment with T. Rowe Price.
All Funds except Personal Strategy Funds
Independent Directors/Trustees
CALVIN W. BURNETT, PH.D., President, Coppin State College; Director, Maryland
Chamber of Commerce and Provident Bank of Maryland; Former President,
Baltimore Area Council Boy Scouts of America; Vice President, Board of
Directors, The Walters Art Gallery; Address: 2500 West North Avenue,
Baltimore, Maryland 21216
ANTHONY W. DEERING, Director, Chairman of the Board, President and Chief
Operating Officer, The Rouse Company, real estate developers, Columbia,
Maryland; Advisory Director, Kleinwort, Benson (North America) Corporation, a
registered broker-dealer; Address: 10275 Little Patuxent Parkway, Columbia,
Maryland 21044
F. PIERCE LINAWEAVER, President, F. Pierce Linaweaver & Associates, Inc.;
Consulting Environmental & Civil Engineer(s); formerly Executive Vice
President, EA Engineering, Science, and Technology, Inc., and President, EA
Engineering, Inc., Baltimore, Maryland; Address: Green Spring Station, 2360
West Joppa Road, Suite 224, Lutherville, Maryland 21093
JOHN G. SCHREIBER, President, Schreiber Investments, Inc., a real estate
investment company; Director, AMLI Residential Properties Trust and Urban
Shopping Centers, Inc.; Partner, Blackstone Real Estate Partners, L.P.;
Director and formerly Executive Vice President, JMB Realty Corporation, a
national real estate investment manager and developer; Address: 1115 East
Illinois Road, Lake Forest, Illinois 60045
Personal Strategy Funds
DONALD W. DICK, JR., Principal, EuroCapital Advisors, LLC, an acquisition and
management advisory firm; formerly (5/89-6/95) Principal, Overseas Partners,
Inc., a financial investment firm; formerly (6/65-3/89) Director and Vice
President; Consumer Products Division, McCormick & Company, Inc.,
international food processors; Director, Waverly, Inc., Baltimore, Maryland;
Address: P.O. Box 491, Chilmark, MA 02535-0491
DAVID K. FAGIN, Chairman and Chief Executive Officer, Western Exploration and
Development, Ltd.; Director Golden Star Resources Ltd. and Miranda Mining
Development Corporation; formerly (1986-7/91)
<PAGE>
President, Chief Operating Officer and Director, Homestake Mining Company;
Address: 1660 Lincoln Street, Suite 3000, Denver, Colorado 80264-3001
HANNE M. MERRIMAN, Retail business consultant; formerly President and Chief
Operating Officer (1991-92), Nan Duskin, Inc., a women's specialty store,
Director (1984-90) and Chairman (1989-90) Federal Reserve Bank of Richmond,
and President and Chief Executive Officer (1988-89), Honeybee, Inc., a
division of Spiegel, Inc.; Director, Central Illinois Public Service Company,
CIPSCO Incorporated, Finlay Enterprises, Inc., The Rouse Company, State Farm
Mutual Automobile Insurance Company and USAir Group, Inc.; Address: 3201 New
Mexico Avenue, N.W., Suite 350, Washington, D.C. 20016
HUBERT D. VOS, President, Stonington Capital Corporation, a private
investment company; Address: 1231 State Street, Suite 247, Santa Barbara,
California 93190-0409
PAUL M. WYTHES, Founding General Partner, Sutter Hill Ventures, a venture
capital limited partnership, providing equity capital to young high
technology companies throughout the United States; Director, Teltone
Corporation, Interventional Technologies Inc. and Stuart Medical, Inc.;
Address: 755 Page Mill Road, Suite A200, Palo Alto, California 94304-1005
Inside Directors/Trustees/Officers
All Funds
* JAMES S. RIEPE, Director/Trustee and Vice President -Vice Chairman of the
Board and Managing Director, T. Rowe Price; Chairman of the Board, T. Rowe
Price Investment Services, Inc., T. Rowe Price Services, Inc., T. Rowe Price
Retirement Plan Services, Inc., and T. Rowe Price Trust Company; Director,
Price-Fleming and General Re Corporation
HENRY H. HOPKINS, Vice President-Vice President, Price-Fleming and T. Rowe
Price Retirement Plan Services, Inc.; Director and Managing Director, T. Rowe
Price; Vice President and Director, T. Rowe Price Investment Services, Inc.,
T. Rowe Price Services, Inc. and T. Rowe Price Trust Company
PATRICIA S. LIPPERT, Secretary-Assistant Vice President, T. Rowe Price and T.
Rowe Price Investment Services, Inc.
CARMEN F. DEYESU, Treasurer-Vice President, T. Rowe Price, T. Rowe Price
Services, Inc., and T. Rowe Price Trust Company
DAVID S. MIDDLETON, Controller-Vice President, T. Rowe Price, T. Rowe Price
Services, Inc., and T. Rowe Price Trust Company
INGRID I. VORDEMBERGE, Assistant Vice President-Employee, T. Rowe Price
Corporate Income Fund
* WILLIAM T. REYNOLDS, Chairman of the Board -Managing Director, T. Rowe
Price; Chartered Financial Analyst
* M. DAVID TESTA, Director -Chairman of the Board, Price-Fleming; Vice
Chairman of the Board, Chief Investment Officer, and Managing Director, T.
Rowe Price; Vice President and Director, T. Rowe Price Trust Company;
Chartered Financial Analyst
PETER VAN DYKE, President -Managing Director, T. Rowe Price; Vice President,
Price-Fleming, T. Rowe Price Trust Company, and T. Rowe Price Retirement Plan
Services, Inc., Chartered Investment Counselor
ROBERT M. RUBINO, Executive Vice President -Vice President, T. Rowe Price
MARK J. VASELKIV, Executive Vice President -Vice President, T. Rowe Price
STEVEN G. BROOKS, Vice President -Vice President, T. Rowe Price; Chartered
Financial Analyst
PATRICK S. CASSIDY, Vice President -Vice President, T. Rowe Price; Chartered
Financial Analyst
DEBRA R. DIES, Vice President -Credit Analyst, T. Rowe Price; formerly
employed at J.P. Morgan Securities
<PAGE>
HEATHER R. LANDON, Vice President -Vice President, T. Rowe Price and T. Rowe
Price Trust Company
EDWARD T. SCHNEIDER, Vice President -Vice President, T. Rowe Price
CHARLES P. SMITH, Vice President -Managing Director, T. Rowe Price; Vice
President, Price-Fleming
VIRGINIA A. STIRLING, Vice President -Vice President, T. Rowe Price
THOMAS E. TEWKSBURY, Vice President -Vice President, T. Rowe Price; formerly
senior bond trader, Scudder, Stevens & Clark, New York, New York
THEA N. WILLIAMS, Vice President -Vice President, T. Rowe Price
GNMA Fund
* WILLIAM T. REYNOLDS, Trustee -Managing Director, T. Rowe Price; Chartered
Financial Analyst
* M. DAVID TESTA, Trustee -Chairman of the Board, Price-Fleming; Vice
Chairman of the Board, Chief Investment Officer, and Managing Director, T.
Rowe Price; Vice President and Director, T. Rowe Price Trust Company;
Chartered Financial Analyst
PETER VAN DYKE, President -Managing Director, T. Rowe Price; Vice President,
Price-Fleming, T. Rowe Price Trust Company, and T. Rowe Price Retirement Plan
Services, Inc., Chartered Investment Counselor
CONNICE A. BAVELY, Vice President -Vice President and Senior Portfolio
Manager, T. Rowe Price; formerly founding partner and Senior Vice President
of Atlantic Asset Management Partners, LLC; Special Partner and Portfolio
Manager at Weiss Peck and Greer
DEBORAH L. BOYER, Vice President -Assistant Vice President, T. Rowe Price;
formerly Assistant Vice President and Government Bond Trader for First
Chicago NBD Corporation
HEATHER R. LANDON, Vice President -Vice President, T. Rowe Price and T. Rowe
Price Trust Company
EDMUND M. NOTZON, Vice President -Managing Director, T. Rowe Price; Vice
President, T. Rowe Price Trust Company; Chartered Financial Analyst
EDWARD T. SCHNEIDER, Vice President -Vice President, T. Rowe Price
CHARLES P. SMITH, Vice President -Managing Director, T. Rowe Price; Vice
President, Price-Fleming
Government Reserve Investment and Reserve Investment Funds
* WILLIAM T. REYNOLDS, Chairman of the Board -Managing Director, T. Rowe
Price; Chartered Financial Analyst
* M. DAVID TESTA, Director -Chairman of the Board, Price-Fleming; Vice
Chairman of the Board, Chief Investment Officer, and Managing Director, T.
Rowe Price; Vice President and Director, T. Rowe Price Trust Company;
Chartered Financial Analyst
EDWARD A. WIESE, President -Vice President, T. Rowe Price; Chartered
Financial Analyst
ROBERT P. CAMPBELL, Executive Vice President -Vice President, T. Rowe Price
and Price-Fleming
JAMES M. MCDONALD, Executive Vice President -Vice President, T. Rowe Price
PATRICE BERCHTENBREITER ELY, Vice President -Vice President, T. Rowe Price
BRIAN E. BURNS, Vice President -Assistant Vice President, T. Rowe Price
JOAN R. POTEE, Vice President -Vice President, T. Rowe Price
ROBERT M. RUBINO, Vice President -Vice President, T. Rowe Price
EDWARD T. SCHNEIDER, Vice President -Vice President, T. Rowe Price
<PAGE>
PETER VAN DYKE, Vice President -Managing Director, T. Rowe Price; Vice
President, Price-Fleming, T. Rowe Price Trust Company, and T. Rowe Price
Retirement Plan Services, Inc., Chartered Investment Counselor
GWENDOLYN G. WAGNER, Vice President -Vice President and Economist, T. Rowe
Price; Chartered Financial Analyst
High Yield Fund
* WILLIAM T. REYNOLDS, Chairman of the Board -Managing Director, T. Rowe
Price; Chartered Financial Analyst
* M. DAVID TESTA, Director -Chairman of the Board, Price-Fleming; Vice
Chairman of the Board, Chief Investment Officer, and Managing Director, T.
Rowe Price; Vice President and Director, T. Rowe Price Trust Company;
Chartered Financial Analyst
MARK J. VASELKIV, President -Vice President, T. Rowe Price
JANET G. ALBRIGHT, Vice President -Vice President, T. Rowe Price
ANDREW M. BROOKS, Vice President -Vice President, T. Rowe Price
PAUL A. KARPERS, Vice President -Employee, T. Rowe Price; formerly an
Investment Analyst at the Vanguard Group, Philadelphia, Pennsylvania
NATHANIEL S. LEVY, Vice President -Vice President, T. Rowe Price
KEVIN P. LOOME, Vice President -Employee, T. Rowe Price; formerly a Corporate
Finance Analyst for Morgan Stanley in both London and New York
MICHAEL J. MCGONIGLE, Vice President -Assistant Vice President, T. Rowe Price
EDWARD T. SCHNEIDER, Vice President -Vice President, T. Rowe Price
HUBERT M. STILES, JR., Vice President -Vice President, T. Rowe Price
THOMAS E. TEWKSBURY, Vice President -Vice President, T. Rowe Price; formerly
senior bond trader, Scudder, Stevens & Clark, New York, New York
PETER VAN DYKE, Vice President -Managing Director, T. Rowe Price; Vice
President, Price-Fleming, T. Rowe Price Trust Company, and T. Rowe Price
Retirement Plan Services, Inc., Chartered Investment Counselor
THEA N. WILLIAMS, Vice President -Vice President, T. Rowe Price
New Income Fund
* WILLIAM T. REYNOLDS, Chairman of the Board -Managing Director, T. Rowe
Price; Chartered Financial Analyst
* M. DAVID TESTA, Director -Chairman of the Board, Price-Fleming; Vice
Chairman of the Board, Chief Investment Officer, and Managing Director, T.
Rowe Price; Vice President and Director, T. Rowe Price Trust Company;
Chartered Financial Analyst
CHARLES P. SMITH, President -Managing Director, T. Rowe Price; Vice
President, Price-Fleming
ROBERT M. RUBINO, Executive Vice President -Vice President, T. Rowe Price
CONNICE A. BAVELY, Vice President -Vice President and Senior Portfolio
Manager, T. Rowe Price; formerly founding partner and Senior Vice President
of Atlantic Asset Management Partners, LLC; Special Partner and Portfolio
Manager at Weiss Peck and Greer
STEVEN G. BROOKS, Vice President -Vice President, T. Rowe Price; Chartered
Financial Analyst
PATRICK S. CASSIDY, Vice President -Vice President, T. Rowe Price; Chartered
Financial Analyst
DEBRA R. DIES, Vice President -Credit Analyst, T. Rowe Price; formerly
employed at J.P. Morgan Securities
<PAGE>
HEATHER R. LANDON, Vice President -Vice President, T. Rowe Price and T. Rowe
Price Trust Company
JAMES M. MCDONALD, Vice President -Vice President, T. Rowe Price
EDMUND M. NOTZON, Vice President -Managing Director, T. Rowe Price; Vice
President, T. Rowe Price Trust Company; Chartered Financial Analyst
JOAN R. POTEE, Vice President -Vice President, T. Rowe Price
THEODORE E. ROBSON, Vice President -Assistant Vice President, T. Rowe Price
EDWARD T. SCHNEIDER, Vice President -Vice President, T. Rowe Price
VIRGINIA A. STIRLING, Vice President -Vice President, T. Rowe Price
SUSAN G. TROLL, Vice President -Vice President and Analyst, T. Rowe Price;
formerly Vice President at Merrill Lynch Asset Management; Certified Public
Accountant
PETER VAN DYKE, Vice President -Managing Director, T. Rowe Price; Vice
President, Price-Fleming, T. Rowe Price Trust Company, and T. Rowe Price
Retirement Plan Services, Inc., Chartered Investment Counselor
GWENDOLYN G. WAGNER, Vice President -Vice President and Economist, T. Rowe
Price; Chartered Financial Analyst
Personal Strategy Balanced, Growth, and Income Funds
* JAMES A.C. KENNEDY III, Director -Managing Director, T. Rowe Price;
Chartered Financial Analyst
* M. DAVID TESTA, Chairman of the Board -Chairman of the Board,
Price-Fleming; Vice Chairman of the Board, Chief Investment Officer, and
Managing Director, T. Rowe Price; Vice President and Director, T. Rowe Price
Trust Company; Chartered Financial Analyst
PETER VAN DYKE, President -Managing Director, T. Rowe Price; Vice President,
Price-Fleming, T. Rowe Price Trust Company, and T. Rowe Price Retirement Plan
Services, Inc., Chartered Investment Counselor
STEPHEN W. BOESEL, Executive Vice President -Managing Director, T. Rowe Price
EDMUND M. NOTZON, Executive Vice President -Managing Director, T. Rowe Price;
Vice President, T. Rowe Price Trust Company; Chartered Financial Analyst
LARRY J. PUGLIA, Executive Vice President -Vice President, T. Rowe Price;
Chartered Financial Analyst
HEATHER R. LANDON, Vice President -Vice President, T. Rowe Price and T. Rowe
Price Trust Company
JOHN H. LAPORTE, JR., Vice President -Managing Director, T. Rowe Price;
Chartered Financial Analyst
DONALD J. PETERS, Vice President -Vice President, T. Rowe Price
WILLIAM T. REYNOLDS, Vice President -Managing Director, T. Rowe Price;
Chartered Financial Analyst
BRIAN C. ROGERS, Vice President -Director and Managing Director, T. Rowe
Price; Chartered Financial Analyst
MARK J. VASELKIV, Vice President -Vice President, T. Rowe Price
JUDITH B. WARD, Vice President -Employee, T. Rowe Price
RICHARD T. WHITNEY, Vice President -Managing Director, T. Rowe Price and T.
Rowe Price Trust Company; Chartered Financial Analyst
J. JEFFREY LANG, Assistant Vice President-Assistant Vice President, T. Rowe
Price
MARY C. MUNOZ, Vice President -Assistant Vice President, T. Rowe Price
<PAGE>
Prime Reserve Fund
* WILLIAM T. REYNOLDS, Chairman of the Board -Managing Director, T. Rowe
Price; Chartered Financial Analyst
* M. DAVID TESTA, Director -Chairman of the Board, Price-Fleming; Vice
Chairman of the Board, Chief Investment Officer, and Managing Director, T.
Rowe Price; Vice President and Director, T. Rowe Price Trust Company;
Chartered Financial Analyst
EDWARD A. WIESE, President -Vice President, T. Rowe Price; Chartered
Financial Analyst
ROBERT P. CAMPBELL, Executive Vice President -Vice President, T. Rowe Price
and Price-Fleming
JAMES M. MCDONALD, Executive Vice President -Vice President, T. Rowe Price
PATRICE BERCHTENBREITER ELY, Vice President -Vice President, T. Rowe Price
BRIAN E. BURNS, Vice President -Assistant Vice President, T. Rowe Price
JOAN R. POTEE, Vice President -Vice President, T. Rowe Price
ROBERT M. RUBINO, Vice President -Vice President, T. Rowe Price
EDWARD T. SCHNEIDER, Vice President -Vice President, T. Rowe Price
SUSAN G. TROLL, Vice President -Vice President and Analyst, T. Rowe Price;
formerly Vice President at Merrill Lynch Asset Management; Certified Public
Accountant
PETER VAN DYKE, Vice President -Managing Director, T. Rowe Price; Vice
President, Price-Fleming, T. Rowe Price Trust Company, and T. Rowe Price
Retirement Plan Services, Inc., Chartered Investment Counselor
GWENDOLYN G. WAGNER, Vice President -Vice President and Economist, T. Rowe
Price; Chartered Financial Analyst
Short-Term Bond Fund
* WILLIAM T. REYNOLDS, Chairman of the Board -Managing Director, T. Rowe
Price; Chartered Financial Analyst
* M. DAVID TESTA, Director -Chairman of the Board, Price-Fleming; Vice
Chairman of the Board, Chief Investment Officer, and Managing Director, T.
Rowe Price; Vice President and Director, T. Rowe Price Trust Company;
Chartered Financial Analyst
EDWARD A. WIESE, President -Vice President, T. Rowe Price; Chartered
Financial Analyst
CONNICE A. BAVELY, Vice President -Vice President and Senior Portfolio
Manager, T. Rowe Price; formerly founding partner and Senior Vice President
of Atlantic Asset Management Partners, LLC; Special Partner and Portfolio
Manager at Weiss Peck and Greer
STEVEN G. BROOKS, Vice President -Vice President, T. Rowe Price; Chartered
Financial Analyst
ROBERT P. CAMPBELL, Vice President -Vice President, T. Rowe Price and
Price-Fleming
PATRICK S. CASSIDY, Vice President -Vice President, T. Rowe Price; Chartered
Financial Analyst
DEBRA R. DIES, Vice President -Credit Analyst, T. Rowe Price; formerly
employed at J.P. Morgan Securities
CHARLES B. HILL, Vice President -Vice President, T. Rowe Price
HEATHER R. LANDON, Vice President -Vice President, T. Rowe Price and T. Rowe
Price Trust Company
JAMES M. MCDONALD, Vice President -Vice President, T. Rowe Price
CHERYL A. MICKEL, Vice President -Assistant Vice President, T. Rowe Price
THEODORE E. ROBSON, Vice President -Assistant Vice President, T. Rowe Price
<PAGE>
ROBERT M. RUBINO, Vice President -Vice President, T. Rowe Price
EDWARD T. SCHNEIDER, Vice President -Vice President, T. Rowe Price
CHARLES P. SMITH, Vice President -Managing Director, T. Rowe Price; Vice
President, Price-Fleming
VIRGINIA A. STIRLING, Vice President -Vice President, T. Rowe Price
PETER VAN DYKE, Vice President -Managing Director, T. Rowe Price; Vice
President, Price-Fleming, T. Rowe Price Trust Company, and T. Rowe Price
Retirement Plan Services, Inc., Chartered Investment Counselor
GWENDOLYN G. WAGNER, Vice President -Vice President and Economist, T. Rowe
Price; Chartered Financial Analyst
Short-Term U.S. Government Fund
* WILLIAM T. REYNOLDS, Chairman of the Board -Managing Director, T. Rowe
Price; Chartered Financial Analyst
* M. DAVID TESTA, Director -Chairman of the Board, Price-Fleming; Vice
Chairman of the Board, Chief Investment Officer, and Managing Director, T.
Rowe Price; Vice President and Director, T. Rowe Price Trust Company;
Chartered Financial Analyst
PETER VAN DYKE, President -Managing Director, T. Rowe Price; Vice President,
Price-Fleming, T. Rowe Price Trust Company, and T. Rowe Price Retirement Plan
Services, Inc., Chartered Investment Counselor
HEATHER R. LANDON, Executive Vice President -Vice President, T. Rowe Price
and T. Rowe Price Trust Company
JAMES M. MCDONALD, Vice President -Vice President, T. Rowe Price
EDMUND M. NOTZON, Vice President -Managing Director, T. Rowe Price; Vice
President, T. Rowe Price Trust Company; Chartered Financial Analyst
EDWARD T. SCHNEIDER, Vice President -Vice President, T. Rowe Price
CHARLES P. SMITH, Vice President -Managing Director, T. Rowe Price; Vice
President, Price-Fleming
GWENDOLYN G. WAGNER, Vice President -Vice President and Economist, T. Rowe
Price; Chartered Financial Analyst
U.S. Treasury Intermediate, Long-Term, and Money Funds
* WILLIAM T. REYNOLDS, Director -Managing Director, T. Rowe Price; Chartered
Financial Analyst
* M. DAVID TESTA, Director -Chairman of the Board, Price-Fleming; Vice
Chairman of the Board, Chief Investment Officer, and Managing Director, T.
Rowe Price; Vice President and Director, T. Rowe Price Trust Company;
Chartered Financial Analyst
PETER VAN DYKE, President -Managing Director, T. Rowe Price; Vice President,
Price-Fleming, T. Rowe Price Trust Company, and T. Rowe Price Retirement Plan
Services, Inc., Chartered Investment Counselor
CHARLES P. SMITH, Executive Vice President -Managing Director, T. Rowe Price;
Vice President, Price-Fleming
EDWARD A. WIESE, Executive Vice President -Vice President, T. Rowe Price;
Chartered Financial Analyst
CONNICE A. BAVELY, Vice President -Vice President and Senior Portfolio
Manager, T. Rowe Price; formerly founding partner and Senior Vice President
of Atlantic Asset Management Partners, LLC; Special Partner and Portfolio
Manager at Weiss Peck and Greer
PATRICE BERCHTENBREITER ELY, Vice President -Vice President, T. Rowe Price
BRIAN E. BURNS, Vice President -Assistant Vice President, T. Rowe Price
<PAGE>
ROBERT P. CAMPBELL, Vice President -Vice President, T. Rowe Price and
Price-Fleming
JEROME A. CLARK, Vice President -Vice President, T. Rowe Price
HEATHER R. LANDON, Vice President -Vice President, T. Rowe Price and T. Rowe
Price Trust Company
JAMES M. MCDONALD, Vice President -Vice President, T. Rowe Price
CHERYL A. MICKEL, Vice President -Assistant Vice President, T. Rowe Price
EDMUND M. NOTZON, Vice President -Managing Director, T. Rowe Price; Vice
President, T. Rowe Price Trust Company; Chartered Financial Analyst
JOAN R. POTEE, Vice President -Vice President, T. Rowe Price
ROBERT M. RUBINO, Vice President -Vice President, T. Rowe Price
EDWARD T. SCHNEIDER, Vice President -Vice President, T. Rowe Price
GWENDOLYN G. WAGNER, Vice President -Vice President and Economist, T. Rowe
Price; Chartered Financial Analyst
Compensation Table
The Funds do not pay pension or retirement benefits to their officers or
directors/trustees. Also, any director/ trustee of a Fund who is an officer
or employee of T. Rowe Price or Price-Fleming does not receive any
remuneration from the Fund.
<TABLE>
<CAPTION>
Name of Person, Aggregate Compensation from Fund(a) Total Compensation from Fund and Fund Complex Paid
Position ------- to Directors/ Trustees(b)
- -------------------------------- -----------
- -----------------------------------------------------------------------
-----------------------------------------------------------------------------------
---------------------------------------------------
<S> <S> <S>
GNMA Fund
Robert P. Black, Trustee(c) $2,752 $65,000
Calvin W. Burnett, Ph.D., Trustee 2,752 65,000
Anthony W. Deering, Trustee 1,694 81,000
F. Pierce Linaweaver, Trustee 2,752 66,000
John G. Schreiber, Trustee 2,752 65,000
- -----------------------------------------------------------------------------------------------------------------------------------
High Yield Fund
Robert P. Black, Director(c) $3,630 $65,000
Calvin W. Burnett, Ph.D.,
Director 3,630 65,000
Anthony W. Deering, Director 2,037 81,000
F. Pierce Linaweaver, Director 3,630 66,000
John G. Schreiber, Director 3,630 65,000
- -----------------------------------------------------------------------------------------------------------------------------------
New Income Fund
Robert P. Black, Director(c) $4,205 $65,000
Calvin W. Burnett, Ph.D.,
Director 4,205 65,000
Anthony W. Deering, Director 2,265 81,000
F. Pierce Linaweaver, Director 4,205 66,000
John G. Schreiber, Director 4,205 65,000
- -----------------------------------------------------------------------------------------------------------------------------------
Personal Strategy Balanced Fund
Donald W. Dick, Jr., Director $1,126 $81,000
David K. Fagin, Director 1,220 65,000
Hanne M. Merriman, Director 1,220 65,000
Hubert D. Vos, Director 1,220 66,000
Paul M. Wythes, Director 1,126 80,000
- -----------------------------------------------------------------------------------------------------------------------------------
Personal Strategy Growth Fund
Donald W. Dick, Jr., Director $1,049 $81,000
David K. Fagin, Director 1,084 65,000
Hanne M. Merriman, Director 1,084 65,000
Hubert D. Vos, Director 1,084 66,000
Paul M. Wythes, Director 1,049 80,000
- -----------------------------------------------------------------------------------------------------------------------------------
Personal Strategy Income Fund
Donald W. Dick, Jr., Director $1,037 $81,000
David K. Fagin, Director 1,059 65,000
Hanne M. Merriman, Director 1,059 65,000
Hubert D. Vos, Director 1,059 66,000
Paul M. Wythes, Director 1,037 80,000
- -----------------------------------------------------------------------------------------------------------------------------------
Prime Reserve Fund
Robert P. Black, Director(c) $8,713 $65,000
Calvin W. Burnett, Ph.D.,
Director 8,713 65,000
Anthony W. Deering, Director 4,057 81,000
F. Pierce Linaweaver, Director 8,713 66,000
John G. Schreiber, Director 8,713 65,000
- -----------------------------------------------------------------------------------------------------------------------------------
Short-Term Bond Fund
Robert P. Black, Director(c) $1,611 $65,000
Calvin W. Burnett, Ph.D.,
Director 1,611 65,000
Anthony W. Deering, Director 1,240 81,000
F. Pierce Linaweaver, Director 1,611 66,000
John G. Schreiber, Director 1,611 65,000
- -----------------------------------------------------------------------------------------------------------------------------------
Short-Term U.S. Government Fund
Robert P. Black, Director(c) $1,140 $65,000
Calvin W. Burnett, Ph.D.,
Director 1,140 65,000
Anthony W. Deering, Director 1,340 81,000
F. Pierce Linaweaver, Director 1,140 66,000
John G. Schreiber, Director 1,140 65,000
- -----------------------------------------------------------------------------------------------------------------------------------
U.S. Treasury Intermediate Fund
Robert P. Black, Director(c) $1,124 $65,000
Calvin W. Burnett, Ph.D.,
Director 1,124 65,000
Anthony W. Deering, Director 1,292 81,000
F. Pierce Linaweaver, Director 1,124 66,000
John G. Schreiber, Director 1,124 65,000
- -----------------------------------------------------------------------------------------------------------------------------------
U.S. Treasury Long-Term Fund
Robert P. Black, Director(c) $1,559 $65,000
Calvin W. Burnett, Ph.D.,
Director 1,559 65,000
Anthony W. Deering, Director 2,412 81,000
F. Pierce Linaweaver, Director 1,559 66,000
John G. Schreiber, Director 1,559 65,000
- -----------------------------------------------------------------------------------------------------------------------------------
U.S. Treasury Money Fund
Robert P. Black, Director(c) $1,157 $65,000
Calvin W. Burnett, Ph.D.,
Director 1,157 65,000
Anthony W. Deering, Director 1,383 81,000
F. Pierce Linaweaver, Director 1,157 66,000
John G. Schreiber, Director 1,157 65,000
- -----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
<PAGE>
<PAGE>
(a) Amounts in this column are based on accrued compensation from June 1,
1997 to May 31, 1998.
(b) Amounts in this column are based on compensation received from January
1, 1997, to December 31, 1997. The T. Rowe Price complex included 84 funds
as of December 31, 1997.
(c) Mr. Black retired from his position with the Funds in April 1998.
Note: Government Reserve Investment and Reserve Investments Funds will not
incur director's fees.
All Funds
The Fund's Executive Committee, consisting of the Fund's interested
directors/trustees, has been authorized by its respective Board of
Directors/Trustees to exercise all powers of the Board to manage the Funds in
the intervals between meetings of the Board, except the powers prohibited by
statute from being delegated.
PRINCIPAL HOLDERS OF SECURITIES
-------------------------------------------------------------------------------
As of the date of the prospectus, the officers and directors/trustees of the
Fund, as a group, owned less than 1% of the outstanding shares of the Fund.
As of June 30, 1998, the following shareholders beneficially owned more than
5% of the outstanding shares of:
GNMA, High Yield, New Income, and U.S. Treasury Long-Term Funds: Yachtcrew &
Co., T. Rowe Price Associates, Inc., 100 East Pratt Street, Baltimore,
Maryland 21202;
Government Reserve Investment Fund: Barnaclesail, c/o T. Rowe Price
Associates, Inc., 100 East Pratt Street, Baltimore, Maryland 21202;
Bridgesail & Co., c/o T. Rowe Price Associates, Inc., 100 East Pratt Street,
Baltimore, Maryland 21202
<PAGE>
Reserve Investment Fund: Drakkar & Co., c/o T. Rowe Price Associates, Inc.,
100 East Pratt Street, Baltimore, Maryland 21202; Eye & Co., c/o T. Rowe
Price Associates, Inc., 100 East Pratt Street, Baltimore, Maryland 21202;
Taskforce & Co., c/o T. Rowe Price Associates, Inc., 100 East Pratt Street,
Baltimore, Maryland 21202; Shorebird & Co., c/o T. Rowe Price Associates,
Inc., 100 East Pratt Street, Baltimore, Maryland 21202;
U.S. Treasury Intermediate Fund: First American Trust Co., Managed Omnibus,
421 N Main Street, Santa Ana, California 92701-4699.
INVESTMENT MANAGEMENT SERVICES
-------------------------------------------------------------------------------
Services
Under the Management Agreement, T. Rowe Price provides the Fund with
discretionary investment services. Specifically, T. Rowe Price is responsible
for supervising and directing the investments of the Fund in accordance with
the Fund's investment objectives, program, and restrictions as provided in
its prospectus and this Statement of Additional Information. T. Rowe Price is
also responsible for effecting all security transactions on behalf of the
Fund, including the negotiation of commissions and the allocation of
principal business and portfolio brokerage. In addition to these services, T.
Rowe Price provides the Fund with certain corporate administrative services,
including: maintaining the Fund's corporate existence and corporate records;
registering and qualifying Fund shares under federal laws; monitoring the
financial, accounting, and administrative functions of the Fund; maintaining
liaison with the agents employed by the Fund such as the Fund's custodian and
transfer agent; assisting the Fund in the coordination of such agents'
activities; and permitting T. Rowe Price's employees to serve as officers,
directors/trustees, and committee members of the Fund without cost to the
Fund.
The Management Agreement also provides that T. Rowe Price, its
directors/trustees, officers, employees, and certain other persons performing
specific functions for the Fund will only be liable to the Fund for losses
resulting from willful misfeasance, bad faith, gross negligence, or reckless
disregard of duty.
All Funds except Government Reserve Investment and Reserve Investment Funds
Management Fee
The Fund pays T. Rowe Price a fee ("Fee") which consists of two components: a
Group Management Fee ("Group Fee") and an Individual Fund Fee ("Fund Fee").
The Fee is paid monthly to T. Rowe Price on the first business day of the
next succeeding calendar month and is calculated as described below.
The monthly Group Fee ("Monthly Group Fee") is the sum of the daily Group Fee
accruals ("Daily Group Fee Accruals") for each month. The Daily Group Fee
Accrual for any particular day is computed by multiplying the Price Funds'
group fee accrual as determined below ("Daily Price Funds' Group Fee
Accrual") by the ratio of the Price Fund's net assets for that day to the sum
of the aggregate net assets of the Price Funds for that day. The Daily Price
Funds' Group Fee Accrual for any particular day is calculated by multiplying
the fraction of one (1) over the number of calendar days in the year by the
annualized Daily Price Funds' Group Fee Accrual for that day as determined in
accordance with the following schedule:
<TABLE>
Price Funds' Annual Group Base Fee Rate for Each Level of
Assets
<CAPTION>
<S> <C> <C> <C> <C> <C> <C>
0.480% First $1 billion 0.360% Next $2 billion 0.310% Next $16
billion
---------------------------------------------------------------------------
0.450% Next $1 billion 0.350% Next $2 billion 0.305% Next $30
billion
---------------------------------------------------------------------------
0.420% Next $1 billion 0.340% Next $5 billion 0.300% Thereafter
---------------------------------------------------------------------------
0.390% Next $1 billion 0.330% Next $10 billion
---------------------------------------------------------------------------
0.370% Next $1 billion 0.320% Next $10 billion
</TABLE>
For the purpose of calculating the Group Fee, the Price Funds include all the
mutual funds distributed by T. Rowe Price Investment Services, Inc.,
(excluding the T. Rowe Price Spectrum Funds, and any institutional, index, or
private label mutual funds). For the purpose of calculating the Daily Price
Funds' Group Fee
<PAGE>
Accrual for any particular day, the net assets of each Price Fund are
determined in accordance with the Funds' prospectus as of the close of
business on the previous business day on which the Fund was open for
business.
The monthly Fund Fee ("Monthly Fund Fee") is the sum of the daily Fund Fee
accruals ("Daily Fund Fee Accruals") for each month. The Daily Fund Fee
Accrual for any particular day is computed by multiplying the fraction of one
(1) over the number of calendar days in the year by the individual Fund Fee
Rate and multiplying this product by the net assets of the Fund for that day,
as determined in accordance with the Fund's prospectus as of the close of
business on the previous business day on which the Fund was open for
business. The individual fund fees of each Fund are listed in the following
chart:
<TABLE>
<CAPTION>
<S> <C>
Corporate Income Fund 0.15%
GNMA Fund 0.15%
High Yield Fund 0.30%
New Income Fund 0.15%
Personal Strategy Balanced Fund 0.25%
Personal Strategy Growth Fund 0.30%
Personal Strategy Income Fund 0.15%
Prime Reserve Fund 0.05%
Short-Term Bond Fund 0.10%
Short-Term U.S. Government Fund 0.10%
U.S. Treasury Intermediate Fund 0.05%
U.S. Treasury Long-Term Fund 0.05%
U.S. Treasury Money Fund 0.00%
</TABLE>
The following chart sets forth the total management fees, if any, paid to T.
Rowe Price by each Fund, during the last three years:
<TABLE>
<CAPTION>
Fund 1998 1997 1996
---- ---- ---- ----
<S> <C> <C> <C>
Corporate Income (a) (a) (a)
GNMA $ 4,928,000 $ 4,398,000 $ 4,223,000
High Yield 9,797,000 8,206,000 7,752,000
New Income 9,047,000 7,984,000 7,886,000
Personal Strategy Balanced 1,685,000 897,000 150,000
Personal Strategy Growth 514,000 92,000 (a)
Personal Strategy Income 206,000 22,000 (a)
Prime Reserve 17,281,000 16,431,000 15,320,000
Short-Term Bond 1,478,000 1,795,000 2,099,000
Short-Term U.S. Government 317,000 250,000 281,000
U.S. Treasury Intermediate 724,000 694,000 684,000
U.S. Treasury Long-Term 687,000 276,000 240,000
U.S. Treasury Money 2,668,000 2,585,000 2,507,000
- -----------------------------------------------------------------------------------------------
</TABLE>
(a) Due to the Fund's expense limitation in effect at that time, no
management fee was paid by the Fund to T. Rowe Price.
Limitation on Fund Expenses
The Management Agreement between the Fund and T. Rowe Price provides that the
Fund will bear all expenses of its operations not specifically assumed by T.
Rowe Price.
<PAGE>
The following chart sets forth expense ratio limitations and the periods for
which they are effective. For each, T. Rowe Price has agreed to bear any Fund
expenses which would cause the Fund's ratio of expenses to average net assets
to exceed the indicated percentage limitations. The expenses borne by T. Rowe
Price are subject to reimbursement by the Fund through the indicated
reimbursement date, provided no reimbursement will be made if it would result
in the Fund's expense ratio exceeding its applicable limitation.
<TABLE>
<CAPTION>
Expense Reimbursement
Fund Limitation Period ------- -------------
---- ----------------- Ratio Date
- ----------------------------------------------------------------------------------------- ----- ----
Limitation
----------
---------------------------
<S> <S> <S> <S>
June 1, 1997 - May 31,
Corporate Income(a) 1999 0.80% May 31, 2001
June 1, 1998 - May 31,
Personal Strategy Growth(b) 2000 1.10% May 31, 2000
June 1, 1998 - May 31,
Personal Strategy Income(c) 2000 0.95% May 31, 2000
June 1, 1998 - May 31,
Short-Term U.S. Government(d) 2000 0.70% May 31, 2000
U.S. Treasury Long-Term(e) June 1, 1997 - May 31, 0.80% May 31, 2001
1999
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
(a) The Corporate Income Fund operated under a 0.80% limitation that
expired May 31, 1997. The reimbursement period for this limitation
extends through May 31, 1999.
(b) The Personal Strategy Growth Fund previously operated under a 1.10%
limitation that expired May 31, 1998. The reimbursement period for this
limitation extends through May 31, 2000.
(c) The Personal Strategy Income Fund previously operated under a 0.95%
limitation that expired May 31, 1998. The reimbursement period for this
limitation extends through May 31, 2000.
(d) The Short-Term U.S. Government Fund previously operated under a 0.70%
limitation that expired May 31, 1998. The reimbursement period for this
limitation extends through May 31, 2000.
(e) The Long-Term Fund operated under a 0.80% limitation that expired May
31, 1997. The reimbursement period for this limitation extends through
May 31, 1999.
Each of the above-referenced Fund's Management Agreement also provides that
one or more additional expense limitations periods (of the same or different
time periods) may be implemented after the expiration of the current expense
limitation, and that with respect to any such additional limitation period,
the Fund may reimburse T. Rowe Price, provided the reimbursement does not
result in the Fund's aggregate expenses exceeding the additional expense
limitation.
Pursuant to the Corporate Income Fund's current expense limitation, $148,000
of management fees were not accrued by the Fund for the year ended May 31,
1998, and $1,000 of other expenses were borne by the manager. Additionally,
$261,000 of unaccrued fees and expenses related to a prior period are subject
to reimbursement through May 31, 1999.
Pursuant to the U.S. Treasury Long-Term Fund's previous expense limitation,
$22,000 of unaccrued 1996-1997 management fees were repaid during the year
ended May 31, 1998.
Pursuant to the Personal Strategy Balanced Fund's previous expense
limitation, $62,000 of unaccrued management fees related to a previous
expense limitation are subject to reimbursement through May 31, 2000.
Pursuant to the Personal Strategy Growth Fund's previous expense limitation,
$110,000 of management fees were not accrued by the Fund for the year ended
May 31, 1998. Additionally, $177,000 of unaccrued management fees related to
a previous expense limitation are subject to reimbursement through May 31,
2000. Additionally, $137,000 of management fees and $188,000 of expenses from
a previous limitation were permanently waived.
Pursuant to the Personal Strategy Income Fund's previous expense limitation,
$97,000 of management fees were not accrued by the Fund for the year ended
May 31, 1998. Additionally, $141,000 of unaccrued management fees related to
a previous expense limitation are subject to reimbursement through May 31,
2000. Additionally, $163,000 of management fees and $123,000 of expenses from
a previous limitation were permanently waived.
<PAGE>
Pursuant to the Short-Term U.S. Government Fund's current expense limitation,
$111,000 of management fees were not accrued by the Fund for the year ended
May 31, 1998. Additionally, $155,000 of unaccrued management fees remain
subject to reimbursement through May 31, 2000.
GNMA, High Yield, New Income, Short-Term Bond, and U.S. Treasury Long-Term
Funds
T. Rowe Price Spectrum Fund, Inc.
The Funds listed above are a party to a Special Servicing Agreement
("Agreement") between and among T. Rowe Price Spectrum Fund, Inc. ("Spectrum
Fund"), T. Rowe Price, and various other T. Rowe Price funds which, along
with the Fund, are funds in which Spectrum Fund invests (collectively all
such funds "Underlying Price Funds").
The Agreement provides that, if the Board of Directors/Trustees of any
Underlying Price Fund determines that such Underlying Fund's share of the
aggregate expenses of Spectrum Fund is less than the estimated savings to the
Underlying Price Fund from the operation of Spectrum Fund, the Underlying
Price Fund will bear those expenses in proportion to the average daily value
of its shares owned by Spectrum Fund, provided further that no Underlying
Price Fund will bear such expenses in excess of the estimated savings to it.
Such savings are expected to result primarily from the elimination of
numerous separate shareholder accounts which are or would have been invested
directly in the Underlying Price Funds and the resulting reduction in
shareholder servicing costs. Although such cost savings are not certain, the
estimated savings to the Underlying Price Funds generated by the operation of
Spectrum Fund are expected to be sufficient to offset most, if not all, of
the expenses incurred by Spectrum Fund.
Management Fee
Government Reserve Investment and Reserve Investment Funds
Neither Fund pays T. Rowe Price an investment management fee.
Management Related Services
As noted above, the Management Agreement spells out the expenses to be paid
by the Fund. In addition to the Management Fee, the Fund pays for the
following: shareholder service expenses; custodial, accounting, legal, and
audit fees; costs of preparing and printing prospectuses and reports sent to
shareholders; registration fees and expenses; proxy and annual meeting
expenses (if any); and director/trustee fees and expenses.
T. Rowe Price Services, Inc., a wholly owned subsidiary of T. Rowe Price,
acts as the Fund's transfer and dividend disbursing agent and provides
shareholder and administrative services. Services for certain types of
retirement plans are provided by T. Rowe Price Retirement Plan Services,
Inc., also a wholly owned subsidiary. The address for each is 100 East Pratt
St., Baltimore, MD 21202. Additionally, T. Rowe Price, under a separate
agreement with the Funds, provides accounting services to the Funds.
The Funds paid the expenses shown in the following table for the fiscal year
ended May 31, 1998, to T. Rowe Price and its affiliates.
<TABLE>
<CAPTION>
Transfer Agent and Retirement Accounting
Fund Shareholder Services Subaccounting Services
---- -------------------- Services --------
--------
<S> <C> <C> <C>
Corporate Income $ 47,000 -- $ 71,000
GNMA 1,471,000 $ 195,000 121,000
Government Reserve Investment -- -- 45,000
High Yield 1,966,000 169,000 166,000
New Income 2,112,000 1,368,000 107,000
Personal Strategy Balanced 103,000 643,000 71,000
Personal Strategy Growth 110,000 178,000 71,000
Personal Strategy Income 48,000 105,000 71,000
Prime Reserve 4,913,000 3,785,000 85,000
- ------------------------------------------------------------------------------------------------------------
Reserve Investment 1,000 -- 45,000
Short-Term Bond 351,000 251,000 121,000
Short-Term U.S. Government 111,000 11,000 101,000
U.S. Treasury Intermediate 157,000 70,000 61,000
U.S. Treasury Long-Term 300,000 17,000 61,000
U.S. Treasury Money 522,000 528,000 61,000
- ------------------------------------------------------------------------------------------------------------
</TABLE>
<PAGE>
All Funds except Government Reserve Investment and Reserve Investment Funds
DISTRIBUTOR FOR THE FUNDS
-------------------------------------------------------------------------------
T. Rowe Price Investment Services, Inc. ("Investment Services"), a Maryland
corporation formed in 1980 as a wholly owned subsidiary of T. Rowe Price,
serves as the Fund's distributor. Investment Services is registered as a
broker-dealer under the Securities Exchange Act of 1934 and is a member of
the National Association of Securities Dealers, Inc. The offering of the
Fund's shares is continuous.
Investment Services is located at the same address as the Fund and T. Rowe
Price-100 East Pratt Street, Baltimore, Maryland 21202.
Investment Services serves as distributor to the Fund pursuant to an
Underwriting Agreement ("Underwriting Agreement"), which provides that the
Fund will pay all fees and expenses in connection with: necessary state
filings; preparing, setting in type, printing, and mailing its prospectuses
and reports to shareholders; and issuing its shares, including expenses of
confirming purchase orders.
The Underwriting Agreement provides that Investment Services will pay all
fees and expenses in connection with: printing and distributing prospectuses
and reports for use in offering and selling Fund shares; preparing, setting
in type, printing, and mailing all sales literature and advertising;
Investment Services' federal and state registrations as a broker-dealer; and
offering and selling Fund shares, except for those fees and expenses
specifically assumed by the Fund. Investment Services' expenses are paid by
T. Rowe Price.
Investment Services acts as the agent of the Fund in connection with the sale
of its shares in the various states in which Investment Services is qualified
as a broker-dealer. Under the Underwriting Agreement, Investment Services
accepts orders for Fund shares at net asset value. No sales charges are paid
by investors or the Fund.
CUSTODIAN
-------------------------------------------------------------------------------
State Street Bank and Trust Company is the custodian for the Fund's U.S.
securities and cash, but it does not participate in the Fund's investment
decisions. Portfolio securities purchased in the U.S. are maintained in the
custody of the Bank and may be entered into the Federal Reserve Book Entry
System, or the security depository system of the Depository Trust
Corporation. State Street Bank's main office is at 225 Franklin Street,
Boston, Massachusetts 02110.
The Fund (other than GNMA, Prime Reserve, U.S. Treasury Intermediate,
Long-Term, Money, Government Reserve Investment, and Reserve Investment
Funds) has entered into a Custodian Agreement with The Chase Manhattan Bank,
N.A., London, pursuant to which portfolio securities which are purchased
outside the United States are maintained in the custody of various foreign
branches of The Chase Manhattan Bank and such other custodians, including
foreign banks and foreign securities depositories as are approved in
accordance with regulations under the Investment Company Act of 1940. The
address for The Chase Manhattan Bank, N.A., London is Woolgate House, Coleman
Street, London, EC2P 2HD, England.
<PAGE>
SHAREHOLDER SERVICES
-------------------------------------------------------------------------------
T. Rowe Price Services, Inc., another wholly owned subsidiary, acts as the
Fund's transfer and dividend disbursing agent and provides shareholder and
administrative services. Services for certain types of retirement plans are
provided by T. Rowe Price Retirement Plan Services, Inc., also a wholly owned
subsidiary. The address for each is 100 East Pratt St., Baltimore, MD 21202.
The Fund from time to time may enter into agreements with outside parties
through which shareholders hold Fund shares. The shares would be held by such
parties in omnibus accounts. The agreements would provide for payments by the
Fund to the outside party for shareholder services provided to shareholders
in the omnibus accounts.
CODE OF ETHICS
-------------------------------------------------------------------------------
The Fund's investment adviser (T. Rowe Price) has a written Code of Ethics
which requires all employees to obtain prior clearance before engaging in
personal securities transactions. In addition, all employees must report
their personal securities transactions within 10 days of their execution.
Employees will not be permitted to effect transactions in a security: if
there are pending client orders in the security; the security has been
purchased or sold by a client within seven calendar days; the security is
being considered for purchase for a client; a change has occurred in T. Rowe
Price's rating of the security within seven calendar days prior to the date
of the proposed transaction; or the security is subject to internal trading
restrictions. In addition, employees are prohibited from profiting from
short-term trading (e.g., purchases and sales involving the same security
within 60 days). Any material violation of the Code of Ethics is reported to
the Board of the Fund. The Board also reviews the administration of the Code
of Ethics on an annual basis.
PORTFOLIO TRANSACTIONS
-------------------------------------------------------------------------------
Investment or Brokerage Discretion
Decisions with respect to the purchase and sale of portfolio securities on
behalf of the Fund are made by T. Rowe Price. T. Rowe Price is also
responsible for implementing these decisions, including the negotiation of
commissions and the allocation of portfolio brokerage and principal business.
The Fund's purchases and sales of fixed income portfolio securities are
normally done on a principal basis and do not involve the payment of a
commission although they may involve the designation of selling concessions.
That part of the discussion below relating solely to brokerage commissions
would not normally apply to the Fund (except to the extent it purchases
equity securities (High Yield, New Income, and Personal Strategy Funds
only)). However, it is included because T. Rowe Price does manage a
significant number of common stock portfolios which do engage in agency
transactions and pay commissions and because some research and services
resulting from the payment of such commissions may benefit the Fund.
How Brokers and Dealers Are Selected
Equity Securities
In purchasing and selling the Fund's portfolio securities, it is T. Rowe
Price's policy to obtain quality execution at the most favorable prices
through responsible brokers and dealers and, in the case of agency
transactions, at competitive commission rates. However, under certain
conditions, the Fund may pay higher brokerage commissions in return for
brokerage and research services. As a general practice, over-the-counter
orders are executed with market-makers. In selecting among market-makers, T.
Rowe Price generally seeks to select those it believes to be actively and
effectively trading the security being purchased or sold. In selecting
broker-dealers to execute the Fund's portfolio transactions, consideration is
given to such factors as the price of the security, the rate of the
commission, the size and difficulty of the order, the reliability, integrity,
financial condition, general execution and operational capabilities of
competing brokers and dealers, and
<PAGE>
brokerage and research services provided by them. It is not the policy of T.
Rowe Price to seek the lowest available commission rate where it is believed
that a broker or dealer charging a higher commission rate would offer greater
reliability or provide better price or execution.
Fixed Income Securities
Fixed income securities are generally purchased from the issuer or a primary
market-maker acting as principal for the securities on a net basis, with no
brokerage commission being paid by the client although the price usually
includes an undisclosed compensation. Transactions placed through dealers
serving as primary market-makers reflect the spread between the bid and asked
prices. Securities may also be purchased from underwriters at prices which
include underwriting fees.
With respect to equity and fixed income securities, T. Rowe Price may effect
principal transactions on behalf of the Fund with a broker or dealer who
furnishes brokerage and/or research services, designate any such broker or
dealer to receive selling concessions, discounts or other allowances, or
otherwise deal with any such broker or dealer in connection with the
acquisition of securities in underwritings. T. Rowe Price may receive
research services in connection with brokerage transactions, including
designations in a fixed price offerings.
How Evaluations Are Made of the Overall Reasonableness of Brokerage Commissions
Paid
On a continuing basis, T. Rowe Price seeks to determine what levels of
commission rates are reasonable in the marketplace for transactions executed
on behalf of the Fund. In evaluating the reasonableness of commission rates,
T. Rowe Price considers: (a) historical commission rates, both before and
since rates have been fully negotiable; (b) rates which other institutional
investors are paying, based on available public information; (c) rates quoted
by brokers and dealers; (d) the size of a particular transaction, in terms of
the number of shares, dollar amount, and number of clients involved; (e) the
complexity of a particular transaction in terms of both execution and
settlement; (f) the level and type of business done with a particular firm
over a period of time; and (g) the extent to which the broker or dealer has
capital at risk in the transaction.
Descriptions of Research Services Received From Brokers and Dealers
T. Rowe Price receives a wide range of research services from brokers and
dealers. These services include information on the economy, industries,
groups of securities, individual companies, statistical information,
accounting and tax law interpretations, political developments, legal
developments affecting portfolio securities, technical market action, pricing
and appraisal services, credit analysis, risk measurement analysis,
performance analysis and analysis of corporate responsibility issues. These
services provide both domestic and international perspective. Research
services are received primarily in the form of written reports, computer
generated services, telephone contacts and personal meetings with security
analysts. In addition, such services may be provided in the form of meetings
arranged with corporate and industry spokespersons, economists, academicians
and government representatives. In some cases, research services are
generated by third parties but are provided to T. Rowe Price by or through
broker-dealers.
Research services received from brokers and dealers are supplemental to T.
Rowe Price's own research effort and, when utilized, are subject to internal
analysis before being incorporated by T. Rowe Price into its investment
process. As a practical matter, it would not be possible for T. Rowe Price's
Equity Research Division to generate all of the information presently
provided by brokers and dealers. T. Rowe Price pays cash for certain research
services received from external sources. T. Rowe Price also allocates
brokerage for research services which are available for cash. While receipt
of research services from brokerage firms has not reduced T. Rowe Price's
normal research activities, the expenses of T. Rowe Price could be materially
increased if it attempted to generate such additional information through its
own staff. To the extent that research services of value are provided by
brokers or dealers, T. Rowe Price may be relieved of expenses which it might
otherwise bear.
T. Rowe Price has a policy of not allocating brokerage business in return for
products or services other than brokerage or research services. In accordance
with the provisions of Section 28(e) of the Securities Exchange Act of 1934,
T. Rowe Price may from time to time receive services and products which serve
both research and non-research functions. In such event, T. Rowe Price makes
a good faith determination of the anticipated
<PAGE>
research and non-research use of the product or service and allocates
brokerage only with respect to the research component.
Commissions to Brokers Who Furnish Research Services
Certain brokers and dealers who provide quality brokerage and execution
services also furnish research services to T. Rowe Price. With regard to the
payment of brokerage commissions, T. Rowe Price has adopted a brokerage
allocation policy embodying the concepts of Section 28(e) of the Securities
Exchange Act of 1934, which permits an investment adviser to cause an account
to pay commission rates in excess of those another broker or dealer would
have charged for effecting the same transaction, if the adviser determines in
good faith that the commission paid is reasonable in relation to the value of
the brokerage and research services provided. The determination may be viewed
in terms of either the particular transaction involved or the overall
responsibilities of the adviser with respect to the accounts over which it
exercises investment discretion. Accordingly, while T. Rowe Price cannot
readily determine the extent to which commission rates or net prices charged
by broker-dealers reflect the value of their research services, T. Rowe Price
would expect to assess the reasonableness of commissions in light of the
total brokerage and research services provided by each particular broker. T.
Rowe Price may receive research, as defined in Section 28(e), in connection
with selling concessions and designations in fixed price offerings in which
the Funds participate.
Internal Allocation Procedures
T. Rowe Price has a policy of not precommitting a specific amount of business
to any broker or dealer over any specific time period. Historically, the
majority of brokerage placement has been determined by the needs of a
specific transaction such as market-making, availability of a buyer or seller
of a particular security, or specialized execution skills. However, T. Rowe
Price does have an internal brokerage allocation procedure for that portion
of its discretionary client brokerage business where special needs do not
exist, or where the business may be allocated among several brokers or
dealers which are able to meet the needs of the transaction.
Each year, T. Rowe Price assesses the contribution of the brokerage and
research services provided by brokers or dealers, and attempts to allocate a
portion of its brokerage business in response to these assessments. Research
analysts, counselors, various investment committees, and the Trading
Department each seek to evaluate the brokerage and research services they
receive from brokers or dealers and make judgments as to the level of
business which would recognize such services. In addition, brokers or dealers
sometimes suggest a level of business they would like to receive in return
for the various brokerage and research services they provide. Actual
brokerage received by any firm may be less than the suggested allocations but
can, and often does, exceed the suggestions, because the total business is
allocated on the basis of all the considerations described above. In no case
is a broker or dealer excluded from receiving business from T. Rowe Price
because it has not been identified as providing research services.
Miscellaneous
T. Rowe Price's brokerage allocation policy is consistently applied to all
its fully discretionary accounts, which represent a substantial majority of
all assets under management. Research services furnished by brokers or
dealers through which T. Rowe Price effects securities transactions may be
used in servicing all accounts (including non-Fund accounts) managed by T.
Rowe Price. Conversely, research services received from brokers or dealers
which execute transactions for the Fund are not necessarily used by T. Rowe
Price exclusively in connection with the management of the Fund.
From time to time, orders for clients may be placed through a computerized
transaction network.
The Fund does not allocate business to any broker-dealer on the basis of its
sales of the Fund's shares. However, this does not mean that broker-dealers
who purchase Fund shares for their clients will not receive business from the
Fund.
Some of T. Rowe Price's other clients have investment objectives and programs
similar to those of the Fund. T. Rowe Price may occasionally make
recommendations to other clients which result in their purchasing or selling
securities simultaneously with the Fund. As a result, the demand for
securities being purchased or the
<PAGE>
supply of securities being sold may increase, and this could have an adverse
effect on the price of those securities. It is T. Rowe Price's policy not to
favor one client over another in making recommendations or in placing orders.
T. Rowe Price frequently follows the practice of grouping orders of various
clients for execution which generally results in lower commission rates being
attained. In certain cases, where the aggregate order is executed in a series
of transactions at various prices on a given day, each participating client's
proportionate share of such order reflects the average price paid or received
with respect to the total order. T. Rowe Price has established a general
investment policy that it will ordinarily not make additional purchases of a
common stock of a company for its clients (including the T. Rowe Price Funds)
if, as a result of such purchases, 10% or more of the outstanding common
stock of such company would be held by its clients in the aggregate.
At the present time, T. Rowe Price does not recapture commissions or
underwriting discounts or selling group concessions in connection with
taxable securities acquired in underwritten offerings. T. Rowe Price does,
however, attempt to negotiate elimination of all or a portion of the
selling-group concession or underwriting discount when purchasing tax-exempt
municipal securities on behalf of its clients in underwritten offerings.
Other
For the fiscal years ended May 31, 1998, 1997, and 1996, the Fund's engaged
in portfolio transactions involving broker-dealers in the following amounts:
<TABLE>
<CAPTION>
Fund 1998 1997 1996
---- ---- ---- ----
<S> <C> <C> <C>
Corporate Income $ 151,154,000 $ 176,025,000 $ 47,773,000
GNMA 3,404,198,000 3,521,560,000 2,878,094,000
Government Reserve Investment 46,218,342,000 -- --
High Yield 5,081,624,000 7,709,749,000 8,397,015,000
New Income 7,287,233,000 9,166,858,000 5,290,374,000
Personal Strategy Balanced 589,959,000 796,969,000 554,041,000
Personal Strategy Growth 225,909,000 354,770,000 128,451,000
Personal Strategy Income 188,714,000 350,204,000 230,017,000
Prime Reserve 64,296,588,000 84,827,266,000 52,505,379,000
Reserve Investment Fund 66,138,193,000 -- --
Short-Term Bond 1,113,884,000 3,380,454,000 4,596,925,000
Short-Term U.S. Government 332,928,000 640,894,000 646,520,000
U.S. Treasury Intermediate 507,228,000 806,082,000 215,529,000
U.S. Treasury Long-Term 604,802,000 352,705,000 149,585,000
U.S. Treasury Money 5,373,760,000 6,115,390,000 5,834,599,000
- -------------------------------------------------------------------------------------------------------------------------------
</TABLE>
With respect to the GNMA, Government Reserve, Prime Reserve, Reserve
Investment, Short-Term U.S. Government, U.S. Treasury Intermediate, Long-Term
and Money Funds, the entire amount for each of these years represented
principal transactions as to which the Funds have no knowledge of the profits
or losses realized by the respective broker-dealers for the fiscal years
ended May 31, 1998, 1997, and 1996.
With respect to the Corporate Income, High Yield, New Income, Short-Term
Bond, Personal Strategy Income, Personal Strategy Growth, and Personal
Strategy Balanced Funds, the following amounts consisted of principal
transactions as to which the Funds have no knowledge of the profits or losses
realized by the respective broker-dealers for the fiscal years ended May 31,
1998, 1997, and 1996.
<PAGE>
<TABLE>
<CAPTION>
Fund 1998 1997 1996
---- ---- ---- ----
<S> <C> <C> <C>
Corporate Income $ 147,537,000 $ 174,157,000 $ 46,566,000
High Yield 3,854,884,000 7,056,968,000 7,702,492,000
New Income 7,223,043,000 9,061,109,000 5,273,923,000
Personal Strategy Balanced 441,500,000 630,132,000 479,660,000
Personal Strategy Growth 147,604,000 303,598,000 111,536,000
Personal Strategy Income 159,536,000 327,683,000 220,100,000
Short-Term Bond 1,085,314,000 3,372,793,000 4,590,728,000
- ----------------------------------------------------------------------------
</TABLE>
The following amounts involved trades with brokers acting as agents or
underwriters for the fiscal years ended May 31, 1998, 1997, and 1996.
<TABLE>
<CAPTION>
Fund 1998 1997 1996
---- ---- ---- ----
<S> <C> <C> <C>
Corporate Income $ 3,617,000 $ 1,868,000 $ 1,207,000
High Yield 1,226,740,000 652,781,000 694,523,000
New Income 64,189,000 105,749,000 16,451,000
Personal Strategy Balanced 148,459,000 166,836,000 74,381,000
Personal Strategy Growth 78,305,000 51,173,000 16,915,000
Personal Strategy Income 29,178,000 22,521,000 9,917,000
Short-Term Bond 28,570,000 7,661,000 6,197,000
- -----------------------------------------------------------------------------------------------------------------
</TABLE>
The amounts shown below involved trades with brokers acting as agents or
underwriters, in which such brokers received total commissions, including
discounts received in connection with underwritings for the fiscal years
ended May 31, 1998, 1997, and 1996.
<TABLE>
<CAPTION>
Fund 1998 1997 1996
---- ---- ---- ----
<S> <C> <C> <C>
Corporate Income $ 79,000 $ 90,000 $ 34,000
High Yield 30,944,000 17,280,000 15,925,000
New Income 133,000 74,000 61,000
Personal Strategy Balanced 174,000 75,000 334,000
Personal Strategy Growth 46,000 17,000 124,000
Personal Strategy Income 47,000 18,000 136,000
Short-Term Bond 123,000 23,000 21,000
- --------------------------------------------------------------------------------
</TABLE>
The percentage of total portfolio transactions, placed with firms which
provided research, statistical, or other services to T. Rowe Price in
connection with the management of the Funds, or in some cases, to the Funds
for the fiscal years ended May 31, 1998, 1997, and 1996, are shown below:
<TABLE>
<CAPTION>
Fund 1998 1997 1996
---- ---- ---- ----
<S> <C> <C> <C>
Corporate Income 92% 82% 66%
GNMA 98 98 99
Government Reserve Investment 97 N/A N/A
High Yield 88 83 85
New Income 95 87 71
Personal Strategy Balanced 21 14 36
- ----------------------------------------------------------------------------------------------------------------------
Personal Strategy Growth 32 37 46
Personal Strategy Income 39 11 46
Prime Reserve 87 79 72
Reserve Investment 77 N/A N/A
Short-Term Bond 85 81 64
Short-Term U.S. Government 95 85 68
U.S. Treasury Intermediate 96 99 94
U.S. Treasury Long-Term 100 100 96
U.S. Treasury Money 57 71 56
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
<PAGE>
The portfolio turnover rates for the following Funds for the fiscal years
ended May 31, 1998, 1997, and 1996, are as follows:
<TABLE>
<CAPTION>
Fund 1998 1997 1996
---- ---- ---- ----
<S> <C> <C> <C>
Corporate Income 146.0% 119.5% 70.5%
GNMA 120.6 115.9 113.6
High Yield 129.6 111.3 100.1
New Income 147.3 87.1 35.5
Personal Strategy Balanced 41.5 54.0 47.7
Personal Strategy Growth 33.3 39.6 39.5
Personal Strategy Income 30.9 44.8 34.1
Short-Term Bond 73.0 103.9 118.7
Short-Term U.S. Government 107.5 82.9 152.8
U.S. Treasury Intermediate 112.8 57.9 40.7
U.S. Treasury Long-Term 80.8 67.6 60.1
- -----------------------------------------------------------------------------------------------
</TABLE>
Government Reserve Investment, Prime Reserve, Reserve Investment, and U.S.
Treasury Money Funds
The Fund, in pursuing its objectives, may engage in short-term trading to
take advantage of market variations. The Fund will seek to protect principal,
improve liquidity of its securities, or enhance yield by purchasing and
selling securities based upon existing or anticipated market discrepancies.
PRICING OF SECURITIES
-------------------------------------------------------------------------------
Corporate Income, GNMA, High Yield, New Income, Personal Strategy, Short-Term
Bond, Short-Term U.S. Government, U.S. Treasury Intermediate, and Long-Term
Funds
Debt securities are generally traded in the over-the-counter market.
Investments in domestic securities with remaining maturities of one year or
more and foreign securities are stated at fair value using a bid-side
valuation as furnished by dealers who make markets in such securities or by
an independent pricing service, which considers yield or price of bonds of
comparable quality, coupon, maturity, and type, as well as prices quoted by
dealers who make markets in such securities. Domestic securities with
remaining maturities less than one year are stated at fair value which is
determined by using a matrix system that establishes a value for each
security based on bid-side money market yields. The Personal Strategy Funds
value short-term debt securities at their cost in local currency which, when
combined with accrued interest, approximates fair value.
<PAGE>
There are a number of pricing services available, and the Board of
Directors/Trustees, on the basis of an ongoing evaluation of these services,
may use or may discontinue the use of any pricing service in whole or part.
Corporate Income, High Yield, New Income, and Personal Strategy Funds
Equity securities listed or regularly traded on a securities exchange are
valued at the last quoted sales price at the time the valuations are made. A
security that is listed or traded on more than one exchange is valued at the
quotation on the exchange determined to be the primary market for such
security. Listed securities not traded on a particular day and securities
regularly traded in the over-the-counter market are valued at the mean of the
latest bid and asked prices. Other equity securities are valued at a price
within the limits of the latest bid and asked prices deemed by the Board of
Directors/Trustees, or by persons delegated by the Board, best to reflect
fair value.
Investments in mutual funds are valued at the closing net asset value per
share of the mutual fund on the day of valuation.
Government Reserve Investment, Prime Reserve, Reserve Investment, and U.S.
Treasury Money Funds
Securities are valued at amortized cost.
Corporate Income, High Yield, New Income, Personal Strategy, and Short-Term
Bond Funds
For the purposes of determining the Fund's net asset value per share, the
U.S. dollar value of all assets and liabilities initially expressed in
foreign currencies is determined by using the mean of the bid and offer
prices of such currencies against U.S. dollars quoted by a major bank.
All Funds
Assets and liabilities for which the above valuation procedures are
inappropriate or are deemed not to reflect fair value, are stated at fair
value as determined in good faith by or under the supervision of the officers
of the Fund, as authorized by the Board of Directors/Trustees.
Government Reserve Investment, Prime Reserve, Reserve Investment, and U.S.
Treasury Money Funds
Maintenance of Money Fund's Net Asset Value Per Share at $1.00
It is the policy of the Fund to attempt to maintain a net asset value of
$1.00 per share by using the amortized cost method of valuation permitted by
Rule 2a-7 under the Investment Company Act of 1940. Under this method,
securities are valued by reference to the Fund's acquisition cost as adjusted
for amortization of premium or accumulation of discount rather than by
reference to their market value. Under Rule 2a-7:
(a) The Board of Directors must establish written procedures reasonably
designed, taking into account current market conditions and the Fund's
investment objectives, to stabilize the Fund's net asset value per share,
as computed for the purpose of distribution, redemption and repurchase,
at a single value;
(b) The Fund must (i) maintain a dollar-weighted average portfolio maturity
appropriate to its objective of maintaining a stable price per share,
(ii) not purchase any instrument with a remaining maturity greater than
397 days, and (iii) maintain a dollar-weighted average portfolio maturity
of 90 days or less;
(c) The Fund must limit its purchase of portfolio instruments, including
repurchase agreements, to those U.S. dollar-denominated instruments which
the Fund's Board of Directors determines present minimal credit risks,
and which are eligible securities as defined by Rule 2a-7; and
(d) The Board of Directors must determine that (i) it is in the best interest
of the Fund and its shareholders to maintain a stable net asset value per
share under the amortized cost method; and (ii)
<PAGE>
the Fund will continue to use the amortized cost method only so long as
the Board of Directors believes that it fairly reflects the market based
net asset value per share.
Although the Fund believes that it will be able to maintain its net asset
value at $1.00 per share under most conditions, there can be no absolute
assurance that it will be able to do so on a continuous basis. If the Fund's
net asset value per share declined, or was expected to decline, below $1.00
(rounded to the nearest one cent), the Board of Directors of the Fund might
temporarily reduce or suspend dividend payments in an effort to maintain the
net asset value at $1.00 per share. As a result of such reduction or
suspension of dividends, an investor would receive less income during a given
period than if such a reduction or suspension had not taken place. Such
action could result in an investor receiving no dividend for the period
during which he holds his shares and in his receiving, upon redemption, a
price per share lower than that which he paid. On the other hand, if the
Fund's net asset value per share were to increase, or were anticipated to
increase above $1.00 (rounded to the nearest one cent), the Board of
Directors of the Fund might supplement dividends in an effort to maintain the
net asset value at $1.00 per share.
Prime Reserve and Reserve Investment Funds
Prime Money Market Securities Defined
Prime money market securities are those which are described as First Tier
Securities under Rule 2a-7 of the 1940 Act. These include any security with a
remaining maturity of 397 days or less that is rated (or that has been issued
by an issuer that is rated with respect to a class of short-term debt
obligations, or any security within that class that is comparable in priority
and security with the security) by any two nationally recognized statistical
rating organizations (NRSROs) (or if only one NRSRO has issued a rating, that
NRSRO) in the highest rating category for short-term debt obligations (within
which there may be sub-categories). First Tier Securities also include
unrated securities comparable in quality to rated securities, as determined
by T. Rowe Price under the supervision of the Fund's Board of Director.
All Funds
NET ASSET VALUE PER SHARE
-------------------------------------------------------------------------------
The purchase and redemption price of the Fund's shares is equal to the Fund's
net asset value per share or share price. The Fund determines its net asset
value per share by subtracting its liabilities (including accrued expenses
and dividends payable) from its total assets (the market value of the
securities the Fund holds plus cash and other assets, including income
accrued but not yet received) and dividing the result by the total number of
shares outstanding. The net asset value per share of the Fund is normally
calculated as of the close of trading on the New York Stock Exchange ("NYSE")
every day the NYSE is open for trading. The NYSE is closed on the following
days: New Year's Day, Dr. Martin Luther King, Jr. Holiday, Presidents' Day,
Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day, and
Christmas Day.
Determination of net asset value (and the offering, sale redemption and
repurchase of shares) for the Fund may be suspended at times (a) during which
the NYSE is closed, other than customary weekend and holiday closings, (b)
during which trading on the NYSE is restricted, (c) during which an emergency
exists as a result of which disposal by the Fund of securities owned by it is
not reasonably practicable or it is not reasonably practicable for the Fund
fairly to determine the value of its net assets, or (d) during which a
governmental body having jurisdiction over the Fund may by order permit such
a suspension for the protection of the Fund's shareholders; provided that
applicable rules and regulations of the Securities and Exchange Commission
(or any succeeding governmental authority) shall govern as to whether the
conditions prescribed in (b), (c), or (d) exist.
<PAGE>
DIVIDENDS AND DISTRIBUTIONS
-------------------------------------------------------------------------------
Unless you elect otherwise, the Fund's annual capital gain distribution, if
any, will be reinvested on the reinvestment date using the NAV per share of
that date. The reinvestment date normally precedes the payment date by about
10 days although the exact timing is subject to change.
TAX STATUS
-------------------------------------------------------------------------------
The Fund intends to qualify as a "regulated investment company" under
Subchapter M of the Code.
Dividends paid by certain Funds may be eligible for the dividends-received
deduction applicable to corporate shareholders. For tax purposes, it does not
make any difference whether dividends and capital gain distributions are paid
in cash or in additional shares. The Fund must declare dividends by December
31 of each year equal to at least 98% of ordinary income (as of December 31)
and capital gains (as of October 31) in order to avoid a federal excise tax
and distribute within 12 months 100% of ordinary income and capital gains as
of December 31 to avoid a federal income tax.
At the time of your purchase, the Fund's net asset value may reflect
undistributed capital gains or net unrealized appreciation of securities held
by the Fund. A subsequent distribution to you of such amounts, although
constituting a return of your investment, would be taxable as a capital gain
distribution. For federal income tax purposes, the Fund is permitted to carry
forward its net realized capital losses, if any, for eight years and realize
net capital gains up to the amount of such losses without being required to
pay taxes on, or distribute, such gains.
If, in any taxable year, the Fund should not qualify as a regulated
investment company under the code: (i) the Fund would be taxed at normal
corporate rates on the entire amount of its taxable income, if any, without
deduction for dividends or other distributions to shareholders; and (ii) the
Fund's distributions to the extent made out of the Fund's current or
accumulated earnings and profits would be taxable to shareholders as ordinary
dividends (regardless of whether they would otherwise have been considered
capital gain dividends).
Taxation of Foreign Shareholders
The Code provides that dividends from net income will be subject to U.S. tax.
For shareholders who are not engaged in a business in the U.S., this tax
would be imposed at the rate of 30% upon the gross amount of the dividends in
the absence of a Tax Treaty providing for a reduced rate or exemption from
U.S. taxation. Distributions of net long-term capital gains realized by the
Fund are not subject to tax unless the foreign shareholder is a nonresident
alien individual who was physically present in the U.S. during the tax year
for more than 182 days.
To the extent the Fund invests in foreign securities, the following would
apply:
Passive Foreign Investment Companies
The Fund may purchase the securities of certain foreign investment funds or
trusts called passive foreign investment companies. Such trusts have been the
only or primary way to invest in certain countries. Capital gains on the sale
of such holdings will be deemed to be ordinary income regardless of how long
the Fund holds its investment. In addition to bearing their proportionate
share of the fund's expenses (management fees and operating expenses),
shareholders will also indirectly bear similar expenses of such funds. In
addition, the Fund may be subject to corporate income tax and an interest
charge on certain dividends and capital gains earned from these investments,
regardless of whether such income and gains were distributed to shareholders.
To avoid such tax and interest, the Fund intends to treat these securities as
sold on the last day of the Fund's fiscal year and recognize any gains for
tax purposes at that time; deductions for losses are allowable only to the
extent of any gains resulting from these deemed sales for prior taxable
years. Such gains and losses will be
<PAGE>
treated as ordinary income for tax purposes. The Fund will be required to
distribute any resulting income even though it has not sold the security and
received cash to pay such distributions.
Foreign Currency Gains and Losses
Foreign currency gains and losses, including the portion of gain or loss on
the sale of debt securities attributable to foreign exchange rate
fluctuations, are taxable as ordinary income. If the net effect of these
transactions is a gain, the ordinary income dividend paid by the Fund will be
increased. If the result is a loss, the income dividend paid by the Fund will
be decreased, or to the extent such dividend has already been paid, it may be
classified as a return of capital. Adjustments to reflect these gains and
losses will be made at the end of the Fund's taxable year.
YIELD INFORMATION
-------------------------------------------------------------------------------
GNMA and Short-Term U.S. Government Funds
In conformity with regulations of the Securities and Exchange Commission, an
income factor is calculated for each security in the portfolio based upon the
security's coupon rate. The income factors are then adjusted for any gains or
losses which have resulted from prepayments of principal during the period.
The income factors are then totalled for all securities in the portfolio.
Next, expenses of the Fund for the period, net of expected reimbursements,
are deducted from the income to arrive at net income, which is then converted
to a per-share amount by dividing net income by the average number of shares
outstanding during the period. The net income per share is divided by the net
asset value on the last day of the period to produce a monthly yield which is
then annualized. Quoted yield factors are for comparison purposes only, and
are not intended to indicate future performance or forecast the dividend per
share of the Fund.
The yields of the GNMA and Short-Term U.S. Government Funds calculated under
the above-described method for the month ended May 31, 1998, were 6.36% and
5.76%, respectively.
Corporate Income, High Yield, New Income, Short-Term Bond, U.S. Treasury
Intermediate, and Long-Term Funds
An income factor is calculated for each security in the portfolio based upon
the security's market value at the beginning of the period and yield as
determined in conformity with regulations of the SEC. The income factors are
then totaled for all securities in the portfolio. Next, expenses of the Fund
for the period, net of expected reimbursements, are deducted from the income
to arrive at net income, which is then converted to a per share amount by
dividing net income by the average number of shares outstanding during the
period. The net income per share is divided by the net asset value on the
last day of the period to produce a monthly yield which is then annualized.
If applicable, a taxable-equivalent yield is calculated by dividing this
yield by one minus the effective federal, state, and/or city or local income
tax rates. Quoted yield factors are for comparison purposes only, and are not
intended to indicate future performance or forecast the dividend per share of
the Fund.
The yields of the Corporate Income, High Yield, New Income, Short-Term Bond,
Intermediate, and Long-Term Treasury Funds calculated under the
above-described method for the month ended May 31, 1998, were 7.66%, 8.19%,
6.29%, 5.52%, 5.29%, and 5.35%, respectively.
Government Reserve Investment, Prime Reserve, Reserve Investment, and U.S.
Treasury Money Funds
The Fund's current and historical yield for a period is calculated by
dividing the net change in value of an account (including all dividends
accrued and dividends reinvested in additional shares) by the account value
at the beginning of the period to obtain the base period return. This base
period return is divided by the number of days in the period than multiplied
by 365 to arrive at the annualized yield for that period. The
<PAGE>
Fund's annualized compound yield for such period is compounded by dividing
the base period return by the number of days in the period, and compounding
that figure over 365 days.
The seven-day yields ending May 31, 1998, for the Prime Reserve, and U.S.
Treasury Money Funds were 5.03% and 4.80%, respectively, and the Funds'
compound yield for the same period were 5.16 and 4.91%, respectively.
All Funds
INVESTMENT PERFORMANCE
-------------------------------------------------------------------------------
Total Return Performance
The Fund's calculation of total return performance includes the reinvestment
of all capital gain distributions and income dividends for the period or
periods indicated, without regard to tax consequences to a shareholder in the
Fund. Total return is calculated as the percentage change between the
beginning value of a static account in the Fund and the ending value of that
account measured by the then current net asset value, including all shares
acquired through reinvestment of income and capital gain dividends. The
results shown are historical and should not be considered indicative of the
future performance of the Fund. Each average annual compound rate of return
is derived from the cumulative performance of the Fund over the time period
specified. The annual compound rate of return for the Fund over any other
period of time will vary from the average.
<TABLE>
<CAPTION>
Cumulative Performance Percentage Change
Fund 1 Yr. Ended 5 Yrs. Ended 10 Yrs. Ended % Since Incep- Inception
---- ----------- ------------ ------------- -------------- ---------
- ------------------------ 5/31/98 5/31/98 5/31/98 tion to 5/31/98 Date
------- ------- ------- --------------- ----
----------------------------------------------------------------------
<S> <C> <C> <C> <C> <S>
Corporate Income 13.96% -- -- 25.87% 10/31/95
GNMA 9.97 37.67% 125.57% 164.57 11/26/85
High Yield 14.51 55.03 147.80 292.39 12/31/84
New Income 10.84 39.47 125.38 721.27 08/31/73
Personal Strategy
Balanced 19.15 -- -- 88.41 07/29/94
Personal Strategy
Growth 22.02 -- -- 107.81 07/29/94
Personal Strategy
Income 16.61 -- -- 71.89 07/29/94
Prime Reserve 5.16 25.07 69.09 407.06 01/26/76
Short-Term Bond 6.87 24.50 85.08 169.06 03/02/84
Short-Term U.S.
Government 6.71 27.97 -- 36.70 09/30/91
U.S. Treasury
Intermediate 9.58 32.93 -- 90.91 09/29/89
U.S. Treasury
Long-Term 18.58 48.91 -- 116.76 09/29/89
U.S. Treasury Money 4.91 23.91 64.86 150.42 06/28/82
- ----------------------------------------------------------------------------------------------
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Average Annual Compound Rates of Return
Fund 1 Yr. Ended 5 Yrs. Ended 10 Yrs. Ended % Since Incep- Inception
---- ----------- ------------ ------------- -------------- ---------
- ------------------------ 5/31/98 5/31/98 5/31/98 tion to 5/31/98 Date
------- ------- ------- --------------- ----
----------------------------------------------------------------------
<S> <C> <C> <C> <C> <S>
Corporate Income 13.96% -- -- 9.32% 10/31/95
GNMA 9.97 6.60% 8.47% 8.09 11/26/85
High Yield 14.51 9.21 9.50 10.73 12/31/84
New Income 10.84 6.88 8.47 8.88 08/31/73
Personal Strategy
Balanced 19.15 -- -- 17.94 07/29/94
Personal Strategy
Growth 22.02 -- -- 20.99 07/29/94
Personal Strategy
Income 16.61 -- -- 15.15 07/29/94
Prime Reserve 5.16 4.58 5.39 7.54 01/26/76
Short-Term Bond 6.87 4.48 6.35 7.19 03/02/84
Short-Term U.S.
Government 6.71 5.06 -- 4.80 09/30/91
U.S. Treasury
Intermediate 9.58 5.86 -- 7.74 09/29/89
U.S. Treasury
Long-Term 18.58 8.29 -- 9.33 09/29/89
U.S. Treasury Money 4.91 4.38 5.13 5.93 06/28/82
- ----------------------------------------------------------------------------------------------
</TABLE>
Outside Sources of Information
From time to time, in reports and promotional literature: (1) the Fund's
total return performance, ranking, or any other measure of the Fund's
performance may be compared to any one or combination of the following: (i) a
broadbased index; (ii) other groups of mutual funds, including T. Rowe Price
Funds, tracked by independent research firms ranking entities, or financial
publications; (iii) indices of securities comparable to those in which the
Fund invests; (2) the Consumer Price Index (or any other measure for
inflation, government statistics, such as GNP may be used to illustrate
investment attributes of the Fund or the general economic, business,
investment, or financial environment in which the Fund operates; (3) various
financial, economic and market statistics developed by brokers, dealers and
other persons may be used to illustrate aspects of the Fund's performance;
(4) the effect of tax-deferred compounding on the Fund's investment returns,
or on returns in general in both qualified and nonqualified retirement plans
or any other tax advantage product, may be illustrated by graphs, charts,
etc.; and (5) the sectors or industries in which the Fund invests may be
compared to relevant indices or surveys in order to evaluate the Fund's
historical performance or current or potential value with respect to the
particular industry or sector.
Other Publications
From time to time, in newsletters and other publications issued by Investment
Services, T. Rowe Price mutual fund portfolio managers may discuss economic,
financial and political developments in the U.S. and abroad and how these
conditions have affected or may affect securities prices or the Fund;
individual securities within the Fund's portfolio; and their philosophy
regarding the selection of individual stocks, including why specific stocks
have been added, removed or excluded from the Fund's portfolio.
Other Features and Benefits
The Fund is a member of the T. Rowe Price family of Funds and may help
investors achieve various long-term investment goals, which include, but are
not limited to, investing money for retirement, saving for a down payment on
a home, or paying college costs. To explain how the Fund could be used to
assist investors in planning for these goals and to illustrate basic
principles of investing, various worksheets and guides prepared by T. Rowe
Price Associates, Inc. and/or Investment Services may be made available.
<PAGE>
Redemptions in Kind
In the unlikely event a shareholder were to receive an in kind redemption of
portfolio securities of the Fund, brokerage fees could be incurred by the
shareholder in a subsequent sale of such securities.
Issuance of Fund Shares for Securities
Transactions involving issuance of Fund shares for securities or assets other
than cash will be limited to (1) bona fide reorganizations; (2) statutory
mergers; or (3) other acquisitions of portfolio securities that: (a) meet the
investment objective and policies of the Fund; (b) are acquired for
investment and not for resale except in accordance with applicable law; (c)
have a value that is readily ascertainable via listing on or trading in a
recognized United States or international exchange or market; and (d) are not
illiquid.
All Funds except GNMA Fund
CAPITAL STOCK
-------------------------------------------------------------------------------
The Fund's Charter authorizes the Board of Directors to classify and
reclassify any and all shares which are then unissued, including unissued
shares of capital stock into any number of classes or series, each class or
series consisting of such number of shares and having such designations, such
powers, preferences, rights, qualifications, limitations, and restrictions,
as shall be determined by the Board subject to the Investment Company Act and
other applicable law. The shares of any such additional classes or series
might therefore differ from the shares of the present class and series of
capital stock and from each other as to preferences, conversions or other
rights, voting powers, restrictions, limitations as to dividends,
qualifications or terms or conditions of redemption, subject to applicable
law, and might thus be superior or inferior to the capital stock or to other
classes or series in various characteristics. The Board of Directors may
increase or decrease the aggregate number of shares of stock or the number of
shares of stock of any class or series that the Fund has authorized to issue
without shareholder approval.
Except to the extent that the Fund's Board of Directors might provide by
resolution that holders of shares of a particular class are entitled to vote
as a class on specified matters presented for a vote of the holders of all
shares entitled to vote on such matters, there would be no right of class
vote unless and to the extent that such a right might be construed to exist
under Maryland law. The Charter contains no provision entitling the holders
of the present class of capital stock to a vote as a class on any matter.
Accordingly, the preferences, rights, and other characteristics attaching to
any class of shares, including the present class of capital stock, might be
altered or eliminated, or the class might be combined with another class or
classes, by action approved by the vote of the holders of a majority of all
the shares of all classes entitled to be voted on the proposal, without any
additional right to vote as a class by the holders of the capital stock or of
another affected class or classes.
Shareholders are entitled to one vote for each full share held (and
fractional votes for fractional shares held) and will vote in the election of
or removal of directors (to the extent hereinafter provided) and on other
matters submitted to the vote of shareholders. There will normally be no
meetings of shareholders for the purpose of electing directors unless and
until such time as less than a majority of the directors holding office have
been elected by shareholders, at which time the directors then in office will
call a shareholders' meeting for the election of directors. Except as set
forth above, the directors shall continue to hold office and may appoint
successor directors. Voting rights are not cumulative, so that the holders of
more than 50% of the shares voting in the election of directors can, if they
choose to do so, elect all the directors of the Fund, in which event the
holders of the remaining shares will be unable to elect any person as a
director. As set forth in the By-Laws of the Fund, a special meeting of
shareholders of the Fund shall be called by the Secretary of the Fund on the
written request of shareholders entitled to cast at least 10% of all the
votes of the Fund entitled to be cast at such meeting. Shareholders
requesting such a meeting must pay to the Fund the reasonably estimated costs
of preparing and mailing the notice of the meeting. The Fund, however, will
otherwise assist the shareholders seeking to hold the special meeting in
communicating to the other shareholders of the Fund to the extent required by
Section 16(c) of the Investment Company Act of 1940.
<PAGE>
GNMA Fund
Description of the Fund
For tax and business reasons, the Fund was organized in 1985 as a
Massachusetts Business Trust, and is registered with the Securities and
Exchange Commission under the Investment 1940 Act as diversified, open-end
investment companies, commonly known as "mutual fund."
The Declaration of Trust permits the Board of Trustees to issue an unlimited
number of full and fractional shares of a single class. The Declaration of
Trust also provides that the Board of Trustees may issue additional series or
classes of shares. Each share represents an equal proportionate beneficial
interest in the Fund. In the event of the liquidation of the Fund, each share
is entitled to a pro-rata share of the net assets of the Fund.
Shareholders are entitled to one vote for each full share held (and
fractional votes for fractional shares held) and will vote in the election of
or removal of trustees (to the extent hereinafter provided) and on other
matters submitted to the vote of shareholders. There will normally be no
meetings of shareholders for the purpose of electing trustees unless and
until such time as less than a majority of the trustees holding office have
been elected by shareholders, at which time the trustees then in office will
call a shareholders' meeting for the election of trustees. Pursuant to
Section 16(c) of the 1940 Act, holders of record of not less than two-thirds
of the outstanding shares of the Fund may remove a trustee by a vote cast in
person or by proxy at a meeting called for that purpose. Except as set forth
above, the trustees shall continue to hold office and may appoint successor
trustees. Voting rights are not cumulative, so that the holders of more than
50% of the shares voting in the election of trustees can, if they choose to
do so, elect all the trustees of the Trust, in which event the holders of the
remaining shares will be unable to elect any person as a trustee. No
amendments may be made to the Declaration of Trust without the affirmative
vote of a majority of the outstanding shares of the Trust.
Shares have no preemptive or conversion rights; the right of redemption and
the privilege of exchange are described in the prospectus. Shares are fully
paid and nonassesable, except as set forth below. The Trust may be terminated
(i) upon the sale of its assets to another diversified, open-end management
investment company, if approved by the vote of the holders of two-thirds of
the outstanding shares of the Trust, or (ii) upon liquidation and
distribution of the assets of the Trust, if approved by the vote of the
holders of a majority of the outstanding shares of the Trust. If not so
terminated, the Trust will continue indefinitely.
Under Massachusetts law, shareholders could, under certain circumstances, be
held personally liable for the obligations of the Fund. However, the
Declaration of Trust disclaims shareholder liability for acts or obligations
of the Fund and requires that notice of such disclaimer be given in each
agreement, obligation or instrument entered into or executed by the Fund or a
Trustee. The Declaration of Trust provides for indemnification from Fund
property for all losses and expenses of any shareholder held personally
liable for the obligations of the Fund. Thus, the risk of a shareholder
incurring financial loss on account of shareholder liability is limited to
circumstances in which the Fund itself would be unable to meet its
obligations, a possibility which T. Rowe Price believes is remote. Upon
payment of any liability incurred by the Fund, the shareholders of the Fund
paying such liability will be entitled to reimbursement from the general
assets of the Fund. The Trustees intend to conduct the operations of the Fund
is such a way so as to avoid, as far as possible, ultimate liability of the
shareholders for liabilities of such Fund.
FEDERAL REGISTRATION OF SHARES
-------------------------------------------------------------------------------
The Fund's shares (except for Government Reserve and Reserve Investment
Funds) are registered for sale under the Securities Act of 1933. Registration
of the Fund's shares is not required under any state law, but the Fund is
required to make certain filings with and pay fees to the states in order to
sell its shares in the states.
<PAGE>
LEGAL COUNSEL
-------------------------------------------------------------------------------
Swidler Berlin Shereff Friedman, LLP, whose address is 919 Third Avenue, New
York, New York 10022-9998, is legal counsel to the Fund.
INDEPENDENT ACCOUNTANTS
-------------------------------------------------------------------------------
PricewaterhouseCoopers LLP, 250 West Pratt Street, 21st Floor, Baltimore,
Maryland 21201, are the independent accountants to the Funds.
The financial statements of the Funds for the year ended May 31, 1998, and
the report of independent accountants are included in each Fund's Annual
Report for the year ended May 31, 1998. A copy of each Annual Report
accompanies this Statement of Additional Information. The following financial
statements and the report of independent accountants appearing in each Annual
Report for the year ended May 31, 1998, are incorporated into this Statement
of Additional Information by reference:
<TABLE>
<CAPTION>
ANNUAL REPORT REFERENCES:
CORPORATE GNMA NEW PRIME
INCOME FUND FUND INCOME RESERVE
----------- ---- FUND FUND
---- ----
<S> <S> <S> <S> <S>
Report of Independent Accountants 20 15 23 21
Statement of Net Assets, May 31, 1998 9-13 7-9 9-16 8-16
Statement of Operations, year ended
May 31, 1998 14 10 17 17
Statement of Changes in Net Assets,
years ended
May 31, 1998 and May 31, 1997 15 11 18 18
Notes to Financial Statements, May 31,
1998 16-19 12-14 19-22 19-20
Financial Highlights 8 6 8 7
</TABLE>
<TABLE>
<CAPTION>
PERSONAL PERSONAL PERSONAL
STRATEGY STRATEGY STRATEGY
BALANCED FUND GROWTH FUND INCOME FUND
------------- ----------- -----------
<S> <S> <S> <S>
Report of Independent Accountants 31 29 28
Portfolio of Investments, May 31,
1998 3-22 3-21 3-20
Statement of Assets and Liabilities,
May 31, 1998 23 22 21
Statement of Operations, year ended
May 31, 1998 24 23 22
Statement of Changes in Net Assets,
years ended
May 31, 1998 and May 31, 1997 25 24 23
Notes to Financial Statements, May
31, 1998 26-30 25-28 24-27
Financial Highlights 2 2 2
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
HIGH YIELD SHORT-TERM SHORT-TERM U.S.
FUND BOND FUND GOVERNMENT FUND
---- --------- ---------------
<S> <C> <C> <C>
Report of Independent Accountants 29 20 16
Statement of Net Assets, May 31,
1998 9-21 8-13 7-10
Statement of Operations, year
ended
May 31, 1998 22 14 11
Statement of Changes in Net
Assets, years ended
May 31, 1998 and May 31, 1997 23 15 12
Notes to Financial Statements, May
31, 1998 24-27 16-19 13-15
Financial Highlights 8 7 6
</TABLE>
<TABLE>
<CAPTION>
U.S. TREASURY U.S. TREASURY U.S. TREASURY
INTERMEDIATE FUND LONG-TERM FUND MONEY FUND
----------------- -------------- ----------
<S> <C> <C> <C>
Report of Independent
Accountants 27 27 27
Statement of Net Assets,
May 31, 1998 14-16 17-18 13
Statement of Operations,
year ended
May 31, 1998 19 19 19
Statement of Changes in Net
Assets, years
ended May 31, 1998 and May
31, 1997 21 22 20
Notes to Financial
Statements, May 31, 1998 23-26 23-26 23-26
Financial Highlights 11 12 10
</TABLE>
<TABLE>
<CAPTION>
RESERVE GOVERNMENT
INVESTMENT FUND RESERVE
--------------- INVESTMENT FUND
---------------
<S> <C> <C>
Report of Independent Accountants 13 13
Statement of Net Assets, May 31, 1998 3-6 7
Statement of Operations, period from
August 25, 1997 (commencement of
operations) to May 31, 1998 8 8
Statement of Changes in Net Assets, period
from August 25, 1997 (commencement of
operations)
to May 31, 1998 9 9
Notes to Financial Statements, May 31,
1998 10-12 10-12
Financial Highlights 1 2
</TABLE>
RATINGS OF COMMERCIAL PAPER
-------------------------------------------------------------------------------
Moody's Investors Service, Inc. The rating of Prime-1 is the highest
commercial paper rating assigned by Moody's. Among the factors considered by
Moody's in assigning rating are the following: valuation of the management of
the issuer; economic evaluation of the issuer's industry or industries and an
appraisal of speculative-type risks which may be inherent in certain areas;
evaluation of the issuer's products in relation to competition and customer
acceptance; liquidity; amount and quality of long-term debt; trend of
earnings over a period of 10 years; financial strength of the parent company
and the relationships which exist with the issuer; and recognition by the
management of obligations which may be present or may arise as a result of
<PAGE>
public interest questions and preparations to meet such obligations. These
factors are all considered in determining whether the commercial paper is
rated P1, P2, or P3.
Standard & Poor's Corporation Commercial paper rated A (highest quality) by
S&P has the following characteristics: liquidity ratios are adequate to meet
cash requirements; long-term senior debt is rated "A" or better, although in
some cases "BBB" credits may be allowed. The issuer has access to at least
two additional channels of borrowing. Basic earnings and cash flow have an
upward trend with allowance made for unusual circumstances. Typically, the
issuer's industry is well established and the issuer has a strong position
within the industry. The reliability and quality of management are
unquestioned. The relative strength or weakness of the above factors
determines whether the issuer's commercial paper is rated A1, A2, or A3.
Fitch IBCA, Inc. Fitch 1-Highest grade Commercial paper assigned this rating
is regarded as having the strongest degree of assurance for timely payment.
Fitch 2-Very good grade Issues assigned this rating reflect an assurance of
timely payment only slightly less in degree than the strongest issues.
Government Reserve Investment, Prime Reserve, and Reserve Investment Funds
RATINGS OF CORPORATE DEBT SECURITIES
-------------------------------------------------------------------------------
Moody's Investors Services, Inc. (Moody's)
Aaa-Bonds rated Aaa are judged to be of the best quality. They carry the
smallest degree of investment risk and are generally referred to as "gilt
edge."
Aa-Bonds rated Aa are judged to be of high quality by all standards. Together
with the Aaa group they comprise what are generally know as high-grade bonds.
A-Bonds rated A possess many favorable investment attributes and are to be
considered as upper medium-grade obligations.
Baa-Bonds rated Baa are considered as 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-Bonds rated Ba are judged to have speculative elements: their futures
cannot be considered as well assured. Often the protection of interest and
principal payments may be very moderate and thereby not well safeguarded
during both good and bad times over the future. Uncertainty of position
characterize bonds in this class.
B-Bonds rated B generally lack the characteristics of a desirable investment.
Assurance of interest and principal payments or of maintenance of other terms
of the contract over any long period of time may be small.
Caa-Bonds rated Caa are of poor standing. Such issues may be in default or
there may be present elements of danger with respect to principal or
interest.
Ca-Bonds rated Ca represent obligations which are speculative in a high
degree. Such issues are often in default or have other marked short-comings.
C-Bonds rated C represent the lowest-rated, and have extremely poor prospects
of attaining investment standing.
Standard & Poor's Corporation (S&P)
AAA-This is the highest rating assigned by Standard & Poor's to a debt
obligation and indicates an extremely strong capacity to pay principal and
interest.
<PAGE>
AA-Bonds rated AA also qualify as high-quality debt obligations. Capacity to
pay principal and interest is very strong.
A-Bonds rated A have a strong capacity to pay principal and interest,
although they are somewhat more susceptible to the adverse effects of changes
in circumstances and economic conditions.
BBB-Bonds rated BBB are regarded as having an adequate capacity to pay
principal and interest. Whereas they normally exhibit adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay principal and interest for bonds
in this category than for bonds in the A category.
BB, B, CCC, CC, C-Bonds rated BB, B, CCC, and CC are regarded on balance, as
predominantly speculative with respect to the issuer's capacity to pay
interest and repay principal. BB indicates the lowest degree of speculation
and CC the highest degree of speculation. While such bonds will likely have
some quality and protective characteristics, these are outweighed by large
uncertainties or major risk exposures to adverse conditions.
D-In default.
Fitch IBCA, Inc.
AAA-High grade, broadly marketable, suitable for investment by trustees and
fiduciary institutions, and liable to but slight market fluctuation other
than through changes in the money rate. The prime feature of a "AAA" bond is
the showing of earnings several times or many times interest requirements for
such stability of applicable interest that safety is beyond reasonable
question whenever changes occur in conditions. Other features may enter, such
as wide margin of protection through collateral, security or direct lien on
specific property. Sinking funds or voluntary reduction of debt by call or
purchase or often factors, while guarantee or assumption by parties other
than the original debtor may influence their rating.
AA-Of safety virtually beyond question and readily salable. Their merits are
not greatly unlike those of "AAA" class but a bond so rated may be junior
though of strong lien, or the margin of safety is less strikingly broad. The
issue may be the obligation of a small company, strongly secured, but
influenced as to rating by the lesser financial power of the enterprise and
more local type of market.
A-Bonds rated A are 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 rated BBB are 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 ad
circumstances, however, are more likely to have 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, and C are regarded on balance as predominantly speculative
with respect to the issuer's capacity to repay interest and repay principal
in accordance with the terms of the obligation for bond issues not in
default. BB indicates the lowest degree of speculation and C the highest
degree of speculation. The rating takes into consideration special features
of the issue, its relationship to other obligations of the issuer, and the
current and prospective financial condition and operating performance of the
issuer.
