<PAGE> 1
GEMINI II
Annual Report
December 31, 1996
[PHOTO]
THE VANGUARD GROUP: LINKING TRADITION AND INNOVATION
At Vanguard, we treasure our rich nautical heritage--even as we steer our
course toward the twenty-first century. Our Report cover reflects that blending
of tradition and innovation, of past, present, and future. The montage
includes a bronze medallion with a likeness of our namesake, HMS Vanguard (Lord
Nelson's flagship at The Battle of the Nile); a clock built circa 1816 in
Scotland, featuring a portrait of Nelson (who is also shown, accepting a
surrender, in a detail from a nineteenth-century engraving); and several views
of our recently completed campus, which is steeped in nautical imagery--from our
buildings named after Nelsons warships (Victory, Majestic, and Goliath are
three shown), to our artwork and ornamental compass rose.
<PAGE> 2
VANGUARD HAS ALWAYS STRIVED TO BE THE STANDARD-BEARER for mutual fund
disclosure, going well beyond the "letter of the law" in our shareholder
communications. During the past year, we raised the standard once again by
rewriting and reformatting our Fund prospectuses. They are designed to ensure
that prospective investors fully understand, before they make an investment,
each Fund's investment strategies, risks, and costs. In that spirit, we have
redesigned our Annual Reports to shareholders, which provide a comprehensive
discussion and analysis of the year's results in the context of each Fund's
investment objectives and policies. Since Vanguard has long been recognized for
the quality and content of these Fund Reports, our overriding objective was to
maintain the character of the previous Reports, while adding information to
assist shareholders in understanding the investment characteristics of their
Fund.
THE NEW FUND REPORTS INCLUDE A MESSAGE TO SHAREHOLDERS from Chairman John C.
Bogle and President John J. Brennan. This Message continues to provide a candid
assessment of the Fund's performance relative to an appropriate unmanaged
market benchmark and a peer group of mutual funds with similar investment
policies. It also reviews the principal factors contributing to--and detracting
from--the returns earned by the Fund. To help you evaluate your Fund's
current-year performance, the Message includes a discussion of the Fund's
long-term investment results, as well as a look ahead to the prospects for the
coming year. A recap of the financial markets, which had been included as part
of the Chairman's letter, now appears in The Markets In Perspective. This
overview covers the world's financial markets, putting the results of the
Fund's strategy in a global perspective.
THE PORTFOLIO PROFILE REPRESENTS AN ADDITION TO OUR FUND REPORTS. In this day
and age, many investors use detailed statistical information to evaluate their
mutual fund holdings, and our new Portfolio Profile furnishes shareholders with
comprehensive data on key characteristics--sector diversification, volatility,
top-ten holdings, among others--that ultimately define how a Fund is likely to
perform in various market environments. For this information to be used
effectively, we include a brief description of the profiled characteristics.
The Report From The Adviser (for our traditionally managed Funds) now covers
specific topics that we have defined as being the important ones for the
adviser to address--and we do our best to ensure that this Report is written in
the same simple and candid manner that characterizes all Vanguard
communications. Finally, each Adviser's Report will include an inset reminder
of the adviser's basic investment philosophy.
WE TRUST THAT THIS REDESIGNED FUND REPORT will continue to meet your need for
a fair, candid, and clear presentation of your Fund's investment results and a
thorough portfolio review. We welcome any comments that you might have at any
time regarding these Reports.
CONTENTS
A Message To
Our Shareholders
1
The Markets
In Perspective
5
Report From
The Adviser
7
Portfolio
Profile
8
Performance
Summary
10
Financial
Statements
11
Report Of
Independent
Accountants
18
Directors And
Officers
INSIDE BACK COVER
<PAGE> 3
FELLOW SHAREHOLDER,
Gemini II provided a total return of +16.2% in 1996, our final full year of
operations. As planned at our inception in February 1985, Gemini II's existence
as a dual-purpose, closed-end fund is drawing to a close, a process discussed
in more detail later in this letter.
[PHOTO]
John C. Bogle
[PHOTO]
John J. Brennan
Our total return (capital change plus reinvested dividends) of +16.2% in
1996, however respectable in absolute terms, fell short of competitive
standards. We lagged by 6.8 percentage points the exceptionally strong +23.0%
total return on the unmanaged Standard & Poor's 500 Composite Stock Price
Index; we were 4.7 percentage points behind the +20.9% return on the average
value (growth and income) mutual fund. The table at right presents the return
of the Fund as a whole and the returns of our two comparative benchmarks.
<TABLE>
<CAPTION>
- ---------------------------------------------
TOTAL RETURN
YEAR ENDED
DECEMBER 31, 1996
- ---------------------------------------------
<S> <C>
Gemini II +16.2%
- ---------------------------------------------
Average Value Fund +20.9%
- ---------------------------------------------
S&P 500 Index +23.0%
- ---------------------------------------------
</TABLE>
The Fund's total return takes into account the increase in our net asset
value, distributions from net investment income and realized short-term capital
gains, and federal taxes accrued on net long-term capital gains.
CAPITAL SHARE RESULTS
The return on our Capital Shares was +9.1% for the year, compared with a price
return of +20.3% for the S&P 500 Index. This return was based on a change in
net asset value from $26.35 on December 31, 1995, to $28.75 on December 31,
1996, net of our accrual of $1.06 per share for federal taxes on long-term
capital gains realized during the year and a distribution of $0.24 from
short-term gains. The dramatic shortfall in our return versus the S&P 500 Index
was due to the fact that we held, on average, less than half the Fund's assets
in common stocks during the year, a significant handicap in a sharply rising
stock market. We also held a sizable position (34% of assets) in convertible
securities, which were hurt by rising interest rates in 1996.
This handicap was only partially offset by the Capital Shares' leverage of
1.3 times, which magnified by roughly 30% the increase in the net asset value
of Gemini II's total portfolio. In our initial public offering of shares, on
February 15, 1985, the leverage factor of the Capital Shares was 2.0, since the
Capital Shares provided only 50% of the Fund's total initial assets but
received 100% of any appreciation or depreciation. This leverage ratio has
declined over time because of the substantial growth in the market value of our
assets.
INCOME SHARE RESULTS
Gemini II's Income Shares earned dividends of $1.93 per share for 1996,
compared with $1.80 per share in 1995. The 1996 income distributions consisted
of regular quarterly dividends at the rate of $0.35 per share and an extra
dividend of $0.53 per share declared in December. This year-end dividend was
simply the amount by which our net investment income for the full year exceeded
the quarterly dividend payments.
1
<PAGE> 4
The 7% increase in annual net investment income was achieved despite the
"drag" of federal income taxes. As you know, each year these taxes are charged
directly against the Fund's assets, giving the Income Shares a commensurately
lower asset base on which to earn income. For 1996, our total portfolio
provided an annual yield, net of operating expenses, of 5.1%, 21/2 times the
year-end yield of 2.0% on the S&P 500 Index. Based on their year-end net asset
value of $9.34, our Income Shares provided a yield of 20.7%.
1996 OVERVIEW
In a nearly ideal environment of moderate economic growth, rising corporate
profits, and continued low inflation, the U.S. stock market flourished in 1996.
Interest rates fluctuated substantially, rising early in the year along with
estimates of the economy's strength, then declining in the autumn as estimates
of economic growth abated--and with them, inflation anxieties. However,
interest rates closed the year with a sharp upward spike in December. The yield
on the benchmark 30-year U.S. Treasury bond finished 1996 at 6.6%, up about
six-tenths of a percentage point from 6.0% at the end of 1995, driving the
price of the long bond down by nearly -8%.
In contrast, the price trend for common stocks was virtually one-way: up.
The S&P 500 Index provided positive returns in all but two months (July and
December), as both growth stocks and value stocks performed well. While returns
on these two groups are quite similar over long periods, they often diverge
over shorter periods. In 1996, the S&P/BARRA Growth Index earned a return of
+24.0%, not far ahead of the +22.0% earned by the S&P/BARRA Value Index.
As noted earlier, with such an ebullient stock market during 1996, we were
distinctly disadvantaged relative to our performance benchmarks by holding less
than half of our assets in common stocks. Our cash reserves were built up to
22% of assets at year-end 1996 (as the Fund prepared for redemption of the
Income Shares in January 1997) and were a significant drag on our performance
in such a strong year for equities. Most equity mutual funds carry much smaller
cash reserve positions, and the S&P 500 Index, which exists only "on paper," is
100% invested in stocks.
We also note that our 34% (average for the year) position in convertible
securities, which gave us a better-than-stock-market return in 1995, did just
the opposite in 1996. By way of comparison, the average growth and income fund
holds less than 5% of its assets in these securities.
<TABLE>
<CAPTION>
- -------------------------------------------------------
PERCENTAGE OF NET ASSETS
DECEMBER 31,
-------------------------
1995 1996
- -------------------------------------------------------
<S> <C> <C>
EQUITY EQUIVALENTS
Common Stocks 48% 43%
Convertible Securities 36 33
Lower-Grade Bonds 3 2
- -------------------------------------------------------
SUBTOTAL EQUITY EQUIVALENTS 87% 78%
- -------------------------------------------------------
TEMPORARY CASH INVESTMENTS 13% 22%
- -------------------------------------------------------
TOTAL PORTFOLIO 100% 100%
- -------------------------------------------------------
</TABLE>
That said, our stocks performed well on balance during 1996, earning a
return about one-half percentage point higher than the +23.0% return on the S&P
500 Index. This small edge was due in part to our concentration in
financial-sector stocks (roughly half of our equities versus 14% for the
Index), the second-best sector in 1996, and from a significant underweighting
(roughly 2% versus 11% in the Index) in utilities, the worst-performing sector.
Our charter, which requires that the equities we hold must pay dividends,
rendered most technology stocks--the year's best performers--off limits to
Gemini II.
2
<PAGE> 5
The table at the bottom of the previous page shows the composition of the
Fund at year-end 1996, along with its makeup one year earlier.
OUR LIFETIME RECORD
With the redemption of its Income Shares on January 31, 1997, Gemini II will
soon end its operations as a dual-purpose closed-end fund. In February, we hope
to obtain shareholder approval to convert the remaining Capital Shares into an
open-end fund. If shareholders approve the proposal, they will have the option
of redeeming their shares at the prevailing net asset value or maintaining
their investment in the restructured fund. Thereafter, the Board of Directors
expects to seek a shareholder vote on merging the restructured fund into
Vanguard/Windsor Fund, an open-end, growth and income fund advised by
Wellington Management Company, LLP. Windsor's portfolio manager is Charles T.
Freeman, who has been involved in managing the Fund for more than 25 years.
The record established in the nearly twelve years since Gemini II's
inception is a fine one. The adjacent table compares the cumulative and average
annual returns of Gemini II with those of the S&P 500 Index and the average
value mutual fund. As you can see, Gemini II's average annual return of +15.4%
is a full 1.5 percentage points ahead of the average competing fund, amounting
to a cumulative advantage of more than 75 percentage points (+445% versus
+369%) over the full period.
<TABLE>
<CAPTION>
- -------------------------------------------------------------
TOTAL RETURN
FEB. 15, 1985, TO DEC. 31, 1996
--------------------------------
CUMULATIVE ANNUAL RATE
- -------------------------------------------------------------
<S> <C> <C>
Gemini II +445.2% +15.4%
- -------------------------------------------------------------
Average Value Fund +369.0% +13.9%
- -------------------------------------------------------------
S&P 500 Index +494.1% +16.2%
- -------------------------------------------------------------
</TABLE>
Our shortfall of -0.8% annually versus the Index is due largely to the
fact that Gemini II, as an actual operating portfolio, incurs advisory fees,
operating expenses, and transaction costs, burdens that are not borne by the
Index, a theoretical construct. Also, during the bull market prevailing since
the Fund's inception, our portfolio has been more conservatively positioned
(holding sizable portions of its assets in bonds and cash) than the Index,
which is always fully invested in stocks.
When Gemini II matures on January 31, its Income Shares will be redeemed
at their net asset value on that date, at each shareholder's election either in
cash or in the form of shares in the Prime Portfolio of Vanguard Money Market
Reserves or Vanguard/Windsor Fund. The Capital Shares will continue to trade on
the New York Stock Exchange until shareholders approve conversion to an
open-end mutual fund. Shareholders are scheduled to vote on February 19. For
the record, we present above the net asset value of each share class, its
market price based on trading on the New York Stock Exchange, and the premium
the market price represented over net asset value at year-end 1996. You will
note that now that the redemption date and open-ending date are near, the large
discount on the Capital Shares and large premium on the Income Shares that have
prevailed over the years have been replaced by nominal premiums.
<TABLE>
<CAPTION>
- --------------------------------------------------------
DECEMBER 31, 1996
-----------------------------
NET ASSET MARKET
VALUE PRICE PREMIUM
- --------------------------------------------------------
<S> <C> <C> <C>
Capital Shares $28.75 $29.00 +0.9%
Income Shares 9.34 9.50 +1.7
- --------------------------------------------------------
TOTAL $38.09 $38.50 +1.1%
- --------------------------------------------------------
</TABLE>
3
<PAGE> 6
IN SUMMARY
Gemini II has had the good fortune to exist during one of the most remarkable
periods in history for the U.S. stock market. Stock prices have been
rising--with only a few brief setbacks--for our near-twelve-year history. This
means that many equity fund investors today have experienced only "upside
volatility," and not the "downside volatility" that is also part and parcel of
investing in common stocks.
Now, as Gemini II shareholders decide how to redeploy the assets they have
invested in the Fund, it is appropriate to step back and assess the outlook for
the financial markets. While no one can accurately predict what will happen
over the next decade--or even the next year--it seems unlikely that stocks will
enjoy a repeat of the exceptional returns of this remarkable era. Indeed, there
are sure to be some rough seas ahead. Nonetheless, we believe that investors
who maintain a balanced portfolio of stock funds, bond funds, and money market
funds will overcome the volatility of the financial markets and be rewarded.
This has been our consistent message: "Stay the course." It has proved wise
counsel in the past, and we see no reason why it should not continue to be in
the future.
/s/ JOHN C. BOGLE /s/ JOHN J. BRENAN
Chairman of the Board President
January 24, 1997
4
<PAGE> 7
THE MARKETS IN PERSPECTIVE: YEAR ENDED DECEMBER 31, 1996
U.S. EQUITY MARKETS
The stock market in 1996 could not match its astonishing 37.6% return of the
previous year--but it made a good run, with the Standard & Poor's 500 Composite
Stock Price Index up by 23.0%. When the two years are considered cumulatively,
the S&P 500 Index has risen 69.2%. Not surprisingly, many of the factors that
drove the market higher in 1995 were still at work: Once again, steady economic
growth, low inflation, and solid earnings growth were powerful motivators.
The market's gains, however, were far from evenly distributed. Investors
strongly favored larger companies, such as those that dominate the S&P 500
Index. In fact, even within the Index, it was the largest companies that
prevailed: The 50 biggest (which account for roughly half the Index's market
value) gained 26.7% in 1996, compared with an increase of 23.0% for the entire
Index. Looking at the S&P 500 Index's performance by sector, technology stocks
were strongest, closing the year with a 42.5% gain. Financial stocks were a
close second, gaining 35.5%. Utilities, plagued early in the year by higher
interest rates and a rapidly changing competitive landscape, eked out a meager
1.8% return, the lowest within the Index.
With the largest companies performing so well, most smaller issues could
not keep pace. This was evidenced in the considerable difference between the
23.0% return of the S&P 500 Index and the 16.5% return of the Russell 2000
Index of small stocks. Even for the smaller companies, there was a significant
range of performance among sectors. Energy stocks led the Russell 2000 Index
with a 62.0% gain for the year. Here, rising prices, limited exposure to the
cyclical refining business, and a reduced number of competitors created a
favorable environment for the stocks. At the other end of the spectrum were
health-care stocks, which showed a loss of -3.3%.
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------
AVERAGE ANNUALIZED RETURNS
PERIODS ENDED DECEMBER 31, 1996
-----------------------------------
1 YEAR 3 YEARS 5 YEARS
- -------------------------------------------------------------------------
<S> <C> <C> <C>
Equity
S&P 500 Index 23.0% 19.7% 15.2%
Russell 2000 Index 16.5 13.7 15.6
MSCI-EAFE Index 6.4 8.6 8.5
- -------------------------------------------------------------------------
Fixed-Income
Lehman Aggregate Bond Index 3.6% 6.0% 7.0%
Lehman 10-Year Municipal
Bond Index 4.5 5.3 7.5
Salomon 90-Day U.S. Treasury Bills 5.3 5.1 4.4
- -------------------------------------------------------------------------
Other
Consumer Price Index 3.3% 2.8% 2.8%
- -------------------------------------------------------------------------
</TABLE>
U.S. FIXED-INCOME MARKETS
At year-end, the yield on the 30-year U.S. Treasury bond was 6.64%, noticeably
higher than its 5.95% level on December 31, 1995. The change in rates during
1996 reflects increased concern about the prospects for rising inflation, due
to indications of greater than expected strength in the economy.
When the year began, the general expectation was that modest economic
growth and benign inflation would continue, giving the Federal Reserve no
reason to boost inter-
5
<PAGE> 8
est rates. That complacency was shattered by an exceptionally strong February
jobs report, the first of what turned out to be a succession of signs that in
fact the economy was growing at a much faster--and potentially
inflation-inducing--pace. The bond market reacted swiftly to meet the perceived
risk: The 30-year Treasury bond's yield jumped from just below 6.0% at the end
of 1995 to 6.7% in late March. The next several months saw a consistent pattern
in which bond yields rose on the Friday of the jobs-report release only to fall
back by the middle of the month. Hindsight shows that most of the worry was
wasted: Inflation, as measured by the Consumer Price Index, remained near an
annualized rate of 3.3%. But increasing signs of growth in late November and
December reignited inflation concerns and caused bonds to finish the year on a
sour note.
Despite the numerous setbacks suffered by the bond market in 1996, indexes
were able to finish the year with positive total returns. Although the specter
of the Federal Reserve Board loomed large during the year, in fact the Board
acted only once, lowering the federal funds rate by a total of 0.25% in
January.
Corporate bonds, mortgage-backed issues, and municipals were three
relatively bright spots in 1996. The strength in earnings that benefited stock
prices extended to the corporate bond sector as well. These bonds, especially
those of lower credit quality, performed well relative to Treasuries, supported
by general confidence in companies' ability to meet payments. The
stable-to-rising interest-rate environment throughout most of the year
benefited another large segment of the bond market--mortgage-backed
securities--as the threat of refinancings receded. Finally, municipal bonds
outpaced their U.S. Treasury counterparts. The sector was shielded to a certain
extent from the inflation wars of the Treasury market, as demand outstripped
supply for much of the year.
INTERNATIONAL EQUITY MARKETS
Investors who assess international markets by the often-cited EAFE
benchmark--the Morgan Stanley Capital International-Europe, Australasia, Far
East Index, with its 1996 return of 6.4%--could have overlooked a striking
regional disparity between the European and Pacific markets. Europe's markets
gained 21.4% during the year, while their Pacific counterparts posted a decline
of -8.2%. Clearly, the outlook and environments that characterized the European
and Far East markets were quite different.
The poor returns in the Pacific region largely reflected ongoing concern
about the health of the Japanese economy. Growth in Japan has remained modest
at best for several years despite government efforts to stimulate the economy
through public works programs and tax incentives. In Europe, the picture was
dramatically different, with the region benefiting from a variety of factors.
Among the most important were (1) ongoing efforts to lower government deficits
consistent with the Maastricht Treaty guidelines, (2) improving economic
growth, and (3) a greater commitment by corporate executives to increasing
"shareholder value."
6
<PAGE> 9
REPORT FROM THE ADVISER
[PHOTO]
Gemini II's total return in 1996 was 16.2%, well behind the 23.0% return on
the unmanaged Standard & Poor's 500 Composite Stock Price Index.
Our financial-sector holdings--banks, insurance companies, savings and
loans, and real estate investment trusts, about 29% of the Fund going into
1996--were outstanding performers, but this was not enough to carry the day.
Our other very large concentration, basic materials--aluminum, steel,
chemicals, and paper, more than 34% of the Fund going in--generally performed
poorly and in some cases actually had negative returns. Our 11% position in
automotive stocks was a mild negative. Finally, our cash position, which ranged
from about 15% to 22% during the year, turned out to be a significant drag
given the market's heady advance.
We were mild net sellers of stocks during the year. The sales were largely
a trimming of our financial and energy holdings as their prices reached our
target zones. An additional motive for the energy sales was our belief that the
current $25-per-barrel price of crude oil is unsustainably high, given an
underlying excess of supply over demand.
Our purchases were a mixed bag--building and construction companies,
airlines, and a couple of Bermuda-based reinsurers with good dividend yields.
Gemini II shareholders who also hold shares of Vanguard/Windsor Fund are aware
that Windsor's technology position was greatly increased, and successfully, in
1996. We did not have the opportunity to duplicate this in Gemini II because
the technology stocks Windsor bought are largely non-dividend-payers, which are
a no-no in Gemini II by charter, and there were no companion convertibles that
we could use in place of common stock. The exception was Quantum Corporation,
which does have a convertible that we built into a 2.2% position before selling
it at a profit of nearly 60%.
The largest concentrations in the portfolio at the end of 1996 were basic
materials, constituting a little under 29% of Gemini II's assets; financials,
21%; and autos, 11%. While our basic-materials holdings were disappointing
performers in 1996, we continue to feel that these holdings are well-placed. We
believe that, with inflation low and interest rates easing around the world,
1997 should be a year of synchronous economic growth, with global industrial
production rising on the order of 4.5%. This will chew up a lot of aluminum,
paper, chemicals, and steel, in quantities outstripping the underlying
increases in capacity, and thus we should enjoy a sustained rise in the
commodity prices and, concomitantly, in the share prices of these stocks.
In last year's Annual Report, we said we would strive in 1996 to garner an
increase in per-share income at least as great as the 4% increase in 1995. We
are pleased that the income growth turned out to be 7%.
Charles T. Freeman, Portfolio Manager
Wellington Management Company, LLP
January 14, 1997
7
<PAGE> 10
PORTFOLIO PROFILE: GEMINI II
DECEMBER 31, 1996
This Profile provides a snapshot of the Fund's characteristics, compared where
appropriate to an unmanaged index. Key elements of this Profile are defined on
page 9.
<TABLE>
<CAPTION>
PORTFOLIO CHARACTERISTICS
- --------------------------------------------
GEMINI II S&P 500
- --------------------------------------------
<S> <C> <C>
Number of Stocks 34 500
Median Market Cap $5.6B $24.5B
Price/Earnings Ratio 12.5x 19.6x
Price/Book Ratio 1.7x 3.4x
Yield 5.1% 2.0%
Return on Equity 10.5% 19.6%
Earnings Growth Rate 7.2% 13.5%
Foreign Holdings 4.9% 3.7%
Turnover Rate 20% --
Expense Ratio 0.45% --
Cash Reserves 21.7% --
</TABLE>
INVESTMENT FOCUS
- --------------------------------------------
[CHART]
<TABLE>
<CAPTION>
VOLATILITY MEASURES
- --------------------------------------------
GEMINI II S&P 500
- --------------------------------------------
<S> <C> <C>
R-Squared 0.66 1.00
Beta 0.85 1.00
</TABLE>
<TABLE>
<CAPTION>
TEN LARGEST HOLDINGS (% OF TOTAL NET ASSETS)
- --------------------------------------------
<S> <C>
Chrysler Corp. 6.6%
Atlantic Richfield Co. 5.0
AK Steel Holding 4.8
Reynolds Metals Co. 4.5
Continental Airlines, Inc. 4.4
Ford Motor Co. 4.0
Bowater, Inc. 3.9
Great Western Financial Corp. 3.4
First Union Corp. 3.0
Owens Corning Capital 2.7
- --------------------------------------------
Top Ten 42.3%
</TABLE>
<TABLE>
<CAPTION>
SECTOR DIVERSIFICATION (% OF STOCK)
- ---------------------------------------------------------------------------------------------
DECEMBER 31, 1995 DECEMBER 31, 1996
-------------------------------------------------
GEMINI II GEMINI II S&P 500
-------------------------------------------------
<S> <C> <C> <C>
Basic Materials ............................ 38.0% 36.6% 6.2%
Capital Goods & Construction ............... 0.0 7.2 8.4
Consumer Cyclical ......................... 13.3 14.5 12.1
Consumer Staples ........................... 0.0 0.0 12.4
Energy ..................................... 7.3 4.0 9.7
Financial .................................. 35.5 28.7 15.0
Health Care ................................ 0.0 0.0 10.4
Technology ................................. 0.3 0.0 12.1
Transport & Services ....................... 2.4 8.2 1.5
Utilities .................................. 1.4 0.8 9.9
Miscellaneous .............................. 1.8 0.0 2.3
- ---------------------------------------------------------------------------------------------
</TABLE>
8
<PAGE> 11
[PHOTO]
BETA. A measure of the magnitude of a portfolio's past share-price fluctuations
in relation to the fluctuations in the overall market (or appropriate market
index). The market, or index, has a beta of 1.00, so a portfolio with a beta of
1.20 would have seen its share price rise or fall by 12% when the overall
market rose or fell by 10%.
EARNINGS GROWTH RATE. The annual average rate of growth in earnings over the
past five years for the stocks now in a portfolio.
EXPENSE RATIO. The percentage of a portfolio's average net assets used to pay
its annual administrative and advisory expenses. These expenses directly reduce
returns to investors. The average expense ratio for a stock mutual fund was
1.34% in 1995.
FOREIGN HOLDINGS. The percentage of a portfolio's investments represented by
stocks or American Depository Receipts of companies based outside of the United
States.
INVESTMENT FOCUS. This grid indicates the focus of a portfolio in terms of two
attributes: market capitalization (large, medium, or small) and relative
valuation (growth, value, or a blend).
MEDIAN MARKET CAP. The midpoint of market capitalization (market price x shares
outstanding) of the stocks in a portfolio. Half the stocks in the portfolio
have higher market capitalizations and half lower.
NUMBER OF STOCKS. An indicator of diversification. The more stocks a portfolio
holds, the more diversified it is and the more likely to perform in line with
the overall stock market.
PRICE/BOOK RATIO. The share price of a stock divided by its net worth, or book
value, per share. For a portfolio, the weighted average price/book ratio of the
stocks it holds.
PRICE/EARNINGS RATIO. The ratio of a stock's current price to its per-share
earnings over the past year. For a portfolio, the weighted average P/E of the
stocks it holds. P/E is an indicator of market expectations about corporate
prospects; the higher the P/E, the greater the expectations for a company's
future growth.
RETURN ON EQUITY. The annual average rate of return generated by a company
during the past five years for each dollar of shareholder's equity (net income
divided by shareholder's equity). For a portfolio, the weighted average return
on equity for the companies represented in the portfolio.
R-SQUARED. A measure of how much of a portfolio's past returns can be explained
by the returns from the overall market (or its benchmark index). If a
portfolio's total return were precisely synchronized with the overall market's
return, its R-squared would be 1.00. If a portfolio's returns bore no
relationship to the market's returns, its R-squared would be 0.
SECTOR DIVERSIFICATION. The percentage of a portfolio's stocks invested in each
of the major industry classifications that compose the stock market.
TEN LARGEST HOLDINGS. The percentage of a portfolio's total net assets in its
ten largest investments (the average for stock mutual funds is about 25%). As
this percentage rises, a portfolio's returns are likely to be more volatile
since they are more dependent on the fortunes of a few companies.
TURNOVER RATE. An indication of trading activity during the past year.
Portfolios with high turnover rates incur higher transaction costs and are more
likely to realize and distribute capital gains (which are taxable to
investors). The average turnover rate for stock mutual funds is about 80%.
YIELD. A snapshot of a portfolio's income from interest and dividends. The
yield, expressed as a percentage of Gemini II's total net asset value, is based
on income earned over the past 12 months.
9
<PAGE> 12
PERFORMANCE SUMMARY: GEMINI II
<TABLE>
<CAPTION>
INCOME SHARES: 2/15/85-12/31/96
- --------------------------------------------------------------------------------
<S> <C>
1985 $1.13
1986 $1.23
1987 $1.38
1988 $1.41
1989 $1.58
1990 $1.63
1991 $1.65
1992 $1.66
1993 $1.66
1994 $1.73
1995 $1.80
1996 1.99
</TABLE>
<TABLE>
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
NET INCOME EARNED $1.13* $1.23 $1.38 $1.41 $1.58 $1.63 $1.65 $1.66 $1.66 $1.74 $1.79 $1.94
YEAR-END NET
ASSET VALUE 9.83 9.73 9.39 9.38 9.37 9.34 9.34 9.33 9.33 9.34 9.33 9.34
YEAR-END MARKET PRICE 11 5/8 13 5/8 11 7/8 12 1/2 13 11 1/4 13 3/8 12 11 3/4 10 1/2 10 1/8 9 1/2
PREMIUM 18.3% 40.0% 26.5% 33.3% 38.7% 20.4% 43.2% 28.6% 25.9% 12.4% 8.5% 1.7%
</TABLE>
*Represents net investment income earned from February 15, 1985.
<TABLE>
<CAPTION>
CAPITAL SHARES: 2/15/85-12/31/96
- --------------------------------------------------------------------------------
<S> <C>
2/85 10.00
1985 11.47
1986 13.87
1987 12.98
1988 16.56
1989 17.44
1990 11.51
1991 16.28
1992 18.71
1993 22.10
1994 19.03
1995 26.35
1996 28.75
</TABLE>
<TABLE>
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
ADJUSTED
NET ASSET
VALUE* $10.00 $11.53 $14.67 $14.89 $18.98 $20.38 $14.65 $20.17 $23.05 $27.38 $24.92 $33.72 $37.42
ACTUAL NET
ASSET VALUE 10.00 11.47 13.87 12.98 16.56 17.44 11.51 16.28 18.71 22.10 19.03 26.35 28.75
YEAR-END
MARKET PRICE -- 11 12 1/8 10 5/8 12 7/8 15 5/8 9 1/2 13 1/4 14 7/8 19 7/8 17 5/8 25 3/4 29
PREMIUM/
DISCOUNT -- -4.1% -12.6% -18.1% -22.3% -10.4% -17.5% -18.6% -20.5% -10.1% -7.4% -2.3% 0.9%
COMBINED
PREMIUM/
DISCOUNT -- 6.2% 9.1% 0.6% -2.2% 6.8% -0.5% 3.9% -4.2% 0.6% -0.9% 0.5% 1.1%
</TABLE>
*Net asset value plus cumulative short-term capital gains and capital gains
taxes paid by the Fund.
10
<PAGE> 13
FINANCIAL STATEMENTS
DECEMBER 31, 1996
<TABLE>
<CAPTION>
STATEMENT OF NET ASSETS
- -----------------------------------------------------------------------
MARKET
VALUE*
GEMINI II SHARES (000)
- -----------------------------------------------------------------------
COMMON STOCKS (42.8%)
- -----------------------------------------------------------------------
<S> <C> <C>
BASIC MATERIALS (6.2%)
British Steel PLC ADR 265,700 $ 7,307
Reynolds Metals Co. 329,148 18,556
----------
25,863
----------
CONSUMER CYCLICAL (10.6%)
Chrysler Corp. 830,622 27,410
Ford Motor Co. 522,653 16,660
----------
44,070
----------
ENERGY (2.7%)
Atlantic Richfield Co. 31,000 4,107
USX-Marathon Group 307,100 7,332
----------
11,439
----------
FINANCIAL (21.1%)
BANKS (5.0%)
Chase Manhattan Corp. 26,600 2,374
First Union Corp. 166,300 12,306
KeyCorp 6,089 307
NationsBank Corp. 59,700 5,836
INSURANCE (4.9%)
CIGNA Corp. 46,600 6,367
GCR Holdings, Ltd. 435,000 9,624
IPC Holdings, Ltd. 200,000 4,475
REAL ESTATE INVESTMENT TRUSTS (6.0%)
Camden Property Trust REIT 125,000 3,578
Colonial Properties Trust REIT 74,600 2,266
Equity Residential Properties
Trust REIT 207,100 8,543
Evans Withycombe Residential,
Inc. REIT 195,000 4,095
Oasis Residential, Inc. REIT 180,000 4,095
Urban Shopping Centers,
Inc. REIT 82,800 2,401
SAVINGS & LOAN (5.2%)
H.F. Ahmanson & Co. 229,000 7,443
Great Western Financial Corp. 481,040 13,950
----------
87,660
----------
UTILITIES (0.6%)
Unicom Corp. 87,937 2,385
----------
TRANSPORT & SERVICES (1.6%)
Delta Air Lines, Inc. 93,161 6,603
----------
- -----------------------------------------------------------------------
TOTAL COMMON STOCKS
(COST $130,375) 178,020
- -----------------------------------------------------------------------
CONVERTIBLE PREFERRED STOCKS (30.5%)
- -----------------------------------------------------------------------
BASIC MATERIALS (20.6%)
CHEMICALS (4.1%)
Atlantic Richfield Co. 9.00%
(Convertible into Lyondell
Petrochemical Co.) 785,500 16,888
METALS & MINING (2.6%)
Kaiser Aluminum 8.255% 979,400 $ 11,018
PAPER (6.7%)
Boise Cascade Corp. $1.58 35,800 931
Bowater, Inc. 7.00% 534,000 16,287
International Paper Co. 2.625% 238,000 10,889
STEEL (7.2%)
AK Steel Holding 7.00% 574,500 20,107
Bethlehem Steel Corp. $3.50 258,400 9,722
----------
85,842
----------
CAPITAL GOODS & CONSTRUCTION (5.3%)
Beazer Homes 8.00% 370,000 10,545
Owens Corning Capital 6.50% 200,000 11,400
----------
21,945
----------
ENERGY (0.2%)
Valero Energy $3.125 15,000 859
----------
TRANSPORT & SERVICES (4.4%)
Continental Airlines, Inc. 8.50% 275,000 18,288
----------
- -----------------------------------------------------------------------
TOTAL CONVERTIBLE PREFERRED STOCKS
(COST $124,988) 126,934
- -----------------------------------------------------------------------
<CAPTION>
FACE
AMOUNT
(000)
<S> <C> <C>
- -----------------------------------------------------------------------
CONVERTIBLE BONDS (2.5%)
- -----------------------------------------------------------------------
Quantum Corp.
6.375%, 4/1/02 $ 5,700 8,906
Toll Corp.
4.75%, 1/15/04 58 59
U.S. Home
4.875%, 11/1/05 1,750 1,593
- -----------------------------------------------------------------------
TOTAL CONVERTIBLE BONDS
(COST $7,094) 10,558
- -----------------------------------------------------------------------
BONDS (2.5%)
- -----------------------------------------------------------------------
Geneva Steel
11.125%, 3/15/01 7,000 6,440
Ryland Group
9.625%, 6/1/04 2,500 2,478
Weirton Steel Corp.
10.875%, 10/15/99 1,180 1,227
- -----------------------------------------------------------------------
TOTAL BONDS
(COST $10,653) 10,145
- -----------------------------------------------------------------------
TEMPORARY CASH INVESTMENTS (25.9%)
- -----------------------------------------------------------------------
U.S. GOVERNMENT & AGENCY OBLIGATIONS
Federal Farm Credit Bank
5.547%, 1/15/97 15,000 14,968
Federal Home Loan Mortgage Corp.
5.354%, 1/14/97 7,000 6,987
5.533%, 1/10/97 15,000 14,980
5.545%, 1/15/97 15,000 14,968
</TABLE>
11
<PAGE> 14
<TABLE>
<CAPTION>
FACE MARKET
AMOUNT VALUE*
GEMINI II (000) (000)
- -----------------------------------------------------------------------
<S> <C> <C>
COMMERCIAL PAPER
A1 Credit Corp.
5.404%, 1/24/97 $ 5,000 $ 4,980
Abbott Laboratories, Inc.
5.642%, 1/9/97 5,000 4,994
Coca-Cola Co.
5.397%, 2/4/97 5,000 4,971
E.I. du Pont de Nemours & Co.
5.397%, 1/29/97 5,000 4,976
MetLife Funding, Inc.
5.438%, 2/4/97 5,373 5,346
Private Exporting Funding
5.403%, 2/10/97 5,000 4,967
REPURCHASE AGREEMENT
Collateralized by U.S. Government
Obligations in a Pooled
Cash Account
6.39%, 1/2/97 25,577 25,577
- -----------------------------------------------------------------------
TOTAL TEMPORARY CASH INVESTMENTS
(COST $107,728) 107,714
- -----------------------------------------------------------------------
TOTAL INVESTMENTS (104.2%)
(COST $380,838) 433,371
- -----------------------------------------------------------------------
OTHER ASSETS AND LIABILITIES (-4.2%)
- -----------------------------------------------------------------------
Other Assets--Notes D and F 10,388
Federal Income Tax Payable (11,622)
Distribution Payable (8,409)
Other Liabilities--Note F (7,791)
----------
(17,434)
- -----------------------------------------------------------------------
NET ASSETS (100%) $415,937
- -----------------------------------------------------------------------
</TABLE>
*See Note A in Notes to Financial Statements.
12
<PAGE> 15
STATEMENT OF OPERATIONS
- ---------------------------------------------------------------------------
<TABLE>
<CAPTION>
GEMINI II
YEAR ENDED DECEMBER 31, 1996
(000)
- ---------------------------------------------------------------------------
<S> <C>
INVESTMENT INCOME
INCOME
Dividends $17,196
Interest 5,814
-----------
Total Income 23,010
-----------
EXPENSES
Investment Advisory Fee--Note C
Basic Fee 1,356
Performance Adjustment (185)
The Vanguard Group--Note D 495
Custodian Fees 18
Taxes (other than income taxes) 31
Auditing Fees 8
Shareholders' Reports 46
Annual Meeting and Proxy Costs 58
Directors' Fees and Expenses 1
-----------
Total Expenses 1,828
- ---------------------------------------------------------------------------
NET INVESTMENT INCOME $21,182
- ---------------------------------------------------------------------------
REALIZED AND UNREALIZED GAIN ON INVESTMENTS
Realized Net Gain on Investment Securities Sold $35,808
Change in Unrealized Appreciation (Depreciation) 4,679
- ---------------------------------------------------------------------------
NET REALIZED AND UNREALIZED GAIN ON INVESTMENTS $40,487
===========================================================================
</TABLE>
13
<PAGE> 16
STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
GEMINI II
YEAR ENDED DECEMBER 31,
-------------------------
1996 1995
(000) (000)
- ----------------------------------------------------------------------------------------------------
<S> <C> <C>
INCOME AVAILABLE FOR DISTRIBUTION
Balance, Beginning of Year $ 280 $ 445
Net Investment Income 21,182 19,491
Distributions to Income Shareholders
($1.93 and $1.80 per share, respectively) (21,077) (19,656)
------------------------
Balance, End of Year $ 385 $ 280
- ----------------------------------------------------------------------------------------------------
UNDISTRIBUTED CAPITAL GAINS
Balance, Beginning of Year $138,332 $110,693
Realized Net Gain on Investment Securities Sold 35,808 43,748
Distributions to Capital Shareholders ($.24 and
$.11 per share, respectively) (2,621) (1,201)
Provision for Taxes on Capital Gains Retained (11,622) (14,908)
------------------------
Balance, End of Year $159,897 $138,332
- ----------------------------------------------------------------------------------------------------
UNREALIZED APPRECIATION (DEPRECIATION) OF INVESTMENT SECURITIES
Beginning of Year $47,854 $(4,435)
End of Year--Note F 52,533 47,854
------------------------
Change in Unrealized Appreciation (Depreciation) $ 4,679 $52,289
====================================================================================================
</TABLE>
<TABLE>
<CAPTION>
STATEMENT OF SHAREHOLDERS' EQUITY
- ----------------------------------------------------------------------------------------------------
GEMINI II
DECEMBER 31, 1996
- ----------------------------------------------------------------------------------------------------
<S> <C>
Income Shares, $1.00 Par Value--Redeemable at $9.30 per Share on January 31, 1997:
Authorized 15,000,000 Shares; Issued and Outstanding 10,920,550 Shares $ 10,920*
Capital Surplus 90,641*
Income Available for Distribution 385
-----------
101,946
-----------
Capital Shares, $1.00 Par Value; Authorized 15,000,000 Shares;
Issued and Outstanding 10,920,550 Shares 10,920*
Capital Surplus 90,641*
Undistributed Capital Gains 159,897
Unrealized Appreciation of Investment Securities 52,533
-----------
313,991
- ----------------------------------------------------------------------------------------------------
TOTAL SHAREHOLDERS' EQUITY $415,937
====================================================================================================
</TABLE>
*No change during period.
14
<PAGE> 17
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
GEMINI II
YEAR ENDED DECEMBER 31,
---------------------------------------------------
FOR A SHARE OUTSTANDING THROUGHOUT EACH YEAR 1996 1995 1994 1993 1992
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
INCOME SHARES
NET ASSET VALUE, BEGINNING OF YEAR $9.33 $9.34 $9.33 $9.33 $9.34
- -----------------------------------------------------------------------------------------------------
Net Investment Income 1.94 1.79 1.74 1.66 1.66
Distributions from Net Investment Income (1.93) (1.80) (1.73) (1.66) (1.67)
- -----------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD $9.34 $9.33 $9.34 $9.33 $9.33
=====================================================================================================
CAPITAL SHARES
NET ASSET VALUE, BEGINNING OF YEAR $26.35 $19.03 $22.10 $18.71 $16.28
- -----------------------------------------------------------------------------------------------------
Realized Net Gain on Investments 3.27 4.01 1.73 2.69 1.17
Distributions from Realized Capital Gains (.24) (.11) -- -- (.08)
Provision for Taxes on Capital Gains Retained (1.06) (1.37) (.61) (.94) (.37)
Unrealized Appreciation (Depreciation) .43 4.79 (4.19) 1.64 1.71
- -----------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR $28.75 $26.35 $19.03 $22.10 $18.71
=====================================================================================================
</TABLE>
SUMMARY OF QUARTERLY RESULTS OF OPERATIONS (unaudited)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
GEMINI II
AMOUNTS IN THOUSANDS AND PER SHARE
THREE MONTHS ENDED
- -------------------------------------------------------------------------------------------------------------------------
MARCH 31, 1996 JUNE 30, 1996 SEPTEMBER 30, 1996 DECEMBER 31, 1996
----------------- ----------------- ------------------ -----------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Net Investment Income $ 5,098 $ .46 $ 5,451 $ .50 $5,352 $.49 $ 5,281 $ .49
Net Realized Gain (Loss) and Change in
Unrealized Appreciation (Depreciation) 23,364 2.14 (8,489) (.78) 5,130 .47 20,482 1.87
<CAPTION>
MARCH 31, 1995 JUNE 30, 1995 SEPTEMBER 30, 1995 DECEMBER 31, 1995
----------------- ----------------- ------------------ -----------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Net Investment Income $ 4,785 $ .44 $ 4,320 $ .39 $ 5,181 $ .48 $ 5,205 $.48
Net Realized Gain (Loss) and Change in
Unrealized Appreciation (Depreciation) 22,699 2.08 32,699 2.99 31,715 2.9 18,924 .82
=========================================================================================================================
</TABLE>
15
<PAGE> 18
NOTES TO FINANCIAL STATEMENTS
Gemini II is registered under the Investment Company Act of 1940 as a
diversified closed-end investment company. Certain of the Fund's investments
are in corporate debt instruments; the issuers' abilities to meet these
obligations may be affected by economic developments in their respective
industries.
A. The following significant accounting policies conform to generally accepted
accounting principles for investment companies. The Fund consistently follows
such policies in preparing its financial statements.
1. SECURITY VALUATION: Securities listed on an exchange are valued at the
latest quoted sales prices as of the close of trading on the New York Stock
Exchange (generally 4:00 p.m. Eastern time) on the valuation date; such
securities not traded on the valuation date are valued at the mean of the
latest quoted bid and asked prices. Securities not listed on an exchange are
valued at the latest quoted bid prices. Bonds, and temporary cash investments
acquired more than 60 days to maturity, are valued using the latest bid prices
or using valuations based on a matrix system (which considers such factors as
security prices, yields, maturities, and credit ratings), both as furnished by
independent pricing services. Other temporary cash investments are valued at
amortized cost, which approximates market value.
2. FEDERAL INCOME TAXES: The Fund intends to continue to qualify as a
regulated investment company and distribute all of its taxable income.
Accordingly, no provision for federal income taxes is required in the financial
statements. Realized net long-term gains, if any, on security transactions are
retained and applicable taxes thereon are accrued at the end of the Fund's
fiscal year (see Note B).
3. REPURCHASE AGREEMENTS: The Fund, along with other members of The
Vanguard Group, transfers uninvested cash balances to a Pooled Cash Account,
which is invested in repurchase agreements secured by U.S. government
securities. Securities pledged as collateral for repurchase agreements are held
by a custodian bank until the agreements mature. Each agreement requires that
the market value of the collateral be sufficient to cover payments of interest
and principal; however, in the event of default or bankruptcy by the other
party to the agreement, retention of the collateral may be subject to legal
proceedings.
4. DISTRIBUTIONS: Distributions to shareholders are recorded on the
ex-dividend date.
5. OTHER: Dividend income is recorded on the ex-dividend date. Security
transactions are accounted for on the date securities are bought or sold. Costs
used to determine realized gains (losses) on the sale of investment securities
are those of the specific securities sold.
B. Income Shareholders are entitled to receive as distributions the higher of
$.80 per share (annually) or all of the net investment income available for
distribution. Income distributions to Capital Shareholders are prohibited as
long as any Income Shares remain outstanding. Capital Shareholders are entitled
to receive annual distributions of any net realized short-term gains on sales
of investment securities.
C. Under a contract that expires January 31, 1998, the Fund pays Wellington
Management Company, LLP an investment advisory fee calculated at an annual
percentage rate of average net assets. The basic fee is subject to quarterly
adjustments based on performance relative to the S&P 500 Index. For the year
ended December 31, 1996, the advisory fee represented an effective annual basic
rate of 0.33% of the Fund's average net assets before a decrease of $185,000
(0.05%) based on performance.
D. The Vanguard Group furnishes at cost corporate management, administrative,
marketing, and distribution services. The costs of such services are allocated
to the Fund under methods approved by the Board of Directors. At December 31,
1996, the Fund had contributed capital of $38,000 to Vanguard (included in
Other Assets), representing 0.2% of Vanguard's capitalization. The Fund's
directors and officers are also directors and officers of Vanguard.
16
<PAGE> 19
E. During the year ended December 31, 1996, the Fund purchased $66,267,000 of
investment securities and sold $118,618,000 of investment securities, other
than U.S. government securities and temporary cash investments. There were no
purchases or sales of U.S. government securities.
F. At December 31, 1996, net unrealized appreciation of investment securities
for financial reporting and federal income tax purposes was $52,533,000,
consisting of unrealized gains of $61,265,000 on securities that had risen in
value since their purchase and $8,732,000 in unrealized losses on securities
that had fallen in value since their purchase.
G. The market value of securities on loan to broker/dealers at December 31,
1996, was $7,145,000, for which the Fund held cash collateral of $7,331,000.
H. On January 31, 1997, the Income Shares were redeemed at $9.30 per share plus
accumulated net income of $.115 per share. On January 21, 1997, the Capital
shareholders voted to approve modifications of the Fund's investment objectives
as a result of the redemption of the Income Shares. A shareholder vote on a
proposal to approve the Fund's conversion into an open-end investment company
has been scheduled for February 19, 1997. Thereafter, the Board of Directors
expects to seek shareholder approval to merge the Fund into Vanguard/Windsor
Fund.
17
<PAGE> 20
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders and
Board of Directors of
Gemini II
In our opinion, the accompanying statements of net assets and of shareholders'
equity and the related statements of operations and of changes in net assets
and the financial highlights present fairly, in all material respects, the
financial position of Gemini II (the "Fund") at December 31, 1996, and the
results of its operations, the changes in its shareholders' equity and the
financial highlights for each of the periods indicated, in conformity with
generally accepted accounting principles. These financial statements and
financial highlights (hereafter referred to as "financial statements") are the
responsibility of the Fund's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these financial statements in accordance with generally accepted
auditing standards which require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management,
and evaluating the overall financial statement presentation. We believe that
our audits, which included confirmation of securities at December 31, 1996 by
correspondence with the custodian, provide a reasonable basis for the opinion
expressed above.
As more fully described in Note H, the Income Shares were redeemed on
January 31, 1997, and the form under which the Fund will continue is being
considered.
PRICE WATERHOUSE LLP
Thirty South Seventeenth Street
Philadelphia, Pennsylvania 19103
January 31, 1997
18
<PAGE> 21
SPECIAL 1996 TAX INFORMATION (UNAUDITED)
GEMINI II
CAPITAL SHAREHOLDERS
Gemini II Capital Shares receive all capital appreciation (or depreciation)
from the Fund's investments, including any net capital gains that are realized
from the sale of portfolio securities. The net realized long-term capital gains
are retained in the value of the Capital Shares rather than being distributed
to shareholders. According to provisions of the Internal Revenue Code, the Fund
pays federal income tax on these net realized long-term capital gains at the
corporate capital gains tax rate, and the amount of this tax is deducted from
the net asset value of the Capital Shares at year-end.
As a result of this procedure, there are three important tax steps which
you, as a Capital Shareholder, should take:
1. You should report on your 1996 personal income tax return the net
long-term capital gains realized by your Fund during the year.
2. You should take credit for the federal taxes paid by the Fund on these
realized gains. Since the effective personal capital gains tax rate cannot
exceed 28%, no inequity is created since you receive full credit for the tax
paid by the Fund.
3. You should increase the tax cost basis of your Capital Shares by the
amount of the after-tax gains. This is the difference between the amount of net
capital gains realized and the tax paid on these gains by the Fund (see the
table below).
Federal Tax Form 2439, which you should receive by March 1, 1997, provides
for your account the specific amounts of realized capital gains and
corresponding taxes paid as discussed in 1 and 2 above. Enclosed with this form
are specific instructions on how to record this information for tax purposes,
but please feel free to contact us if you have any questions regarding taxes
and your Gemini II Capital Shares. IF YOUR SHARES ARE HELD FOR YOU IN A NOMINEE
REGISTRATION AND YOU HAVE NOT AS YET RECEIVED TAX FORM 2439, YOU SHOULD CONTACT
YOUR BANK OR BROKER TO OBTAIN THE FORM. A copy must be filed with your federal
income tax return.The table below shows: the amount of net realized capital
gains per Capital Share; the federal taxes paid on your behalf; the Fund's
capital gains tax rate; and the amount by which your cost per share should be
increased for fiscal years 1985 through 1996.
INCOME SHAREHOLDERS
Additional Tax Information--For your state income tax return, 0.29% of your
1996 income was derived from direct U.S. government obligations.
Corporate shareholders should note that 75.2% of the 1996 income qualifies
for the intercorporate dividends-received deduction.
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------
REALIZED LONG-TERM CAPITAL GAINS PER CAPITAL SHARE
- ----------------------------------------------------------------------------------------------------------------------
1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Realized long-term
capital gains $.21 $2.66 $3.14 $.86 $.97 $.27 $1.56 $1.08 $2.69 $1.73 $3.90 $3.04
Federal capital gains
taxes paid .06 .74 1.07 .29 .33 .09 .53 .37 .94 .61 1.37 1.06
(Tax rate in effect) (28%) (28%) (34%) (34%) (34%) (34%) (34%) (34%) (35%) (35%) (35%) (35%)
Net amount by which
your cost should be
increased .15 1.92 2.07 .57 .64 .18 1.03 .71 1.75 1.12 2.53 1.98
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
All comparative mutual fund data are from Lipper Analytical Services, Inc. or
Morningstar unless otherwise noted.
19
<PAGE> 22
DIRECTORS AND OFFICERS
JOHN C. BOGLE, Chairman of the Board and Director
of The Vanguard Group, Inc. and of
each of the investment companies in
The Vanguard Group.
JOHN J. BRENNAN, President, Chief Executive Officer,
and Director of The Vanguard Group,
Inc. and of each of the investment
companies in The Vanguard Group.
ROBERT E. CAWTHORN, Chairman Emeritus and
Director of Rhone-Poulenc Rorer
Inc.; Director of Sun Company, Inc.
and Westinghouse Electric Corp.
BARBARA BARNES HAUPTFUHRER, Director of The Great
Atlantic and Pacific Tea Co., Alco
Standard Corp., Raytheon Co.,
Knight-Ridder, Inc., and Massachusetts
Mutual Life Insurance Co.
BRUCE K. MACLAURY, President Emeritus of The
Brookings Institution; Director of
American Express Bank Ltd., The St.
Paul Companies, Inc., and National
Steel Corp.
BURTON G. MALKIEL, Chemical Bank Chairman's
Professor of Economics, Princeton
University; Director of Prudential
Insurance Co. of America, Amdahl
Corp., Baker Fentress & Co., The
Jeffrey Co., and Southern
New England Communications Co.
ALFRED M. RANKIN, JR., Chairman, President, and
Chief Executive Officer of NACCO
Industries, Inc.; Director of NACCO
Industries, The BFGoodrich Co., and
The Standard Products Co.
JOHN C. SAWHILL, President and Chief Executive
Officer of The Nature Conservancy;
formerly, Director and Senior Partner of
McKinsey & Co. and President of New
York University; Director of Pacific Gas
and Electric Co., Procter & Gamble
Co., and NACCO Industries.
J. LAWRENCE WILSON, Chairman and Chief Executive
Officer of Rohm & Haas Co.;
Director of Cummins Engine Co.;
Trustee of Vanderbilt University.
OTHER FUND OFFICERS
RAYMOND J. KLAPINSKY, Secretary; Senior Vice
President and Secretary of The
Vanguard Group, Inc.; Secretary of
each of the investment companies in
The Vanguard Group.
RICHARD F. HYLAND, Treasurer; Principal of The
Vanguard Group, Inc.; Treasurer of
each of the investment companies in
The Vanguard Group.
KAREN E. WEST, Controller; Principal of The
Vanguard Group, Inc.; Controller of
each of the investment companies in
The Vanguard Group.
OTHER VANGUARD OFFICERS
ROBERT A. DISTEFANO, Senior Vice President,
Information Technology.
JAMES H. GATELY, Senior Vice President,
Individual Investor Group.
IAN A. MACKINNON, Senior Vice President,
Fixed Income Group.
F. WILLIAM MCNABB III, Senior Vice President,
Institutional.
RALPH K. PACKARD, Senior Vice President and
Chief Financial Officer.
[THE VANGUARD GROUP LOGO]
Please send your comments to us at:
Post Office Box 2600, Valley Forge, Pennsylvania 19482
Fund Information: 1-800-662-7447
Individual Account Services: 1-800-662-2739
Institutional Investor Services: 1-800-523-1036
[email protected] http://www.vanguard.com
All Vanguard funds are offered by prospectus only. Prospectuses contain more
complete information on advisory fees, distribution charges, and other expenses
and should be read carefully before investing or sending money. Prospectuses
may be obtained directly from The Vanguard Group.
(C) 1996 Vanguard Marketing Corporation, Distributor
<PAGE> 23
THE VANGUARD FAMILY OF FUNDS
EQUITY AND BALANCED FUNDS
GROWTH AND INCOME FUNDS
Vanguard/Windsor Fund
Vanguard/Windsor II
Vanguard Equity Income Fund
Vanguard Quantitative Portfolios
Vanguard Selected Value Portfolio
Vanguard/Trustees Equity--U.S. Portfolio
Vanguard Convertible Securities Fund
BALANCED FUNDS
Vanguard/Wellington Fund
Vanguard/Wellesley Income Fund
Vanguard STAR Portfolio
Vanguard Asset Allocation Fund
Vanguard LifeStrategy Portfolios
GROWTH FUNDS
Vanguard/Morgan Growth Fund
Vanguard/PRIMECAP Fund
Vanguard U.S. Growth Portfolio
AGGRESSIVE GROWTH FUNDS
Vanguard Explorer Fund
Vanguard Specialized Portfolios
Vanguard Horizon Fund
INTERNATIONAL FUNDS
Vanguard International Growth Portfolio
Vanguard/Trustees' Equity--International
Portfolio
INDEX FUNDS
Vanguard Index Trust
Vanguard Tax-Managed Fund
Vanguard Balanced Index Fund
Vanguard Bond Index Fund
Vanguard International Equity Index Fund
Vanguard Total International Portfolio
FIXED-INCOME FUNDS
MONEY MARKET FUNDS
Vanguard Money Market Reserves
Vanguard Treasury Money Market Portfolio
Vanguard Admiral Funds
INCOME FUNDS
Vanguard Fixed Income Securities Fund
Vanguard Admiral Funds
Vanguard Preferred Stock Fund
TAX-EXEMPT MONEY MARKET FUNDS
Vanguard Municipal Bond Fund
Vanguard State Tax-Free Funds
(CA, NJ, OH, PA)
TAX-EXEMPT INCOME FUNDS
Vanguard Municipal Bond Fund
Vanguard State Tax-Free Funds
(CA, FL, NJ, NY, OH, PA)
Q340 12/96
