<PAGE> 1
PROSPECTUS
DECEMBER 29, 1995
MERRILL LYNCH CALIFORNIA MUNICIPAL BOND FUND
MERRILL LYNCH CALIFORNIA MUNICIPAL SERIES TRUST
P.O. BOX 9011, PRINCETON, NEW JERSEY 08543-9011 - PHONE NO. (609) 282-2800
------------------------
Merrill Lynch California Municipal Bond Fund (the "Fund") is a diversified
mutual fund seeking to provide shareholders with as high a level of income
exempt from Federal and California income taxes as is consistent with prudent
investment management. The Fund invests primarily in a diversified portfolio of
long-term investment grade obligations issued by or on behalf of the State of
California, its political subdivisions, agencies and instrumentalities and
obligations of other qualifying issuers, such as issuers located in Puerto Rico,
the Virgin Islands and Guam, which pay interest exempt, in the opinion of bond
counsel to the issuer, from Federal and California income taxes ("California
Municipal Bonds"). Dividends paid by the Fund are exempt from Federal and
California income taxes to the extent derived from interest payments on
California Municipal Bonds. There can be no assurance that the investment
objective of the Fund will be realized. For more information on the Fund's
investment objective and policies, see "Investment Objective and Policies" on
page 11.
------------------------
Pursuant to the Merrill Lynch Select Pricing(SM) System, the Fund offers
four classes of shares, each with a different combination of sales charges,
ongoing fees and other features. The Merrill Lynch Select Pricing(SM) System
permits an investor to choose the method of purchasing shares that the investor
believes is most beneficial given the amount of the purchase, the length of
time the investor expects to hold the shares and other relevant circumstances.
See "Merrill Lynch Select Pricing(SM) System" on page 3.
Shares may be purchased directly from Merrill Lynch Funds Distributor, Inc.
(the "Distributor"), P.O. Box 9081, Princeton, New Jersey 08543-9081 [(609)
282-2800], or from securities dealers which have entered into selected dealer
agreements with the Distributor, including Merrill Lynch, Pierce, Fenner & Smith
Incorporated ("Merrill Lynch"). The minimum initial purchase is $1,000 and the
minimum subsequent purchase is $50. Merrill Lynch may charge its customers a
processing fee (presently $4.85) for confirming purchases and repurchases.
Purchases and redemptions directly through the Fund's transfer agent are not
subject to the processing fee. See "Purchase of Shares" and "Redemption of
Shares".
------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
------------------------
This Prospectus is a concise statement of information about the Fund that is
relevant to making an investment in the Fund. This Prospectus should be retained
for future reference. A statement containing additional information about the
Fund, dated December 29, 1995 (the "Statement of Additional Information"), has
been filed with the Securities and Exchange Commission (the "Commission") and is
available, without charge, by calling or by writing the Merrill Lynch California
Municipal Series Trust (the "Trust") at the above telephone number or address.
The Statement of Additional Information is hereby incorporated by reference into
this Prospectus. The Fund is a separate series of the Trust, an open-end
management investment company organized as a Massachusetts business trust.
------------------------
FUND ASSET MANAGEMENT--MANAGER
MERRILL LYNCH FUNDS DISTRIBUTOR, INC.--DISTRIBUTOR
<PAGE> 2
FEE TABLE
A general comparison of the sales arrangements and other nonrecurring and
recurring expenses applicable to shares of the Fund follows:
<TABLE>
<CAPTION>
CLASS A(A) CLASS B(B) CLASS C CLASS D
----------- ----------------------- ------------ --------
<S> <C> <C> <C> <C>
SHAREHOLDER TRANSACTION EXPENSES:
Maximum Sales Charge Imposed on Purchases (as
a percentage of offering price)............ 4.00%(c) None None 4.00%(c)
Sales Charge Imposed on Dividend
Reinvestments.............................. None None None None
Deferred Sales Charge (as a percentage of
original purchase price or redemption
proceeds, whichever is lower).............. None(d) 4.0% during the first 1.0% for one None(d)
year, decreasing 1.0% year
annually to 0.0% after
the fourth year
Exchange Fee................................. None None None None
ANNUAL FUND OPERATING EXPENSES (AS A PERCENTAGE
OF AVERAGE NET ASSETS)(E):
Management Fees(f)........................... 0.54% 0.54% 0.54% 0.54%
Rule 12b-1 Fees(g):
Account Maintenance Fees................... None 0.25% 0.25% 0.10%
Distribution Fees.......................... None 0.25% 0.35% None
(Class B shares
convert to Class D
shares automatically
after approximately
ten years, cease being
subject to distribution
fees and become
subject to
lower account
maintenance fees)
Other Expenses:
Custodial Fees........................... 0.01% 0.01% 0.01% 0.01%
Shareholder Servicing Costs(h)........... 0.04% 0.05% 0.05% 0.03%
Miscellaneous............................ 0.06% 0.06% 0.07% 0.08%
-------- ----- ----- ------
Total Other Expenses................. 0.11% 0.12% 0.13% 0.12%
-------- ----- ----- ------
TOTAL FUND OPERATING EXPENSES................ 0.65% 1.16% 1.27% 0.76%
======== ===== ===== =====
</TABLE>
- ---------------
(a) Class A shares are sold to a limited group of investors including existing
Class A shareholders and participants in certain investment programs. See
"Purchase of Shares--Initial Sales Charge Alternatives--Class A and Class D
Shares"--page 25.
(b) Class B shares convert to Class D shares automatically approximately ten
years after initial purchase. See "Purchase of Shares--Deferred Sales Charge
Alternatives--Class B and Class C Shares"--page 27.
(c) Reduced for purchases of $25,000 and over. Class A and Class D purchases of
$1,000,000 or more may not be subject to an initial sales charge. See
"Purchase of Shares--Initial Sales Charge Alternatives--Class A and Class D
Shares"--page 25.
(d) Class A and Class D shares are not subject to a contingent deferred sales
charge (a "CDSC"), except that certain purchases of $1,000,000 or more which
may not be subject to an initial sales charge will instead be subject to a
CDSC of 1.0% of amounts redeemed within the first year after purchase.
(e) Information for Class A and Class B shares is stated for the fiscal year
ended August 31, 1995. Information under "Other Expenses" for Class C and
Class D shares is stated for the period October 21, 1994 (commencement of
operations) to August 31, 1995.
(f) See "Management of the Trust--Management and Advisory Arrangements"--page
21.
(g) See "Purchase of Shares--Distribution Plans"--page 29.
(h) See "Management of the Trust--Transfer Agency Services"--page 22.
2
<PAGE> 3
EXAMPLE:
<TABLE>
<CAPTION>
CUMULATIVE EXPENSES PAID FOR THE PERIOD
OF:
----------------------------------------
1 YEAR 3 YEARS 5 YEARS 10 YEARS
------ ------- ------- --------
<S> <C> <C> <C> <C>
An investor would pay the following expenses on a
$1,000 investment including the maximum $40 front-end
sales charge (Class A and Class D shares only) and
assuming (1) the Total Fund Operating Expenses for
each class set forth above, (2) a 5% annual return
throughout the periods and (3) redemption at the end
of the period:
Class A........................................... $ 46 $60 $75 $118
Class B........................................... $ 52 $57 $64 $141
Class C........................................... $ 23 $40 $70 $153
Class D........................................... $ 47 $63 $81 $130
An investor would pay the following expenses on the
same $1,000 investment assuming no redemption at the
end of the period:
Class A........................................... $ 46 $60 $75 $118
Class B........................................... $ 12 $37 $64 $141
Class C........................................... $ 13 $40 $70 $153
Class D........................................... $ 47 $63 $81 $130
</TABLE>
The foregoing Fee Table is intended to assist investors in understanding
the costs and expenses that a shareholder in the Fund will bear directly or
indirectly. The Example set forth above assumes reinvestment of all dividends
and distributions and utilizes a 5% annual rate of return as mandated by
Commission regulations. THE EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF
PAST OR FUTURE EXPENSES OR ANNUAL RATES OF RETURN, AND ACTUAL EXPENSES OR ANNUAL
RATES OF RETURN MAY BE MORE OR LESS THAN THOSE ASSUMED FOR PURPOSES OF THE
EXAMPLE. Class B and Class C shareholders who hold their shares for an extended
period of time may pay more in Rule 12b-1 distribution fees than the economic
equivalent of the maximum front-end sales charge permitted under the Rules of
Fair Practice of the National Association of Securities Dealers, Inc. (the
"NASD"). Merrill Lynch may charge its customers a processing fee (presently
$4.85) for confirming purchases and repurchases. Purchases and redemptions
directly through the Fund's transfer agent are not subject to the processing
fee. See "Purchase of Shares" and "Redemption of Shares".
MERRILL LYNCH SELECT PRICING(SM) SYSTEM
The Fund offers four classes of shares under the Merrill Lynch Select
Pricing(SM) System. The shares of each class may be purchased at a price equal
to the next determined net asset value per share subject to the sales charges
and ongoing fee arrangements described below. Shares of Class A and Class D are
sold to investors choosing the initial sales charge alternatives, and shares of
Class B and Class C are sold to investors choosing the deferred sales charge
alternatives. The Merrill Lynch Select Pricing(SM) System is used by more than
50 mutual funds advised by Merrill Lynch Asset Management, L.P. ("MLAM") or its
affiliate, FAM. Funds advised by MLAM or the Manager are referred to herein as
"MLAM-advised mutual funds".
3
<PAGE> 4
Each Class A, Class B, Class C or Class D share of the Fund represents an
identical interest in the investment portfolio of the Fund and has the same
rights, except that Class B, Class C and Class D shares bear the expenses of the
ongoing account maintenance fees and Class B and Class C shares bear the
expenses of the ongoing distribution fees and the additional incremental
transfer agency costs resulting from the deferred sales charge arrangements. The
deferred sales charges and account maintenance fees that are imposed on Class B
and Class C shares, as well as the account maintenance fees that are imposed on
the Class D shares, are imposed directly against those classes and not against
all assets of the Fund and, accordingly, such charges will not affect the net
asset value of any other class or have any impact on investors choosing another
sales charge option. Dividends paid by the Fund for each class of shares will be
calculated in the same manner at the same time and will differ only to the
extent that account maintenance and distribution fees and any incremental
transfer agency costs relating to a particular class are borne exclusively by
that class. Each class has different exchange privileges. See "Shareholder
Services--Exchange Privilege".
Investors should understand that the purpose and function of the initial
sales charges with respect to the Class A and Class D shares are the same as
those of the deferred sales charges with respect to the Class B and Class C
shares in that the sales charges applicable to each class provide for the
financing of the distribution of the shares of the Fund. The
distribution-related revenues paid with respect to a class will not be used to
finance the distribution expenditures of another class. Sales personnel may
receive different compensation for selling different classes of shares.
The following table sets forth a summary of the distribution arrangements
for each class of shares under the Merrill Lynch Select Pricing(SM) System,
followed by a more detailed description of each class and a discussion of the
factors that investors should consider in determining the method of purchasing
shares under the Merrill Lynch Select Pricing(SM) System that the investor
believes is most beneficial under his or her particular circumstances. More
detailed information as to each class of shares is set forth under "Purchase of
Shares".
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------------
ACCOUNT
MAINTENANCE DISTRIBUTION
CLASS SALES CHARGE(1) FEE FEE CONVERSION FEATURE
-------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
A Maximum 4.0% initial sales
charge(2)(3) No No No
-------------------------------------------------------------------------------------------------------------
B CDSC for a period of 4 years, at a
rate of 4.0% during the first B shares convert to D shares
year, decreasing 1.0% annually automatically after
to 0.0% 0.25% 0.25% approximately ten years(4)
-------------------------------------------------------------------------------------------------------------
C 1.0% CDSC for one year 0.25% 0.35% No
-------------------------------------------------------------------------------------------------------------
D Maximum 4.0% initial sales
charge(3) 0.10% No No
-------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
(Footnotes on following page)
4
<PAGE> 5
(Footnotes for preceding page)
- ---------------
(1) Initial sales charges are imposed at the time of purchase as a percentage of
the offering price. CDSCs are imposed if the redemption occurs within the
applicable CDSC time period. The charge will be assessed on an amount equal
to the lesser of the proceeds of redemption or the cost of the shares being
redeemed.
(2) Offered only to eligible investors. See "Purchase of Shares--Initial Sales
Charge Alternatives--Class A and Class D Shares--Eligible Class A
Investors".
(3) Reduced for purchases of $25,000 or more. Class A and Class D share
purchases of $1,000,000 or more may not be subject to an initial sales
charge but instead will be subject to up to a 1.00% CDSC if redeemed within
one year. See "Class A" and "Class D" below.
(4) The conversion period for dividend reinvestment shares was modified. Also,
Class B shares of certain other MLAM-advised mutual funds into which
exchanges may be made have an eight year conversion period. If Class B
shares of the Fund are exchanged for Class B shares of another MLAM-advised
mutual fund, the conversion period applicable to the Class B shares acquired
in the exchange will apply, and the holding period for the shares exchanged
will be tacked onto the holding period for the shares acquired.
Class A: Class A shares incur an initial sales charge when they are purchased
and bear no ongoing distribution or account maintenance fees. Class A
shares are offered to a limited group of investors and also will be
issued upon reinvestment of dividends on outstanding Class A shares.
Investors that currently own Class A shares in a shareholder account
are entitled to purchase additional Class A shares in that account. In
addition, Class A shares will be offered to directors and employees of
Merrill Lynch & Co., Inc. ("ML & Co.") and its subsidiaries (the term
"subsidiaries", when used herein with respect to ML & Co., includes
MLAM, the Manager and certain other entities directly or indirectly
wholly-owned and controlled by ML & Co.), and their directors and
employees, and to members of the Boards of MLAM-advised mutual funds.
The maximum initial sales charge is 4.0%, which is reduced for
purchases of $25,000 and over. Purchases of $1,000,000 or more may not
be subject to an initial sales charge but if the initial sales charge
is waived such purchases will be subject to a CDSC of 1.00% if the
shares are redeemed within one year after purchase. Sales charges are
also reduced under a right of accumulation which takes into account
the investor's holdings of all classes of all MLAM-advised mutual
funds. See "Purchase of Shares--Initial Sales Charge
Alternatives--Class A and Class D Shares".
Class B: Class B shares do not incur a sales charge when they are purchased,
but they are subject to an ongoing account maintenance fee of 0.25%
and an ongoing distribution fee of 0.25%, of the Fund's average net
assets attributable to Class B shares as well as a CDSC if they are
redeemed within four years of purchase. Approximately ten years after
issuance, Class B shares will convert automatically into Class D
shares of the Fund, which are subject to a lower account maintenance
fee of 0.10% and no distribution fee; Class B shares of certain other
MLAM-advised mutual funds into which exchanges may be made convert
into Class D shares automatically after approximately eight years. If
Class B shares of the Fund are exchanged for Class B shares of another
MLAM-advised mutual fund, the conversion period applicable to the
Class B shares acquired in the exchange will apply, as will the Class
D account Maintenance fee of the acquired fund upon the conversion and
the holding period for the shares exchanged will be tacked onto the
holding period for the shares acquired. Automatic conversion of Class
B shares into Class D shares will occur at least once a month on the
basis of the relative net asset values of the shares of the two
classes on the conversion date, without the imposition of any sales
load, fee or other charge. Conversion of Class B shares to Class D
shares will not be deemed a purchase or sale of the shares for Federal
income tax purposes. Shares purchased through reinvestment of
dividends on Class B shares also will convert automatically to Class D
shares. The conversion period for dividend reinvestment shares and for
certain retirement plans is modified as described under "Purchase of
Shares--Deferred Sales Charge Alternatives--Class B and Class C
Shares--Conversion of Class B Shares to Class D Shares".
5
<PAGE> 6
Class C: Class C shares do not incur a sales charge when they are purchased,
but they are subject to an ongoing account maintenance fee of 0.25%
and an ongoing distribution fee of 0.35% of the Fund's average net
assets attributable to Class C shares. Class C shares are also subject
to a CDSC if they are redeemed within one year of purchase. Although
Class C shares are subject to a 1.0% CDSC for only one year (as
compared to four years for Class B), Class C shares have no conversion
feature and, accordingly, an investor that purchases Class C shares
will be subject to distribution fees and higher account maintenance
fees that will be imposed on Class C shares for an indefinite period
subject to annual approval by the Trust's Board of Trustees and
regulatory limitations.
Class D: Class D shares incur an initial sales charge when they are purchased
and are subject to an ongoing account maintenance fee of 0.10% of the
Fund's average net assets attributable to Class D shares. Class D
shares are not subject to an ongoing distribution fee or any CDSC
when they are redeemed. Purchases of $1,000,000 or more may not be
subject to an initial sales charge but if the initial sales charge is
waived such purchases may be subject to a CDSC of 1.00% if the shares
are redeemed within one year after purchase. The schedule of initial
sales charges and reductions for Class D shares is the same as the
schedule for Class A shares. Class D shares also will be issued upon
conversion of Class B shares as described above under "Class B". See
"Purchase of Shares--Initial Sales Charge Alternatives--Class A and
Class D Shares".
The following is a discussion of the factors that investors should consider
in determining the method of purchasing shares under the Merrill Lynch Select
Pricing(SM) System that the investor believes is most beneficial under his or
her particular circumstances.
Initial Sales Charge Alternatives. Investors who prefer an initial sales
charge alternative may elect to purchase Class D shares or, if an eligible
investor, Class A shares. Investors choosing the initial sales charge
alternative who are eligible to purchase Class A shares should purchase Class A
shares rather than Class D shares because there is an account maintenance fee
imposed on Class D shares. Investors qualifying for significantly reduced
initial sales charges may find the initial sales charge alternative particularly
attractive because similar sales charges reductions are not available with
respect to the deferred sales charges imposed in connection with purchases of
Class B or Class C shares. Investors not qualifying for reduced initial sales
charges who expect to maintain their investment for an extended period of time
also may elect to purchase Class A or Class D shares, because over time the
accumulated ongoing account maintenance and distribution fees on Class B or
Class C shares may exceed the initial sales charge and, in the case of Class D
shares, the account maintenance fee. Although some investors that previously
purchased Class A shares may no longer be eligible to purchase Class A shares of
other MLAM-advised mutual funds, those previously purchased Class A shares,
together with Class B, Class C and Class D share holdings, will count toward a
right of accumulation which may qualify the investor for reduced initial sales
charges on new initial sales charge purchases. In addition, the ongoing Class B
and Class C account maintenance and distribution fees will cause Class B and
Class C shares to have higher expense ratios, pay lower dividends and have lower
total returns than the initial sales charge shares. The ongoing Class D account
maintenance fees will cause Class D shares to have a higher expense ratio, pay
lower dividends and have a lower total return than Class A shares.
Deferred Sales Charge Alternatives. Because no initial sales charges are
deducted at the time of purchase, Class B and Class C shares provide the benefit
of putting all of the investor's dollars to work from the time the investment is
made. The deferred sales charge alternatives may be particularly appealing to
investors who do not qualify for a reduction in initial sales charges. Both
Class B and Class C shares are
6
<PAGE> 7
subject to ongoing account maintenance fees and distribution fees; however, the
ongoing account maintenance and distribution fees potentially may be offset to
the extent any return is realized on the additional funds initially invested in
Class B or Class C shares. In addition, Class B shares will be converted into
Class D shares of the Fund after a conversion period of approximately ten years,
and thereafter investors will be subject to lower ongoing fees.
Certain investors may elect to purchase Class B shares if they determine it
to be most advantageous to have all of their funds invested initially and intend
to hold their shares for an extended period of time. Investors in Class B shares
should take into account whether they intend to redeem their shares within the
CDSC period and, if not, whether they intend to remain invested until the end of
the conversion period and thereby take advantage of the reduction in ongoing
fees resulting from the conversion into Class D shares. Other investors,
however, may elect to purchase Class C shares if they determine that it is
advantageous to have all of their assets invested initially and they are
uncertain as to the length of time they intend to hold their assets in
MLAM-advised mutual funds. Although Class C shareholders are subject to a
shorter CDSC period at a lower rate, they are subject to higher distribution
fees and forgo the Class B conversion feature, making their investment subject
to account maintenance and distribution fees for an indefinite period of time.
In addition, while both Class B and Class C distribution fees are subject to the
limitations on asset-based sales charges imposed by the NASD, the Class B
distribution fees are further limited under a voluntary waiver of asset-based
sales charges. See "Purchase of Shares--Limitations on the Payment of Deferred
Sales Charges".
7
<PAGE> 8
FINANCIAL HIGHLIGHTS
The financial information in the table below has been audited in
conjunction with the annual audits of the financial statements of the Fund by
Deloitte & Touche LLP, independent auditors. Financial statements for the year
ended August 31, 1995 and the independent auditors' report thereon are included
in the Statement of Additional Information. The following per share data and
ratios have been derived from information provided in the Fund's audited
financial statements. Financial information is presented for Class C and Class D
shares only for the period October 21, 1994 (commencement of operations) to
August 31, 1995. Further information about the performance of the Fund is
contained in the Fund's most recent annual report to shareholders which may be
obtained, without charge, by calling or by writing the Trust at the telephone
number or address on the front cover of this Prospectus.
<TABLE>
<CAPTION>
CLASS A
-------------------------------------------------------------------------
FOR THE YEAR ENDED AUGUST 31,
-------------------------------------------------------------------------
1995 1994 1993 1992 1991 1990 1989+
------- ------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C>
Increase (Decrease) in Net Asset Value:
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period................. $ 11.32 $ 12.38 $ 11.80 $ 11.44 $ 11.03 $ 11.22 $ 11.02
------- ------- ------- ------- ------- ------- -------
Investment income--net........................... .64 .68 .70 .72 .74 .77 .63
Realized and unrealized gain (loss) on
investments--net............................... .08 (.78) .78 .41 .41 (.19) .20
------- ------- ------- ------- ------- ------- -------
Total from investment operations..................... .72 (.10) 1.48 1.13 1.15 .58 .83
------- ------- ------- ------- ------- ------- -------
Less dividends and distributions:
Investment income--net........................... (.64) (.68) (.70) (.72) (.74) (.77) (.63)
Realized gain on investments--net................ -- (.19) (.20) (.05) -- -- --
In excess of realized gain on investments--net... -- (.09) -- -- -- -- --
------- ------- ------- ------- ------- ------- -------
Total dividends and distributions.................... (.64) (.96) (.90) (.77) (.74) (.77) (.63)
------- ------- ------- ------- ------- ------- -------
Net asset value, end of period....................... $ 11.40 $ 11.32 $ 12.38 $ 11.80 $ 11.44 $ 11.03 $ 11.22
======= ======= ======= ======= ======= ======= =======
TOTAL INVESTMENT RETURN:**
Based on net asset value per share................... 6.77% (.92)% 13.19% 10.23% 10.73% 5.21% 7.96%#
======= ======= ======= ======= ======= ======= =======
RATIOS TO AVERAGE NET ASSETS:
Expenses............................................. .65% .62% .63% .63% .64% .65% .65%*
======= ======= ======= ======= ======= ======= =======
Investment income--net............................... 5.83% 5.65% 5.87% 6.26% 6.57% 6.77% 6.80%*
======= ======= ======= ======= ======= ======= =======
SUPPLEMENTAL DATA:
Net assets, end of period (in thousands)............. $44,228 $60,017 $64,526 $46,556 $37,499 $29,558 $19,451
======= ======= ======= ======= ======= ======= =======
Portfolio turnover................................... 53.40% 75.66% 61.24% 52.31% 116.09% 119.66% 114.49%
======= ======= ======= ======= ======= ======= =======
</TABLE>
- ---------------
+ Class A Shares commenced operations on October 25, 1988.
* Annualized.
** Total investment returns exclude the effects of sales loads.
# Aggregate total investment return.
8
<PAGE> 9
FINANCIAL HIGHLIGHTS (CONTINUED)
<TABLE>
<CAPTION>
CLASS B
-------------------------------------------------------------
FOR THE YEAR ENDED AUGUST 31,
-------------------------------------------------------------
1995 1994 1993 1992 1991
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Increase (Decrease) in Net Asset
Value:
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of
period........................... $ 11.32 $ 12.38 $ 11.80 $ 11.44 $ 11.03
------- ------- ------- ------- -------
Investment income--net......... .59 .61 .64 .67 .68
Realized and unrealized gain
(loss) on investments--net... .08 (.78) .78 .41 .41
------- ------- ------- ------- -------
Total from investment operations... .67 (.17) 1.42 1.08 1.09
------- ------- ------- ------- -------
Less dividends and distributions:
Investment income--net......... (.59) (.61) (.64) (.67) (.68)
Realized gain on
investments--net............. -- (.19) (.20) (.05) --
In excess of realized gain on
investments--net............. -- (.09) -- -- --
------- ------- ------- ------- -------
Total dividends and distributions.. (.59) (.89) (.84) (.72) (.68)
------- ------- ------- ------- -------
Net asset value, end of period..... $ 11.40 $ 11.32 $ 12.38 $ 11.80 $ 11.44
======= ======= ======= ======= =======
TOTAL INVESTMENT RETURN:**
Based on net asset value per
share............................ 6.28% (1.50)% 12.62% 9.68% 10.18%
======= ======= ======= ======= =======
RATIOS TO AVERAGE NET ASSETS:
Expenses, excluding account
maintenance and distribution
fees............................. .66% .63% .63% .63% .65%
======= ======= ======= ======= =======
Expenses........................... 1.16% 1.13% 1.13% 1.13% 1.15%
======= ======= ======= ======= =======
Investment income--net............. 5.32% 5.15% 5.38% 5.76% 6.07%
======= ======= ======= ======= =======
SUPPLEMENTAL DATA:
Net assets, end of period (in
thousands)....................... $ 616,199 $ 726,888 $ 821,220 $ 729,569 $ 690,885
======= ======= ======= ======= =======
Portfolio turnover................. 53.40% 75.66% 61.24% 52.31% 116.09%
======= ======= ======= ======= =======
<CAPTION>
1990 1989 1988 1987 1986+
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Increase (Decrease) in Net Asset
Value:
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of
period........................... $ 11.23 $ 10.77 $ 10.96 $ 11.55 $ 10.00
------- -------- ------- ------- -------
Investment income--net......... .71 .71 .71 .72 .71
Realized and unrealized gain
(loss) on investments--net... (.20) .46 (.19) (.54) 1.55
------- -------- ------- ------- -------
Total from investment operations... .51 1.17 .52 .18 2.26
------- -------- ------- ------- -------
Less dividends and distributions:
Investment income--net......... (.71) (.71) (.71) (.72) (.71)
Realized gain on
investments--net............. -- -- -- (.05) --
In excess of realized gain on
investments--net............. -- -- -- -- --
------- -------- ------- ------- -------
Total dividends and distributions.. (.71) (.71) (.71) (.77) (.71)
------- -------- ------- ------- -------
Net asset value, end of period..... $ 11.03 $ 11.23 $ 10.77 $ 10.96 $ 11.55
======= ======== ======= ======= =======
TOTAL INVESTMENT RETURN:**
Based on net asset value per
share............................ 4.58% 11.14% 5.05% 1.52% 23.19%#
======= ======== ======= ======= =======
RATIOS TO AVERAGE NET ASSETS:
Expenses, excluding account
maintenance and distribution
fees............................. .65% .66% .67% .65% .59%*
======= ======== ======= ======= =======
Expenses........................... 1.15% 1.16% 1.16% 1.15% 1.09%*
======= ======== ======= ======= =======
Investment income--net............. 6.27% 6.42% 6.63% 6.34% 6.90%*
======= ======== ======= ======= =======
SUPPLEMENTAL DATA:
Net assets, end of period (in
thousands)....................... $ 663,551 $ 665,566 $ 611,454 $ 661,755 $ 478,320
======= ======== ======= ======= =======
Portfolio turnover................. 119.66% 114.49% 77.99% 69.23% 217.91%
======= ======== ======= ======= =======
</TABLE>
- ---------------
+ Class B Shares commenced operations on September 30, 1985.
* Annualized.
** Total investment returns exclude the effects of sales loads.
# Aggregate total investment return.
9
<PAGE> 10
FINANCIAL HIGHLIGHTS (CONCLUDED)
<TABLE>
<CAPTION>
CLASS C CLASS D
------------------- -------------------
FOR THE PERIOD FOR THE PERIOD
OCTOBER 21, 1994+ OCTOBER 21, 1994+
TO TO
AUGUST 31, 1995 AUGUST 31, 1995
------------------- -------------------
<S> <C> <C>
Increase (Decrease) in Net Asset Value:
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period................................................ $ 10.94 $ 10.94
------- -------
Investment income--net.......................................................... .49 .54
Realized and unrealized gain (loss) on investments--net......................... .46 .46
------- -------
Total from investment operations.................................................... .95 1.00
------- -------
Less dividends from investment income--net.......................................... (.49) (.54)
------- -------
Net asset value, end of period...................................................... $ 11.40 $ 11.40
======= =======
TOTAL INVESTMENT RETURN:**
Based on net asset value per share.................................................. 8.96%# 9.42%#
======= =======
RATIOS TO AVERAGE NET ASSETS:
Expenses, excluding account maintenance and distribution fees....................... .67%* .66%*
======= =======
Expenses............................................................................ 1.27%* .76%*
======= =======
Investment income--net.............................................................. 5.04%* 5.59%*
======= =======
SUPPLEMENTAL DATA:
Net assets, end of period (in thousands)............................................ $ 3,131 $ 3,846
======= =======
Portfolio turnover.................................................................. 53.40% 53.40%
======= =======
</TABLE>
- ---------------
+ Commencement of operations.
* Annualized.
** Total investment returns exclude the effects of sales loads.
# Aggregate total investment return.
10
<PAGE> 11
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Fund is to provide shareholders with as
high a level of income exempt from Federal and California income taxes as is
consistent with prudent investment management. The Fund seeks to achieve its
objective while providing investors with the opportunity to invest in a
diversified portfolio of securities consisting primarily of long-term
obligations issued by or on behalf of the State of California, its political
subdivisions, agencies and instrumentalities and obligations of other qualifying
issuers located in Puerto Rico, the Virgin Islands and Guam. Obligations exempt
from Federal income taxes are referred to herein as "Municipal Bonds" and
obligations exempt from both Federal and California income taxes are referred to
herein as "California Municipal Bonds." Unless otherwise indicated, references
to Municipal Bonds shall be deemed to include California Municipal Bonds. Under
normal circumstances, at least 65% of the Fund's total assets will be invested
in California Municipal Bonds. The investment objective of the Fund is a
fundamental policy and may not be changed without shareholder approval. At
times, the Fund will seek to hedge its portfolio through the use of futures
transactions to reduce volatility in the net asset value of Fund shares.
Municipal Bonds may include several types of bonds. The interest on
Municipal Bonds may bear a fixed rate or be payable at a variable or floating
rate. At least 80% of the Municipal Bonds purchased by the Fund will be what are
commonly referred to as "investment grade" securities, which are obligations
rated at the time of purchase within the four highest quality ratings as
determined by either Moody's Investors Service, Inc. ("Moody's") (currently Aaa,
Aa, A and Baa), Standard & Poor's Ratings Group ("Standard & Poor's") (currently
AAA, AA, A and BBB) or Fitch Investors Service, Inc. ("Fitch") (currently, AAA,
AA, A and BBB). If Municipal Bonds are unrated, such securities will possess
creditworthiness comparable, in the opinion of the Manager, to obligations in
which the Fund may invest. Municipal Bonds rated in the fourth highest rating
category, while considered "investment grade", have certain speculative
characteristics and are more likely to be downgraded to non-investment grade
than obligations rated in one of the top three rating categories. See Appendix
II--"Ratings of Municipal Bonds"--in the Statement of Additional Information for
more information regarding ratings of debt securities. An issue of rated
Municipal Bonds may cease to be rated or its rating may be reduced below
"investment grade" subsequent to its purchase by the Fund. If an obligation is
downgraded below investment grade, the Manager will consider factors such as
price, credit risk, market conditions, financial condition of the issuer and
interest rates to determine whether to continue to hold the obligation in the
Fund's portfolio.
The Fund may invest up to 20% of its total assets in Municipal Bonds that
are rated below Baa by Moody's or below BBB by Standard & Poor's or Fitch or
which, in the Manager's judgment, possess similar credit characteristics. Such
securities, sometimes referred to as "high-yield" or "junk" bonds, are
predominantly speculative with respect to the capacity to pay interest and repay
principal in accordance with the terms of the security and generally involve a
greater volatility of price than securities in higher rating categories. The
market prices of high-yielding, lower-rated securities may fluctuate more than
higher-rated securities and may decline significantly in periods of general
economic difficulty, which may follow periods of rising interest rates. In
purchasing such securities, the Fund will rely on the Manager's judgment,
analysis and experience in evaluating the creditworthiness of the issuer of such
securities. The Manager will take into consideration, among other things, the
issuer's financial resources, its sensitivity to economic conditions and trends,
its operating history, the quality of its management and regulatory matters. See
"Investment Objective and Policies" in the Statement of Additional Information
for a more detailed discussion of the pertinent risk
11
<PAGE> 12
factors involved in investing in "high yield" or "junk" bonds and Appendix
II--"Ratings of Municipal Bonds"--in the Statement of Additional Information for
additional information regarding ratings of debt securities. The Fund does not
intend to purchase debt securities that are in default or which the Manager
believes will be in default.
Certain Municipal Bonds may be entitled to the benefits of letters of
credit or similar credit enhancements issued by financial institutions. In such
instances, the Trustees and the Manager will take into account in assessing the
quality of such bonds not only the creditworthiness of the issuer of such
Municipal Bonds but also the creditworthiness of the financial institution.
The value of Municipal Bonds may fall when interest rates rise and rise
when interest rates fall. In general, Municipal Bonds with longer maturities
will be subject to greater volatility resulting from interest rate fluctuations
than will similar obligations with shorter maturities.
The Fund's investments may also include variable rate demand obligations
("VRDOs") and VRDOs in the form of participation interests ("Participating
VRDOs") in variable rate tax-exempt obligations held by a financial institution.
The VRDOs in which the Fund will invest are tax-exempt obligations which contain
a floating or variable interest rate adjustment formula and an unconditional
right of demand on the part of the holder thereof to receive payment of the
unpaid principal balance plus accrued interest on a short notice period not to
exceed seven days. Participating VRDOs provide the Fund with a specified
undivided interest (up to 100%) of the underlying obligation and the right to
demand payment of the unpaid principal balance plus accrued interest on the
Participating VRDOs from the financial institution on a specified number of
days' notice, not to exceed seven days. There is, however, the possibility that
because of default or insolvency, the demand feature of VRDOs or Participating
VRDOs may not be honored. The Fund has been advised by its counsel that the Fund
should be entitled to treat the income received on Participating VRDOs as
interest from tax-exempt obligations.
VRDOs that contain an unconditional right of demand to receive payment of
the unpaid principal balance plus accrued interest on a notice period exceeding
seven days may be deemed illiquid securities. A VRDO with a demand notice period
exceeding seven days will therefore be subject to the Fund's restriction on
illiquid investments unless, in the judgment of the Trustees, such VRDO is
liquid. The Trustees may adopt guidelines and delegate to the Manager the daily
function of determining and monitoring liquidity of such VRDOs. The Trustees,
however, will retain sufficient oversight and be ultimately responsible for such
determinations.
The Fund ordinarily does not intend to realize investment income from
securities other than California Municipal Bonds. However, to the extent that
suitable California Municipal Bonds are not available for investment by the
Fund, the Fund may purchase Municipal Bonds issued by other states, their
agencies and instrumentalities, the interest income on which is exempt, in the
opinion of bond counsel, from Federal, but not California, taxation. The Fund
also may invest in securities not issued by or on behalf of a state or territory
or by an agency or instrumentality thereof, if the Fund nevertheless believes
such securities to be exempt from Federal income taxation ("Non-Municipal
Tax-Exempt Securities"). Non-Municipal Tax-Exempt Securities may include
securities issued by other investment companies that invest in municipal bonds,
to the extent such investments are permitted by the Investment Company Act of
1940, as amended (the "1940 Act"). Other Non-Municipal Tax-Exempt Securities
could include trust certificates or other derivative instruments evidencing
interests in one or more Municipal Bonds.
12
<PAGE> 13
Under normal circumstances, except when acceptable securities are
unavailable as determined by the Manager, the Fund will invest at least 65% of
its total assets in California Municipal Bonds. Under normal conditions, it is
generally anticipated that the Fund's average weighted maturity would be in
excess of ten years. For temporary defensive periods or to provide liquidity,
the Fund has the authority to invest as much as 35% of its total assets in
tax-exempt or taxable money market obligations with a maturity of one year or
less (such short-term obligations being referred to herein as "Temporary
Investments"), except that taxable Temporary Investments shall not exceed 20% of
the Fund's total assets. The Temporary Investments, VRDOs and Participating
VRDOs in which the Fund may invest will be in the following rating categories at
the time of purchase: MIG-1/VMIG-1 through MIG-4/VMIG-4 for notes and VRDOs and
Prime-1 through Prime-3 for commercial paper (as determined by Moody's), SP-1+
through SP-2 for notes and A-1+ through A-3 for VRDOs and commercial paper (as
determined by Standard & Poor's), or F-1+ through F-3 for notes, VRDOs and
commercial paper (as determined by Fitch) or, if unrated, of comparable quality
in the opinion of the Manager. The Fund at all times will have at least 80% of
its total assets invested in securities the interest on which is exempt from
Federal taxation. However, interest received on certain otherwise tax-exempt
securities which are classified as "private activity bonds" (in general, bonds
that benefit non-governmental entities) may be subject to Federal alternative
minimum tax. The percentage of the Fund's total assets invested in "private
activity bonds" will vary during the year. See "Distributions and Taxes". In
addition, the Fund reserves the right to invest temporarily a greater portion of
its assets in Temporary Investments for defensive purposes, when, in the
judgment of the Manager, market conditions warrant. The investment objective of
the Fund is a fundamental policy of the Fund which may not be changed without a
vote of a majority of the Fund's outstanding voting securities, as defined in
the 1940 Act. The Fund's hedging strategies, which are described in more detail
under "Financial Futures Transactions and Options", are not fundamental policies
and may be modified by the Trustees of the Trust without the approval of the
Fund's shareholders.
POTENTIAL BENEFITS
Investment in shares of the Fund offers several benefits. The Fund offers
investors the opportunity to receive income exempt from Federal and California
income taxes and to own shares in a professionally managed portfolio consisting
primarily of long-term California Municipal Bonds. The Fund also provides
liquidity because of its redemption features and relieves the investor of the
burdensome administrative details involved in managing a portfolio of tax-exempt
securities. The benefits of investing in the Fund are at least partially offset
by the expenses involved in operating an investment company. Such expenses
primarily consist of the management fee and operational costs and, in the case
of certain classes of shares, the account maintenance and distribution fees.
SPECIAL AND RISK CONSIDERATIONS RELATING TO MUNICIPAL BONDS
The risks and special considerations involved in investments in Municipal
Bonds vary with the types of instruments being acquired. Investments in
Non-Municipal Tax-Exempt Securities may present similar risks, depending on the
particular product. Certain instruments in which the Fund may invest may be
characterized as derivative instruments. See "Description of Municipal Bonds"
and "Financial Futures Transactions and Options".
Moreover, the Fund ordinarily will invest at least 65% of its total assets
in California Municipal Bonds, and therefore it is more susceptible to factors
adversely affecting issuers of California Municipal Bonds than is
13
<PAGE> 14
a municipal bond mutual fund that is not concentrated in issuers of California
Municipal Bonds to this degree. Since the start of the 1990-91 fiscal year, the
State of California has faced the worst economic, fiscal and budget conditions
since the 1930's. On July 5, 1994, all three of the rating agencies rating the
State of California's long-term debt lowered their ratings of the State of
California's general obligation bonds. Moody's lowered its rating from "Aa" to
"A1", Standard & Poor's lowered its rating from "A+" to "A" and termed its
outlook as "stable", and Fitch lowered its rating from "AA" to "A". No assurance
can be given that such ratings will not be lowered in the future. Although a
steady upturn has been underway since 1994, pre-recession job levels are not
expected to be reached until later in the decade. The Manager does not believe
that the current economic conditions in California will have a significant
adverse effect on the Fund's ability to invest in high quality California
Municipal Bonds. For a discussion of economic and other conditions in the State
of California, see Appendix I in the Statement of Additional Information.
DESCRIPTION OF MUNICIPAL BONDS
Municipal Bonds include debt obligations issued to obtain funds for various
public purposes, including construction and equipping of a wide range of public
facilities (including water, sewer, gas, electricity, solid waste, health care,
transportation, education and housing facilities), refunding of outstanding
obligations and obtaining funds for general operating expenses and loans to
other public institutions and facilities. In addition, certain types of bonds
are issued by or on behalf of public authorities to finance or refinance various
privately operated facilities, including certain facilities for the local
furnishing of electric energy or gas, sewage facilities, solid waste disposal
facilities and other specialized facilities. For purposes of this Prospectus,
such obligations are referred to as Municipal Bonds even though such bonds may
be "private activity bonds" as discussed below.
In the case of certain community facilities district special tax (or
"Mello-Roos"), tax investment (or tax allocation) and assessment bonds, the
payment of the special tax, tax increment and assessments may be secured solely
by remedies against the land (such as by foreclosure) and not against the
individual property owner, which could be time-consuming and costly.
The two principal classifications of Municipal Bonds are "general
obligation" bonds and "revenue" bonds which latter category includes industrial
development bonds ("IDBs") and, for bonds issued after August 15, 1986, private
activity bonds. General obligation bonds are secured by the issuer's pledge of
its faith, credit and taxing power for the repayment of principal and the
payment of interest. The taxing power of any governmental entity may be limited,
however, by provisions of state constitutions or laws, and an entity's
creditworthiness will depend on many factors, including potential erosion of its
tax base due to population declines, natural disasters, declines in the state's
industrial or commercial base or inability to attract new industries or
businesses, economic limits on the ability to tax without eroding the tax base,
state legislative proposals or voter initiatives to limit ad valorem real
property taxes, and the extent to which the entity relies on Federal or state
aid, access to capital markets or other factors beyond the state's or entity's
control. Accordingly, the capacity of the issuer of a general obligation bond as
to the timely payment of interest and the repayment of principal when due is
affected by the size and stability of the issuer's tax base.
Revenue bonds are payable only from the revenues derived from a particular
facility or class of facilities or, in some cases, from the proceeds of a
special excise tax or other specific revenue source such as payments from the
user of the facility being financed; accordingly, the timely payment of interest
and the repayment of principal in accordance with the terms of the revenue or
special obligation bond is a function of the economic
14
<PAGE> 15
viability of such facility or such revenue source. The Fund will not invest in
IDBs, where the entity supplying the revenues from which the issuer is paid,
including predecessors, has a record of less than three years of continuous
business operations if such investments, together with investments in other
unseasoned issuers, would exceed 5% of the Fund's total assets. Investments
involving entities with less than three years of continuous business operations
may pose somewhat greater risks due to the lack of a substantial operating
history for such entities. The Manager believes, however, that the potential
benefits of such investments outweigh the potential risks, particularly given
the Fund's limitations on such investments.
The Fund may purchase IDBs and private activity bonds. IDBs and private
activity bonds are tax-exempt securities issued by states, municipalities or
public authorities to provide funds, usually through a loan or lease
arrangement, to a private entity for the purpose of financing construction or
improvement of a facility to be used by the entity. Such bonds are secured
primarily by revenues derived from loan repayments or lease payments due from
the entity which may or may not be guaranteed by a parent company or otherwise
secured. Neither IDBs nor private activity bonds are secured by a pledge of the
taxing power of the issuer of such bonds. In view of this, an investor should be
aware that repayment of such bonds depends on the revenues of a private entity
and be aware of the risks that such an investment may entail. Continued ability
of an entity to generate sufficient revenues for the payment of principal and
interest on such bonds will be affected by many factors including the size of
the entity, capital structure, demand for its products or services, competition,
general economic conditions, government regulation and the corporation's
dependence on revenues on the operation of the particular facility being
financed. The Fund may invest more than 25% of its total assets in IDBs or
private activity bonds. The Fund may also invest in "moral obligation" bonds,
which are normally issued by special purpose public authorities. If an issuer of
moral obligation bonds is unable to meet its obligations, the repayment of such
bonds becomes a moral commitment but not a legal obligation, of the state or
municipality in question.
The Fund may invest in Municipal Bonds (and Non-Municipal Tax-Exempt
Securities) the return on which is based on a particular index of value or
interest rates. For example, the Fund may invest in Municipal Bonds that pay
interest based on an index of Municipal Bond interest rates or based on the
value of gold or some other commodity. The principal amount payable upon
maturity of certain Municipal Bonds also may be based on the value of the index.
To the extent the Fund invests in these types of Municipal Bonds, the Fund's
return on such Municipal Bonds will be subject to risk with respect to the value
of the particular index. Interest and principal payable on the Municipal Bonds
may also be based on relative changes among particular indices. Also, the Fund
may invest in so-called "inverse floating obligations" or "residual interest
bonds" on which the interest rates typically decline as market rates increase
and increase as market rates decline. The Fund's return on such types of
Municipal Bonds (and Non-Municipal Tax-Exempt Securities) will be subject to
risk with respect to the value of the particular index, which may include
reduced or eliminated interest payments and losses of invested principal. Such
securities have the effect of providing a degree of investment leverage, since
they may increase or decrease in value in response to changes, as an
illustration, in market interest rates at a rate which is a multiple (typically
two) of the rate at which fixed-rate long term tax exempt securities increase or
decrease in response to such changes. As a result, the market values of such
securities will generally be more volatile than the market values of fixed-rate
tax exempt securities. To seek to limit the volatility of these securities, the
Fund may purchase inverse floating obligations with shorter-term maturities or
which contain limitations on the extent to which the interest rate may vary.
Certain investments in such obligations may be illiquid. The Fund may not invest
in such illiquid obligations if such investments, together with other illiquid
investments, would exceed 15% of the Fund's total assets (however, in accordance
with the
15
<PAGE> 16
provisions of certain state laws, the Fund currently will not invest in excess
of 10% of its total assets in illiquid securities). The Manager believes,
however, that indexed and inverse floating obligations represent flexible
portfolio management instruments for the Fund which allow the Fund to seek
potential investment rewards, to hedge other portfolio positions or to vary the
degree of investment leverage relatively efficiently under different market
conditions.
Also included within the general category of Municipal Bonds are
participation certificates issued by government authorities or entities to
finance the acquisition or construction of equipment, land and/or facilities.
The certificates represent participations in a lease, an installment purchase
contract or a conditional sales contract (hereinafter collectively called "lease
obligations") relating to such equipment, land or facilities. Although lease
obligations do not constitute general obligations of the issuer for which the
issuer's unlimited taxing power is pledged, a lease obligation is frequently
backed by the issuer's covenant to budget for, appropriate and make the payments
due under the lease obligation. However, certain lease obligations contain
"non-appropriation" clauses which provide that the issuer has no obligation to
make lease or installment purchase payments in future years unless money is
appropriated for such purpose on a yearly basis. Although "non-appropriation"
lease obligations are secured by the leased property, disposition of the
property in the event of foreclosure might prove difficult. These securities
represent a relatively new type of financing that has not yet developed the
depth of marketability associated with more conventional securities. Certain
investments in lease obligations may be illiquid. The Fund may not invest in
illiquid lease obligations if such investments, together with all other illiquid
investments, would exceed 15% (10% to the extent required by certain state laws)
of the Fund's total assets. The Fund may, however, invest without regard to such
limitation in lease obligations which the Manager, pursuant to guidelines which
have been adopted by the Board of Trustees and subject to the supervision of the
Board, determines to be liquid. The Manager will deem lease obligations to be
liquid if they are publicly offered and have received an investment grade rating
of Baa or better by Moody's, or BBB or better by Standard & Poor's or Fitch.
Unrated lease obligations, or those rated below investment grade, will be
considered liquid if the obligations come to the market through an underwritten
public offering and at least two dealers are willing to give competitive bids.
In reference to the obligations rated below investment grade, the Manager must,
among other things, also review the creditworthiness of the municipality
obligated to make payment under the lease obligation and make certain specified
determinations based on such factors as the existence of a rating or credit
enhancement (such as insurance), the frequency of trades or quotes for the
obligation and the willingness of dealers to make a market in the obligation.
Federal tax legislation has limited the types and volume of bonds the
interest on which qualifies for a Federal income tax exemption. As a result,
this legislation and legislation which may be enacted in the future may affect
the availability of Municipal Bonds for investment by the Fund.
CALL RIGHTS
The Fund may purchase a Municipal Bond issuer's right to call all or a
portion of such Municipal Bond for mandatory tender for purchase (a "Call
Right"). A holder of a Call Right may exercise such right to require a mandatory
tender for the purchase of related Municipal Bonds, subject to certain
conditions. A Call Right that is not exercised prior to the maturity of the
related Municipal Bond will expire without value. The economic effect of holding
both the Call Right and the related Municipal Bond is identical to that of
holding a Municipal Bond as a non-callable security. Certain investments in such
obligations may be illiquid. The Fund
16
<PAGE> 17
may not invest in such illiquid obligations if such investments, together with
other illiquid investments, would exceed 15% (10% to the extent required by
certain state laws) of the Fund's total assets.
WHEN-ISSUED SECURITIES AND DELAYED DELIVERY TRANSACTIONS
The Fund may purchase or sell Municipal Bonds on a delayed delivery basis
or a when-issued basis at fixed purchase terms. These transactions arise when
securities are purchased or sold by the Fund with payment and delivery taking
place in the future. The purchase will be recorded on the date the Fund enters
into the commitment and the value of the obligation will thereafter be reflected
in the calculation of the Fund's net asset value. The value of the obligation on
the delivery date may be more or less than its purchase price. A separate
account of the Fund will be established with its custodian consisting of cash,
cash equivalents or high grade, liquid Municipal Bonds having a market value at
all times at least equal to the amount of the forward commitment.
FINANCIAL FUTURES TRANSACTIONS AND OPTIONS
The Fund is authorized to purchase and sell certain exchange-traded
financial futures contracts ("financial futures contracts") solely for the
purposes of hedging its investments in Municipal Bonds against declines in value
and hedging against increases in the cost of securities it intends to purchase.
However, any transactions involving financial futures or options (including puts
and calls associated therewith) will be in accordance with the Fund's investment
policies and limitations. A financial futures contract obligates the seller of a
contract to deliver and the purchaser of a contract to take delivery of the type
of financial instrument covered by the contract, or in the case of index-based
financial futures contracts to make and accept a cash settlement, at a specific
future time for a specified price. A sale of financial futures contracts may
provide a hedge against a decline in the value of portfolio securities because
such depreciation may be offset, in whole or in part, by an increase in the
value of the position in the financial futures contracts. A purchase of
financial futures contracts may provide a hedge against an increase in the cost
of securities intended to be purchased, because such appreciation may be offset,
in whole or in part, by an increase in the value of the position in the futures
contracts. Distributions, if any, of net long-term capital gains from certain
transactions in futures or options are taxable at long-term capital gains rates
for Federal income tax purposes, regardless of the length of time the
shareholder has owned Fund shares. See "Distributions and Taxes--Taxes".
The Fund deals in financial futures contracts traded on the Chicago Board
of Trade based on The Bond Buyer Municipal Bond Index, a price-weighted measure
of the market value of 40 large, recently issued tax-exempt bonds. There can be
no assurance, however, that a liquid secondary market will exist to terminate
any particular financial futures contract at any specific time. If it is not
possible to close a financial futures position entered into by the Fund, the
Fund would continue to be required to make daily cash payments of variation
margin in the event of adverse price movements. In such a situation, if the Fund
has insufficient cash, it may have to sell portfolio securities to meet daily
variation margin requirements at a time when it may be disadvantageous to do so.
The inability to close financial futures positions also could have an adverse
impact on the Fund's ability to hedge effectively. There is also the risk of
loss by the Fund of margin deposits in the event of bankruptcy of a broker with
whom the Fund has an open position in a financial futures contract.
The Fund may purchase and sell financial futures contracts on U.S.
Government securities and write and purchase put and call options on such
financial futures contracts as a hedge against adverse changes in interest rates
as described more fully in the Statement of Additional Information. With respect
to U.S. Government
17
<PAGE> 18
securities, currently there are financial futures contracts based on long-term
U.S. Treasury bonds, U.S. Treasury notes, Government National Mortgage
Association ("GNMA") Certificates and three-month U.S. Treasury bills.
Subject to policies adopted by the Trustees, the Fund also may engage in
other financial futures contracts transactions and options thereon, such as
financial futures contracts or options on other municipal bond indexes which may
become available if the Manager of the Fund and the Trustees of the Trust should
determine that there is normally a sufficient correlation between the prices of
such financial futures contracts and the Municipal Bonds in which the Fund
invests to make such hedging appropriate.
Utilization of financial futures transactions and options thereon involves
the risk of imperfect correlation in movements in the price of financial futures
contracts and movements in the price of the security which is the subject of the
hedge. If the price of the financial futures contract moves more or less than
the price of the security that is the subject of the hedge, the Fund will
experience a gain or loss which will not be completely offset by movements in
the price of such security. There is a risk of imperfect correlation where the
securities underlying financial futures contracts have different maturities,
ratings or geographic mixes than the security being hedged. In addition, the
correlation may be affected by additions to or deletions from the index which
serves as a basis for a financial futures contract. Finally, in the case of
financial futures contracts on U.S. Government securities and options on such
financial futures contracts, the anticipated correlation of price movements
between the U.S. Government securities underlying the futures or options and
Municipal Bonds may be adversely affected by economic, political, legislative or
other developments which have a disparate impact on the respective markets for
such securities.
Under regulations of the Commodity Futures Trading Commission, the futures
trading activities described herein will not result in the Fund being deemed to
be a "commodity pool", as defined under such regulations, provided that the Fund
adheres to certain restrictions. In particular, the Fund may purchase and sell
financial futures contracts and options thereon (i) only for bona fide hedging
purposes, and (ii) for non-hedging purposes, if the aggregate initial margins
and premiums required to establish positions in such contracts and options does
not exceed 5% of the liquidation value of the Fund's portfolio assets after
taking into account unrealized profits and unrealized losses on any such
financial futures contracts and options. (However, as stated above, the Fund
intends to engage in options and financial futures transactions only for hedging
purposes.) Margin deposits may consist of cash or securities acceptable to the
broker and the relevant contract market.
When the Fund purchases a financial futures contract, or writes a put
option or purchases a call option thereon, it will maintain an amount of cash,
cash equivalents (e.g., high-grade commercial paper and daily tender adjustable
notes) or short-term, high-grade, fixed-income securities in a segregated
account with the Fund's custodian, so that the amount so segregated plus the
amount of initial and variation margin held in the account of its broker equals
the market value of the financial futures contracts, thereby ensuring that the
use of such financial futures contract is unleveraged. It is not anticipated
that transactions in financial futures contracts will have the effect of
increasing portfolio turnover.
Although certain risks are involved in options and financial futures
transactions, the Manager believes that, because the Fund will engage in
financial futures transactions only for hedging purposes, the futures portfolio
strategies of the Fund will not subject the Fund to certain risks frequently
associated with speculation in futures transactions. The Fund must meet certain
Federal income tax requirements under the Internal
18
<PAGE> 19
Revenue Code of 1986, as amended (the "Code"), in order to qualify for the
special tax treatment afforded regulated investment companies, including a
requirement that less than 30% of its gross income be derived from the sale or
other disposition of securities held for less than three months. Additionally,
the Fund is required to meet certain diversification requirements under the
Code.
The liquidity of a secondary market in a financial futures contract may be
adversely affected by "daily price fluctuation limits" established by commodity
exchanges which limit the amount of fluctuation in a futures contract price
during a single trading day. Once the daily limit has been reached in the
contract, no trades may be entered into at a price beyond the limit, thus
preventing the liquidation of open futures positions. Prices have in the past
reached and exceeded the daily limit on a number of consecutive trading days.
The successful use of transactions in financial futures also depends on the
ability of the Manager to forecast correctly the direction and extent of
interest rate movements within a given time frame. To the extent these rates
remain stable during the period in which a financial futures contract is held by
the Fund or moves in a direction opposite to that anticipated, the Fund may
realize a loss on the hedging transaction which is not fully or partially offset
by an increase in the value of portfolio securities. As a result, the Fund's
total return for such period may be less than if it had not engaged in the
hedging transaction. Furthermore, the Fund will only engage in hedging
transactions from time to time and may not necessarily be engaging in hedging
transactions when movements in interest rates occur.
Reference is made to the Statement of Additional Information for further
information on financial futures contracts and certain options thereon.
REPURCHASE AGREEMENTS
As Temporary Investments, the Fund may invest in securities pursuant to
repurchase agreements. Repurchase agreements may be entered into only with a
member bank of the Federal Reserve System or a primary dealer in U.S. Government
securities, or an affiliate thereof. Under such agreements, the seller agrees,
upon entering into the contract, to repurchase the security from the Fund at a
mutually agreed upon time and price, thereby determining the yield during the
term of the agreement. This results in a fixed rate of return insulated from
market fluctuations during such period. The Fund may not invest in repurchase
agreements maturing in more than seven days if such investments, together with
the Fund's other illiquid investments, exceed 15% (10% to the extent required by
certain state laws) of the Fund's total assets. In the event of default by the
seller under a repurchase agreement, the Fund may suffer time delays and incur
costs or possible losses in connection with the disposition of the underlying
securities.
INVESTMENT RESTRICTIONS
The Fund's investment activities are subject to further restrictions that
are described in the Statement of Additional Information. Investment
restrictions and policies which are fundamental policies of the Fund may not be
changed without the approval of the holders of a majority of the Fund's
outstanding voting securities, as defined in the 1940 Act. Among its fundamental
policies, the Fund may not: (i) invest more than 25% of its total assets, taken
at market value at the time of each investment, in securities of issuers in any
particular industry (excluding the U.S. Government and its agencies and
instrumentalities) (For purposes of this restriction, states, municipalities and
their political subdivisions are not considered to be part of any industry);
19
<PAGE> 20
and (ii) borrow money, except that (a) the Fund may borrow from banks (as
defined in the 1940 Act) in amounts up to 33 1/3% of its total assets (including
the amount borrowed), (b) the Fund may borrow up to an additional 5% of its
total assets for temporary purposes, (c) the Fund may obtain such short-term
credit as may be necessary for the clearance of purchases and sales of portfolio
securities and (d) the Fund may purchase securities on margin to the extent
permitted by applicable law. The Fund may not pledge its assets other than to
secure such borrowings or, to the extent permitted by the Fund's investment
policies as set forth in the Prospectus and Statement of Additional Information,
as they may be amended from time to time, in connection with hedging
transactions, short sales, when-issued and forward commitment transactions and
similar investment strategies.
Among its non-fundamental policies, the Fund may not (i) purchase
securities of other investment companies, except to the extent such purchases
are permitted by applicable law; (ii) invest in securities which cannot be
readily resold because of legal or contractual restrictions or which cannot
otherwise be marketed, redeemed or put to the issuer or a third party, if at the
time of acquisition more than 15% of its total assets would be invested in such
securities [This restriction (ii) shall not apply to securities which mature
within seven days or securities which the Board of Trustees of the Trust has
otherwise determined to be liquid pursuant to applicable law]; and (iii) invest
in securities or companies having a record, together with predecessors, of less
than three years of continuous operation, if more than 5% of the Fund's total
assets would be invested in such securities. This restriction (iii) shall not
apply to mortgaged-backed securities, asset-backed securities or obligations
issued or guaranteed by the U.S. Government, its agencies or instrumentalities.
The Fund's investments will be limited so as to qualify for the special tax
treatment afforded regulated investment companies under the Code. See
"Distributions and Taxes--Taxes". To qualify, among other requirements, the
Trust will limit the Fund's investments so that, at the close of each quarter of
the taxable year, (i) not more than 25% of the market value of the Fund's total
assets will be invested in the securities of a single issuer, and (ii) with
respect to 50% of the market value of its total assets, not more than 5% of the
market value of its total assets will be invested in the securities of a single
issuer and the Fund will not own more than 10% of the outstanding voting
securities of a single issuer. For purposes of this restriction, the Fund will
regard each state and each political subdivision, agency or instrumentality of
such state and each multi-state agency of which such state is a member and each
public authority which issues securities on behalf of a private entity as a
separate issuer, except that if the security is backed only by the assets and
revenues of a non-government entity then the entity with the ultimate
responsibility for the payment of interest and principal may be regarded as the
sole issuer. These tax-related limitations may be changed by the Trustees of the
Trust to the extent necessary to comply with changes to the Federal tax
requirements. The Fund is "diversified" under the 1940 Act and must satisfy the
foregoing 5% and 10% requirements with respect to 75% of its total assets.
Investors are referred to the Statement of Additional Information for a
complete description of the Fund's investment restrictions.
20
<PAGE> 21
MANAGEMENT OF THE TRUST
TRUSTEES
The Trustees of the Trust consist of six individuals, five of whom are not
"interested persons" of the Trust as defined in the 1940 Act. The Trustees are
responsible for the overall supervision of the operations of the Trust and the
Fund and perform the various duties imposed on the directors or trustees of
investment companies by the 1940 Act.
The Trustees are:
ARTHUR ZEIKEL*--President of the Manager and MLAM; President and Director
of Princeton Services, Inc.; Executive Vice President of ML & Co.; Director of
the Distributor.
JAMES H. BODURTHA--Chairman and Chief Executive Officer, China Enterprise
Management Corporation.
HERBERT I. LONDON--John M. Olin Professor of Humanities, New York
University.
ROBERT R. MARTIN--Director, WTC Industries Inc.
JOSEPH L. MAY--Attorney in private practice.
ANDRE F. PEROLD--Professor, Harvard Business School.
- ---------------
* Interested person, as defined in the 1940 Act, of the Trust.
MANAGEMENT AND ADVISORY ARRANGEMENTS
FAM, which is an affiliate of MLAM and is owned and controlled by ML & Co.,
a financial services holding company, acts as the Manager for the Fund and
provides the Fund with management services. The Manager or MLAM acts as the
investment adviser to more than 130 other registered investment companies. MLAM
also provides investment advisory services to individual and institutional
accounts. As of November 30, 1995, the Manager and MLAM had a total of
approximately $194.2 billion in investment company and other portfolio assets
under management, including accounts of certain affiliates of the Manager.
Subject to the direction of the Trustees, the Manager is responsible for
the actual management of the Fund's portfolio and constantly reviews the Fund's
holdings in light of its own research analysis and that from other relevant
sources. The responsibility for making decisions to buy, sell or hold a
particular security rests with the Manager, subject to review by the Board of
Trustees. The Manager performs certain of the other administrative services and
provides all of the office space, facilities, equipment and necessary personnel
for management of the Trust and the Fund.
Walter O'Connor became the Portfolio Manager of the Fund in 1995. He has
been a Vice President of MLAM since 1993 and was an Assistant Vice President
thereof from 1991 to 1993. Prior thereto, he was an Assistant Vice President of
Prudential Securities from 1984 to 1991.
21
<PAGE> 22
Pursuant to the management agreement between the Manager and the Trust on
behalf of the Fund (the "Management Agreement"), the Manager is entitled to
receive compensation at the annual rate of 0.55% of the average daily net assets
of the Fund. Effective December 23, 1987, the Manager voluntarily agreed to
waive the amount of compensation set forth in the Management Agreement and
instead has agreed to receive from the Fund a monthly fee based upon the average
daily net assets of the Fund at the following annual rates: 0.55% of the portion
of the average daily net assets not exceeding $500 million; 0.525% of the
portion of the average daily net assets exceeding $500 million but not exceeding
$1.0 billion and 0.50% of the portion of the average daily net assets exceeding
$1.0 billion. For the year ended August 31, 1995, the total fee paid by the Fund
to the Manager was $3,828,093 (based on average net assets of approximately
$705.9 million).
The Management Agreement obligates the Trust on behalf of the Fund to pay
certain expenses incurred in its operations, including among other things, the
management fee, legal and audit fees, unaffiliated Trustees' fees and expenses,
registration fees, custodian and transfer agency fees, accounting and pricing
costs, and certain of the costs of printing proxies, shareholder reports,
prospectuses and statements of additional information. Accounting services are
provided to the Fund by the Manager and the Fund reimburses the Manager for its
costs in connection with such services. For the year ended August 31, 1995, the
Fund reimbursed the Manager $64,518 for accounting services. For that period,
the ratio of total expenses, net of account maintenance and distribution fees,
to average net assets was .65% for the Class A shares and .66% for the Class B
shares. For the period October 21, 1994 (commencement of operations) to August
31, 1995, the annualized ratio of total expenses, net of account maintenance and
distribution fees, to average net assets was .67% for Class C shares and .66%
for Class D shares.
CODE OF ETHICS
The Board of Trustees of the Trust has adopted a Code of Ethics under Rule
17j-1 of the 1940 Act which incorporates the Code of Ethics of the Manager
(together, the "Codes"). The Codes significantly restrict the personal investing
activities of all employees of the Manager and, as described below, impose
additional, more onerous, restrictions on fund investment personnel.
The Codes require that all employees of the Manager preclear any personal
securities investment (with limited exceptions, such as government securities).
The preclearance requirement and associated procedures are designed to identify
any substantive prohibition or limitation applicable to the proposed investment.
The substantive restrictions applicable to all employees of the Manager include
a ban on acquiring any securities in a "hot" initial public offering and a
prohibition from profiting on short-term trading in securities. In addition, no
employee may purchase or sell any security which at the time is being purchased
or sold (as the case may be), or to the knowledge of the employee is being
considered for purchase or sale, by any fund advised by the Manager.
Furthermore, the Codes provide for trading "blackout periods" which prohibit
trading by investment personnel of the Fund within periods of trading by the
Fund in the same (or equivalent) security (15 or 30 days depending upon the
transaction).
TRANSFER AGENCY SERVICES
Merrill Lynch Financial Data Services, Inc. ("Transfer Agent"), which is a
wholly-owned subsidiary of ML & Co., acts as the Fund's transfer agent pursuant
to a Transfer Agency, Dividend Disbursing Agency and Shareholder Servicing
Agency Agreement (the "Transfer Agency Agreement"). Pursuant to the Transfer
Agency Agreement, the Transfer Agent is responsible for the issuance, transfer
and redemption of shares and
22
<PAGE> 23
the opening and maintenance of shareholder accounts. Pursuant to the Transfer
Agency Agreement, the Fund pays the Transfer Agent an annual fee of $11.00 per
Class A or Class D shareholder account and $14.00 per Class B or Class C
shareholder account and the Transfer Agent is entitled to reimbursement from the
Fund for out-of-pocket expenses incurred by the Transfer Agent under the
Transfer Agency Agreement. For the year ended August 31, 1995, the Fund paid the
Transfer Agent a total fee of $313,732 pursuant to the Transfer Agency Agreement
for providing transfer agency services. At November 30, 1995, the Fund had 1,044
Class A shareholder accounts, 12,744 Class B shareholder accounts, 181 Class C
shareholder accounts and 1,814 Class D shareholder accounts. At this level of
accounts, the annual fee payable to the Transfer Agent would aggregate
approximately $212,388, plus out-of-pocket expenses.
PURCHASE OF SHARES
Merrill Lynch Funds Distributor, Inc. (the "Distributor"), an affiliate of
the Manager, MLAM and Merrill Lynch, acts as the Distributor of the shares of
the Fund. Shares of the Fund are offered continuously for sale by the
Distributor and other eligible securities dealers (including Merrill Lynch).
Shares of the Fund may be purchased from securities dealers or by mailing a
purchase order directly to the Transfer Agent. The minimum initial purchase is
$1,000 and the minimum subsequent purchase is $50.
The Fund offers its shares in four classes at a public offering price equal
to the next determined net asset value per share plus sales charges imposed
either at the time of purchase or on a deferred basis depending upon the class
of shares selected by the investor under the Merrill Lynch Select Pricing
System(SM), as described below. The applicable offering price for purchase
orders is based upon the net asset value of the Fund next determined after
receipt of the purchase order by the Distributor. As to purchase orders
received by securities dealers prior to the close of business on the New York
Stock Exchange (generally, 4:00 P.M., New York time), which includes orders
received after the close of business on the previous day, the applicable
offering price will be based on the net asset value determined as of 15 minutes
after the close of business on the New York Stock Exchange on that day,
provided the Distributor in turn receives the order from the securities dealer
prior to 30 minutes after the close of business on the New York Stock Exchange,
on that day. If the purchase orders are not received by the Distributor prior
to 30 minutes after the close of business on the New York Stock Exchange, such
orders shall be deemed received on the next business day. Any order may be
rejected by the Distributor or the Fund. The Fund or the Distributor may
suspend the continuous offering of the Fund's shares to the general public at
any time in response to conditions in the securities markets or otherwise and
may thereafter resume such offering from time to time. Neither the Distributor
nor the dealers are permitted to withhold placing orders to benefit themselves
by a price change. Merrill Lynch may charge its customers a processing fee
(presently, $4.85) to confirm a sale of shares to such customers. Purchases
directly through the Fund's Transfer Agent are not subject to the processing
fee.
The Fund issues four classes of shares under the Merrill Lynch Select
Pricing(SM) System, which permits each investor to choose the method of
purchasing shares that the investor believes is most beneficial given the
amount of the purchase, the length of time the investor expects to hold the
shares and other relevant circumstances. Shares of Class A and Class D are sold
to investors choosing the initial sales charge alternatives and shares of Class
B and Class C are sold to investors choosing the deferred sales charge
alternatives. Investors should determine whether under their particular
circumstances it is more advantageous to incur an initial sales charge or to
have the entire initial purchase price invested in the Fund with the investment
thereafter being subject to a CDSC and ongoing distribution and higher account
maintenance fees.
23
<PAGE> 24
A discussion of the factors that investors should consider in determining the
method of purchasing shares under the Merrill Lynch Select Pricing(SM) System is
set forth under the "Merrill Lynch Select Pricing(SM) System" on page 3.
Each Class A, Class B, Class C and Class D share of the Fund represents an
identical interest in the investment portfolio of the Fund and has the same
rights, except that Class B, Class C and Class D shares bear the expenses of the
ongoing account maintenance fees, and Class B and Class C shares bear the
expenses of the ongoing distribution fees and the additional incremental
transfer agency costs resulting from the deferred sales charge arrangements. The
deferred sales charges and account maintenance fees that are imposed on Class B
and Class C shares, as well as the account maintenance fees that are imposed on
Class D shares, will be imposed directly against those classes and not against
all assets of the Fund and, accordingly, such charges will not affect the net
asset value of any other class or have any impact on investors choosing another
sales charge option. Dividends paid by the Fund for each class of shares will be
calculated in the same manner at the same time and will differ only to the
extent that account maintenance and distribution fees and any incremental
transfer agency costs relating to a particular class are borne exclusively by
that class. Class B, Class C and Class D shares each have exclusive voting
rights with respect to the Rule 12b-1 distribution plan adopted with respect to
such class pursuant to which account maintenance and/or distribution fees are
paid. See "Distribution Plans" below. Each class has different exchange
privileges. See "Shareholder Services--Exchange Privilege".
Investors should understand that the purpose and function of the initial
sales charges with respect to Class A and Class D shares are the same as those
of the deferred sales charges with respect to Class B and Class C shares in that
the sales charges applicable to each class provide for the financing of the
distribution of the shares of the Fund. The distribution-related revenues paid
with respect to a class will not be used to finance the distribution
expenditures of another class. Sales personnel may receive different
compensation for selling different classes of shares. Investors are advised that
only Class A and Class D shares may be available for purchase through securities
dealers, other than Merrill Lynch, which are eligible to sell shares.
The following table sets forth a summary of the distribution arrangements
for each class of shares under the Merrill Lynch Select Pricing(SM) System.
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------------
ACCOUNT
MAINTENANCE DISTRIBUTION
CLASS SALES CHARGE(1) FEE FEE CONVERSION FEATURE
<S> <C> <C> <C> <C> <C>
-----------------------------------------------------------------------------------------------
A Maximum 4.0% initial sales
charge(2)(3) No No No
-----------------------------------------------------------------------------------------------
B CDSC for a period of 4 years, at a
rate of 4.0% during the first
year, decreasing 1.0% annually to B shares convert to D
0.0% 0.25% 0.25% shares
automatically after
approximately ten years(4)
-----------------------------------------------------------------------------------------------
C 1.0% CDSC for one year 0.25% 0.35% No
-----------------------------------------------------------------------------------------------
D Maximum 4.0% initial sales charge(3) 0.10% No No
-----------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------
</TABLE>
(1) Initial sales charges are imposed at the time of purchase as a percentage of
the offering price. CDSCs may be imposed if the redemption occurs within the
applicable CDSC time period. The charge will be assessed on an amount equal
to the lesser of the proceeds of redemption or the cost of the shares being
redeemed.
(2) Offered only to eligible investors. See "Initial Sales Charge
Alternatives--Class A and Class D Shares--Eligible Class A Investors".
(Footnotes continue on following page)
24
<PAGE> 25
(3) Reduced for purchases of $25,000 or more. Class A and Class D share
purchases of $1,000,000 or more may not be subject to an initial sales
charge but instead may be subject to up to a 1.00% CDSC if redeemed within
one year.
(4) The conversion period for dividend reinvestment shares was modified. Also,
Class B shares of certain other MLAM-advised mutual funds into which
exchanges may be made have an eight-year conversion period. If Class C
shares of the Fund are exchanged for Class B shares of another MLAM-advised
mutual fund, the conversion period applicable to the Class B shares acquired
in the exchange will apply, and the holding period for the shares exchanged
will be tacked onto the holding period for the shares acquired.
INITIAL SALES CHARGE ALTERNATIVES--CLASS A AND CLASS D SHARES
Investors choosing the initial sales charge alternatives who are eligible
to purchase Class A shares should purchase Class A shares rather than Class D
shares because there is an account maintenance fee imposed on Class D shares.
The public offering price of Class A and Class D shares for purchasers
choosing the initial sales charge alternatives is the next determined net asset
value plus varying sales charges (i.e., sales loads), as set forth below.
<TABLE>
<CAPTION>
SALES LOAD AS SALES LOAD AS DISCOUNT TO
PERCENTAGE OF PERCENTAGE* OF SELECTED DEALERS
OFFERING THE NET AMOUNT AS PERCENTAGE OF
AMOUNT OF PURCHASE PRICE INVESTED THE OFFERING PRICE
- ------------------------------------------------- ------------- -------------- ------------------
<S> <C> <C> <C>
Less than $25,000................................ 4.00% 4.17% 3.75%
$25,000 but less than $50,000.................... 3.75 3.90 3.50
$50,000 but less than $100,000................... 3.25 3.36 3.00
$100,000 but less than $250,000.................. 2.50 2.56 2.25
$250,000 but less than $1,000,000................ 1.50 1.52 1.25
$1,000,000 and over**............................ 0.00 0.00 0.00
</TABLE>
- ---------------
* Rounded to the nearest one-hundredth percent.
** The initial sales charge may be waived on Class A and Class D purchases of
$1,000,000 or more made on or after October 21, 1994 (the date Class D shares
were initially offered to the public). If the sales charge is waived in
connection with a purchase of $1,000,000 or more, such purchases will be
subject to a CDSC of 1.0% if the shares are redeemed within one year after
purchase. Class A purchases made prior to October 21, 1994 may be subject to
a CDSC if the shares are redeemed within one year of purchase at the
following rates: 0.75% on purchases of $1,000,000 to $2,500,000; 0.40% on
purchases of $2,500,001 to $3,500,000; 0.25% on purchases of $3,500,001 to
$5,000,000; and 0.20% on purchases of more than $5,000,000 in lieu of paying
an initial sales charge. The charge will be assessed on an amount equal to
the lesser of the proceeds of redemption or the cost of the shares being
redeemed.
The Distributor may reallow discounts to selected dealers and retain the
balance over such discounts. At times the Distributor may reallow the entire
sales charge to such dealers. Since securities dealers selling Class A and Class
D shares of the Fund will receive a concession equal to most of the sales
charge, they may be deemed to be underwriters under the Securities Act. During
the year ended August 31, 1995, the Fund sold 356,036 Class A shares for
aggregate net proceeds of $3,948,528. The gross sales charges for the sale of
Class A shares of the Fund for that year were $30,995, of which $2,220 and
$28,775 were received by the Distributor and Merrill Lynch, respectively. For
the year ended August 31, 1995, the Distributor received no CDSCs with respect
to redemption within one year after purchase of Class A shares purchased subject
to front-end sales charge waivers. For the period October 21, 1994 (commencement
of operations) to August 31, 1995, the Fund sold 383,812 Class D shares for
aggregate net proceeds of $4,170,592. The gross sales charges for the sale of
Class D shares of the Fund for the stated period were $22,241, of which $1,704
and $20,537 were received by the Distributor and Merrill Lynch, respectively.
For the period October 21, 1994 (commencement of operations) to August 31, 1995,
the Distributor received no CDSCs with respect to
25
<PAGE> 26
redemption within one year after purchase of Class D shares purchased subject to
a front-end sales charge waiver.
Eligible Class A Investors. Class A shares are offered to a limited group
of investors and also will be issued upon reinvestment of dividends on
outstanding Class A shares. Investors that currently own Class A shares of the
Fund in a shareholder account are entitled to purchase additional Class A shares
of the Fund in that account. Class A shares are available at net asset value to
corporate warranty insurance reserve fund programs, provided that each program
has $3 million or more initially invested in MLAM-advised mutual funds. Also
eligible to purchase Class A shares at net asset value are participants in
certain investment programs including TMASM Managed Trusts to which Merrill
Lynch Trust Company provides discretionary trustee services and certain
purchases made in connection with the Merrill Lynch Mutual Fund Adviser program.
In addition, Class A shares are offered at net asset value to ML&Co. and its
subsidiaries (the term "subsidiaries", when used herein, includes MLAM, the
Manager and certain other entities directly or indirectly owned or controlled by
ML & Co.), and their directors and employees, and to members of the Boards of
MLAM-advised mutual funds, including the Trust. Certain persons who acquired
shares of certain MLAM-advised closed-end funds who wish to reinvest the net
proceeds from a sale of their closed-end fund shares of common stock in shares
of the Fund also may purchase Class A shares of the Fund if certain conditions
set forth in the Statement of Additional Information are met. For example, Class
A shares of the Fund and certain other MLAM-advised mutual funds are offered at
net asset value to shareholders of Merrill Lynch Senior Floating Rate Fund, Inc.
who wish to reinvest the net proceeds from a sale of certain of their shares of
common stock of Merrill Lynch Senior Floating Rate Fund, Inc. in shares of such
funds.
Reduced Initial Sales Charges. No initial sales charges are imposed upon
Class A and Class D shares issued as a result of the automatic reinvestment of
dividends or capital gains distributions. Class A and Class D sales charges also
may be reduced under a Right of Accumulation and a Letter of Intention.
Class A shares are offered at net asset value to certain eligible Class A
investors as set forth above under "Eligible Class A Investors".
Class A and Class D shares are offered at net asset value to certain
employer sponsored retirement or savings plans and to Employee Access AccountsSM
available through employers which provide such plans.
Class D shares are offered at net asset value without sales charge to an
investor who has a business relationship with a Merrill Lynch financial
consultant, if certain conditions set forth in the Statement of Additional
Information are met. Class D shares may be offered at net asset value in
connection with the acquisition of assets of other investment companies.
Class D shares of the Fund are offered at net asset value to shareholders
of Merrill Lynch Municipal Strategy Fund, Inc. ("Municipal Strategy Fund") and
Merrill Lynch High Income Municipal Bond Fund, Inc. ("High Income Municipal Bond
Fund") who wish to reinvest the net proceeds from a sale of certain of their
shares of common stock of Municipal Strategy Fund and High Income Municipal Bond
Fund, respectively, in shares of the Fund. Similarly, Class A shares of the Fund
are offered at net asset value to shareholders of Merrill Lynch Senior Floating
Rate Fund, Inc. ("Senior Floating Rate Fund") who wish to reinvest the net
proceeds from the sale of certain of their shares of common stock of Senior
Floating Rate Fund in shares of the Fund.
Additional information concerning these reduced initial sales charges is
set forth in the Statement of Additional Information.
26
<PAGE> 27
DEFERRED SALES CHARGE ALTERNATIVES--CLASS B AND CLASS C SHARES
Investors choosing the deferred sales charge alternatives should consider
Class B shares if they intend to hold their shares for an extended period of
time and Class C shares if they are uncertain as to the length of time they
intend to hold their assets in MLAM-advised mutual funds.
The public offering price of Class B and Class C shares for investors
choosing the deferred sales charge alternatives in the next determined net asset
value per share without the imposition of a sales charge at the time of
purchase. As discussed below, Class B shares are subject to a four year CDSC,
while Class C shares are subject only to a one year 1.0% CDSC. On the other
hand, approximately ten years after Class B shares are issued, such Class B
shares, together with shares issued upon dividend reinvestment with respect to
those shares, are automatically converted into Class D shares of the Fund and
thereafter will be subject to lower continuing fees. See "Conversion of Class B
Shares to Class D Shares" below. Both Class B and Class C shares are subject to
an account maintenance fee of 0.25% of net assets, and Class B and Class C
shares are subject to distribution fees of 0.25% and 0.35%, respectively, of net
assets as discussed under "Distribution Plans". The proceeds from the account
maintenance fees are used to compensate Merrill Lynch for providing continuing
account maintenance activities.
Class B and Class C shares are sold without an initial sales charge so that
the Fund will receive the full amount of the investor's purchase payment.
Merrill Lynch compensates its financial consultants for selling Class B and
Class C shares at the time of purchase from its own funds. See "Distribution
Plans" below.
Proceeds from the CDSC and the distribution fee are paid to the Distributor
and are used in whole or in part by the Distributor to defray the expenses of
dealers (including Merrill Lynch) related to providing distribution-related
services to the Fund in connection with the sale of the Class B and Class C
shares, such as the payment of compensation to financial consultants for selling
Class B and Class C shares, from its own funds. The combination of the CDSC and
the ongoing distribution fee facilitates the ability of the Fund to sell the
Class B and Class C shares without a sales charge being deducted at the time of
purchase. Approximately ten years after issuance, Class B shares will convert
automatically into Class D shares of the Fund, which are subject to a lower
account maintenance fee and no distribution fee; Class B shares of certain other
MLAM-advised mutual funds into which exchanges may be made convert into Class D
shares automatically after approximately eight years. If Class B shares of the
Fund are exchanged for Class B shares of another MLAM-advised mutual fund, the
conversion period applicable to the Class B shares acquired in the exchange will
apply, and the holding period for the shares exchanged will be tacked onto the
holding period for the shares acquired.
Imposition of the CDSC and the distribution fee on Class B and Class C
shares is limited by the NASD asset-based sales charge rule. See "Limitations on
the Payment of Deferred Sales Charges" below. The proceeds from the ongoing
account maintenance fees are used to compensate Merrill Lynch for providing
continuing account maintenance activities. Class B shareholders of the Fund
exercising the exchange privilege described under "Shareholder
Services--Exchange Privilege" will continue to be subject to the Fund's CDSC
schedule if such schedule is higher than the CDSC schedule relating to the Class
B shares acquired as a result of the exchange.
Contingent Deferred Sales Charges--Class B Shares. Class B shares which
are redeemed within four years of purchase may be subject to a CDSC at the rates
set forth below charged as a percentage of the dollar amount subject thereto.
The charge will be assessed on an amount equal to the lesser of the proceeds of
27
<PAGE> 28
redemption or the cost of the shares being redeemed. Accordingly, no CDSC will
be imposed on increases in net asset value above the initial purchase price. In
addition, no CDSC will be assessed on shares derived from reinvestment of
dividends or capital gains distributions.
The following table sets forth the rates of the Class B CDSC:
<TABLE>
<CAPTION>
CLASS B CDSC
AS A PERCENTAGE
YEAR SINCE PURCHASE OF DOLLAR AMOUNT
PAYMENT MADE SUBJECT TO CHARGE
--------------------------------------------------------------- -----------------
<S> <C>
0-1...................................................... 4.00%
1-2...................................................... 3.00
2-3...................................................... 2.00
3-4...................................................... 1.00
4 and thereafter......................................... None
</TABLE>
For the fiscal year ended August 31, 1995, the Distributor received CDSCs of
$866,830 with respect to redemptions of Class B shares, all of which were paid
to Merrill Lynch.
In determining whether a CDSC is applicable to a redemption, the
calculation will be determined in the manner that results in the lowest possible
rate being charged. Therefore, it will be assumed that the redemption is first
of shares held for over four years or shares acquired pursuant to reinvestment
of dividends or distributions and then of shares held longest during the
four-year period. The charge will not be applied to dollar amounts representing
an increase in the net asset value since the time of purchase. A transfer of
shares from a shareholder's account to another account will be assumed to be
made in the same order as a redemption.
To provide an example, assume an investor purchases 100 shares at $10 per
share (at a cost of $1,000) and in the third year after purchase, the net asset
value per share is $12 and, during such time, the investor has acquired 10
additional shares through dividend reinvestment. If at such time the investor
makes his or her first redemption of 50 shares (proceeds of $600), 10 shares
will not be subject to the CDSC because of dividend reinvestment. With respect
to the remaining 40 shares, the CDSC is applied only to the original cost of $10
per share and not to the increase in net asset value of $2 per share. Therefore,
$400 of the $600 redemption proceeds will be charged at a rate of 2.0% (the
applicable rate in the third year after purchase).
In the event that Class B shares are exchanged by certain retirement plans
for Class A shares in connection with a transfer to the Merrill Lynch Mutual
Fund Adviser ("MFA") program, the time period that such Class A shares are held
in the MFA program will be included in determining the holding period of Class B
shares reacquired upon termination of participation in the MFA program (see
"Shareholder Services--Exchange Privilege").
The Class B CDSC is waived on redemptions of shares following the death or
disability (as defined in the Code) of a shareholder. Additional information
concerning the waiver of the Class B CDSC is set forth in the Statement of
Additional Information.
Contingent Deferred Sales Charges--Class C Shares. Class C shares which
are redeemed within one year after purchase may be subject to a 1.0% CDSC
charged as a percentage of the dollar amount subject thereto. The charge will be
assessed on an amount equal to the lesser of the proceeds of redemption or the
cost
28
<PAGE> 29
of the shares being redeemed. Accordingly, no Class C CDSC will be imposed on
increases in net asset value above the initial purchase price. In addition, no
Class C CDSC will be assessed on shares derived from reinvestment of dividends
or capital gains distributions. For the period October 21, 1994 (commencement of
operations) to August 31, 1995, the Distributor received CDSCs of $3,844 with
respect to redemptions of Class C shares, all of which were paid to Merrill
Lynch.
In determining whether a Class C CDSC is applicable to a redemption, the
calculation will be determined in the manner that results in the lowest possible
rate being charged. Therefore, it will be assumed that the redemption is first
of shares held for over one year or shares acquired pursuant to reinvestment of
dividends or distributions and then of shares held longest during the one year
period. The charge will not be applied to dollar amounts representing an
increase in the net asset value since the time of purchase. A transfer of shares
from a shareholder's account to another account will be assumed to be made in
the same order as a redemption.
Conversion of Class B Shares to Class D Shares. After approximately ten
years (the "Conversion Period"), Class B shares will be converted automatically
into Class D shares of the Fund. Class D shares are subject to an ongoing
account maintenance fee of 0.10% of net assets but are not subject to the
distribution fee that is borne by Class B shares. Automatic conversion of Class
B shares into Class D shares will occur at least once each month (on the
"Conversion Date") on the basis of the relative net asset values of the shares
of the two classes on the Conversion Date, without the imposition of any sales
load, fee or other charge. Conversion of Class B shares to Class D shares will
not be deemed a purchase or sale of the shares for Federal income tax purposes.
In addition, shares purchased through reinvestment of dividends on Class B
shares also will convert automatically to Class D shares. The Conversion Date
for dividend reinvestment shares will be calculated taking into account the
length of time the shares underlying such dividend reinvestment shares were
outstanding. If at a Conversion Date the conversion of Class B shares to Class D
shares of the Fund in a single account will result in less than $50 worth of
Class B shares being left in the account, all of the Class B shares of the Fund
held in the account on the Conversion Date will be converted to Class D shares
of the Fund.
Share certificates for Class B shares of the Fund to be converted must be
delivered to the Transfer Agent at least one week prior to the Conversion Date
applicable to those shares. In the event such certificates are not received by
the Transfer Agent at least one week prior to the Conversion Date, the related
Class B shares will convert to Class D shares on the next scheduled Conversion
Date after such certificates are delivered.
In general, Class B shares of equity MLAM-advised mutual funds will convert
approximately eight years after initial purchase, and Class B shares of taxable
and tax-exempt fixed income MLAM-advised mutual funds will convert approximately
ten years after initial purchase. If, during the Conversion Period, a
shareholder exchanges Class B shares with an eight-year Conversion Period for
Class B shares with a ten-year Conversion Period, or vice versa, the Conversion
Period applicable to the Class B shares acquired in the exchange will apply, and
the holding period for the shares exchanged will be "tacked" onto the holding
period for the shares acquired.
DISTRIBUTION PLANS
The Fund has adopted separate distribution plans for Class B, Class C and
Class D shares pursuant to Rule 12b-1 under the 1940 Act (each a "Distribution
Plan") with respect to the account maintenance and/or
29
<PAGE> 30
distribution fees paid by the Fund to the Distributor with respect to such
classes. The Class B and Class C Distribution Plans provide for the payment of
account maintenance fees and distribution fees, and the Class D Distribution
Plan provides for the payment of account maintenance fees.
The Distribution Plans for Class B, Class C and Class D shares each provide
that the Fund pays the Distributor an account maintenance fee relating to the
shares of the relevant class, accrued daily and paid monthly, at the annual
rates of 0.25%, 0.25% and 0.10%, respectively, of the average daily net assets
of the Fund attributable to shares of the relevant class in order to compensate
the Distributor and Merrill Lynch (pursuant to a sub-agreement) in connection
with account maintenance activities.
The Distribution Plans for Class B and Class C shares each provide that the
Fund also pays the Distributor a distribution fee relating to the shares of the
relevant class, accrued daily and paid monthly, at the annual rates of 0.25% and
0.35%, respectively, of the average daily net assets of the Fund attributable to
the shares of the relevant class in order to compensate the Distributor and
Merrill Lynch (pursuant to a sub-agreement) for providing shareholder and
distribution services, and bearing certain distribution-related expenses of the
Fund, including payments to financial consultants for selling Class B and Class
C shares of the Fund. The Distribution Plans relating to Class B and Class C
shares are designed to permit an investor to purchase Class B and Class C shares
through dealers without the assessment of an initial sales charge and at the
same time permit the dealer to compensate its financial consultants in
connection with the sale of the Class B and Class C shares. In this regard, the
purpose and function of the ongoing distribution fees and the CDSC are the same
as those of the initial sales charge with respect to the Class A and Class D
shares of the Fund in that the deferred sales charges provide for the financing
of the distribution of the Fund's Class B and Class C shares.
For the year ended August 31, 1995, the Fund paid the Distributor
$3,249,016 pursuant to the Class B Distribution Plan (based on average net
assets subject to such Distribution Plan of $649.8 million), all of which were
paid to Merrill Lynch for providing account maintenance and distribution-related
activities and services in connection with Class B shares. During the period
October 21, 1994 (commencement of operations) to August 31, 1995, the Fund paid
the Distributor $8,263 pursuant to the Distribution Plan relating to Class C
shares (based on average net assets subject to such Distribution Plan of
approximately $1.6 million), all of which were paid to Merrill Lynch for
providing account maintenance and distribution-related activities and services
in connection with Class C shares. During the period October 21, 1994
(commencement of operations) to August 31, 1995, the Fund paid the Distributor
$2,131 pursuant to the Distribution Plan relating to Class D shares (based on
average net assets subject to such Distribution Plan of approximately $2.5
million), all of which were paid to Merrill Lynch for providing account
maintenance services in connection with Class D shares. At November 30, 1995,
the net assets of the Fund subject to the Class B Distribution Plan aggregated
approximately $577.4 million. At this asset level, the annual fee payable
pursuant to the Class B Distribution Plan would aggregate $2.9 million. At
November 30, 1995, the net assets of the Fund subject to the Class C
Distribution Plan aggregated $4.6 million. At this asset level, the annual fee
payable pursuant to the Class C Distribution Plan would aggregate $27,877. At
November 30, 1995, the net assets of the Fund subject to the Class D
Distribution Plan aggregated approximately $48.5 million. At this asset level,
the annual fee payable pursuant to the Class D Distribution Plan would aggregate
$48,473.
The payments under the Distribution Plans are based on a percentage of
average daily net assets attributable to the shares regardless of the amount of
expenses incurred, and accordingly, distribution-related revenues from the
Distribution Plans may be more or less than distribution-related expenses.
Information with
30
<PAGE> 31
respect to the distribution-related revenues and expenses is presented to the
Directors for their consideration in connection with their deliberations as to
the continuance of the Class B and Class C Distribution Plans. This information
is presented annually as of December 31 of each year on a "fully allocated
accrual" basis and quarterly on a "direct expense and revenue/cash" basis. On
the fully allocated accrual basis, revenues consist of the account maintenance
fees, distribution fees, the CDSC and certain other related revenues, and
expenses consist of financial consultant compensation, branch office and
regional operation center selling and transaction processing expenses,
advertising, sales promotion and marketing expenses, corporate overhead and
interest expense. On the direct expense and revenue/cash basis, revenues consist
of the account maintenance fees, distribution fees and CDSCs, and the expenses
consist of financial consultant compensation. At December 31, 1994, the fully
allocated accrual expenses incurred by the Distributor and Merrill Lynch with
respect to Class B shares for the period September 30, 1985 through December 31,
1994 exceeded fully allocated accrual revenues for such period by approximately
$7,326,000 (1.18% of Class B net assets at that date). As of August 31, 1995,
direct cash revenues for the period since the commencement of operations
exceeded direct cash expenses by approximately $19,252,901 (3.12% of Class B net
assets at that date). As of August 31, 1995, direct cash expenses for the period
since October 21, 1994 (commencement of operations) exceeded direct cash
revenues by $9,556 (.31% of Class C net assets at that date).
The Fund has no obligation with respect to distribution and/or account
maintenance-related expenses incurred by the Distributor and Merrill Lynch in
connection with Class B, Class C and Class D shares, and there is no assurance
that the Trustees of the Trust will approve the continuance of the Distribution
Plans from year to year. However, the Distributor intends to seek annual
continuation of the Distribution Plans. In their review of the Distribution
Plans, the Trustees will be asked to take into consideration expenses incurred
in connection with the account maintenance and/or distribution of each class of
shares separately. The initial sales charges, the account maintenance fee, the
distribution fee and/or the CDSCs received with respect to one class will not be
used to subsidize the sale of shares of another class. Payments of the
distribution fee on Class B shares will terminate upon conversion of those Class
B shares into Class D shares as set forth under "Deferred Sales Charge
Alternatives--Class B and Class C Shares--Conversion of Class B Shares to Class
D Shares".
LIMITATIONS ON THE PAYMENT OF DEFERRED SALES CHARGES
The maximum sales charge rule in the Rules of Fair Practice of the NASD
imposes a limitation on certain asset-based sales charges such as the
distribution fee and the CDSC borne by the Class B and Class C shares but not
the account maintenance fee. The maximum sales charge rule is applied separately
to each class. As applicable to the Fund, the maximum sales charge rule limits
the aggregate of distribution fee payments and CDSCs payable by the Fund to (1)
6.25% of eligible gross sales of Class B shares and Class C shares, computed
separately (defined to exclude shares issued pursuant to dividend reinvestments
and exchanges), plus (2) interest on the unpaid balance for the respective
class, computed separately, at the prime rate plus 1% (the unpaid balance being
the maximum amount payable minus amounts received from the payment of the
distribution fee and the CDSC). In connection with the Class B shares, the
Distributor has voluntarily agreed to waive interest charges on the unpaid
balance in excess of 0.50% of eligible gross sales. Consequently, the maximum
amount payable to the Distributor (referred to as the "voluntary maximum") in
connection with the Class B shares is 6.75% of eligible gross sales. The
Distributor retains the right to stop waiving the interest charges at any time.
To the extent payments would exceed the voluntary maximum, the Fund will not
make further payments of the distribution fee with respect to Class B shares,
and any CDSCs
31
<PAGE> 32
will be paid to the Fund rather than to the Distributor; however, the Fund will
continue to make payments of the account maintenance fee. In certain
circumstances, the amount payable pursuant to the voluntary maximum may exceed
the amount payable under the NASD formula. In such circumstances, payment in
excess of the amount payable under the NASD formula will not be made.
------------------------------
REDEMPTION OF SHARES
The Trust is required to redeem for cash all shares of the Fund upon
receipt of a written request in proper form. The redemption price is the net
asset value per share next determined after the initial receipt of proper notice
of redemption. Except for any CDSC which may be applicable, there will be no
charge for redemption if the redemption request is sent directly to the Transfer
Agent. Shareholders liquidating their holdings will receive upon redemption all
dividends reinvested through the date of redemption. The value of shares at the
time of redemption may be more or less than the shareholder's costs, depending
on the market value of the securities held by the Fund at such time.
REDEMPTION
A shareholder wishing to redeem shares may do so by tendering the shares
directly to the Transfer Agent, Merrill Lynch Financial Data Services, Inc.,
P.O. Box 45289, Jacksonville, Florida 32232-5289. Redemption requests delivered
other than by mail should be delivered to Merrill Lynch Financial Data Services,
Inc., 4800 Deer Lake Drive East, Jacksonville, Florida 32246-6484. Proper notice
of redemption in the case of shares deposited with the Transfer Agent may be
accomplished by a written letter requesting redemption. Proper notice of
redemption in the case of shares for which certificates have been issued may be
accomplished by a written letter as noted above accompanied by certificates for
the shares to be redeemed. Redemption requests should not be sent to the Fund.
The notice in either event requires the signature(s) of all persons in whose
name(s) the shares are registered, signed exactly as such name(s) appear(s) on
the Transfer Agent's register. The signature(s) on the redemption request must
be guaranteed by an "eligible guarantor institution" as such is defined in Rule
17Ad-15 under the Securities and Exchange Act of 1934, as amended, the existence
and validity of which may be verified by the Transfer Agent through the use of
industry publications. Notarized signatures are not sufficient. In certain
instances, the Transfer Agent may require additional documents such as, but not
limited to, trust instruments, death certificates, appointments as executor or
administrator, or certificates of corporate authority. For shareholders
redeeming directly with the Transfer Agent, payments will be mailed within seven
days of receipt of a proper notice of redemption.
At various times the Trust may be requested to redeem Fund shares for which
it has not yet received good payment (e.g., cash, Federal Funds or certified
check drawn on a United States bank). The Trust may delay or cause to be delayed
the mailing of a redemption check until such time as it has assured itself that
good payment has been collected for the purchase of such Fund shares which may
take up to 10 days.
REPURCHASE
The Trust also will repurchase Fund shares through a shareholder's listed
securities dealer. The Trust normally will accept orders to repurchase Fund
shares by wire or telephone from dealers for their customers at the net asset
value next computed after receipt of the order by the dealer, provided that the
request for
32
<PAGE> 33
repurchase is received by the dealer prior to the regular close of business on
the New York Stock Exchange (generally, 4:00 P.M., New York time) on the day
received and is received by the Trust from such dealer not later than 30 minutes
after the close of business on the New York Stock Exchange on the same day.
Dealers have the responsibility of submitting such repurchase requests to the
Trust not later than 30 minutes after the close of business on the New York
Stock Exchange in order to obtain that day's closing price.
These repurchase arrangements are for the convenience of shareholders and
do not involve a charge by the Trust (other than any applicable CDSC).
Securities firms that do not have selected dealer agreements with the
Distributor, however, may impose a charge on the shareholder for transmitting
the notice of repurchase to the Trust. Merrill Lynch may charge its customers a
processing fee (presently $4.85) to confirm a repurchase of shares to such
customers. Redemptions directly through the Transfer Agent are not subject to
the processing fee. The Trust reserves the right to reject any order for
repurchase, which right of rejection might adversely affect shareholders seeking
redemption through the repurchase procedure. However, a shareholder whose order
for repurchase is rejected by the Trust may redeem Fund shares as set forth
above.
REINSTATEMENT PRIVILEGE--CLASS A AND CLASS D SHARES
Shareholders who have redeemed their Class A or Class D shares have a
one-time privilege to reinstate their accounts by purchasing Class A or Class D
shares, as the case may be, of the Fund at net asset value without a sales
charge up to the dollar amount redeemed. The reinstatement privilege may be
exercised by sending a notice of exercise along with a check for the amount to
be reinstated to the Transfer Agent within 30 days after the date the request
for redemption was accepted by the Transfer Agent or the Distributor. The
reinstatement will be made at the net asset value per share next determined
after the notice of reinstatement is received and cannot exceed the amount of
the redemption proceeds. The reinstatement privilege is a one-time privilege and
may be exercised by the Class A or Class D shareholder only the first time such
shareholder makes a redemption.
SHAREHOLDER SERVICES
The Trust offers a number of shareholder services and investment plans
designed to facilitate investment in shares of the Fund. Full details as to each
of such services and instructions as to how to participate in the various
services or plans, or to change options with respect thereto can be obtained
from the Trust by calling the telephone number on the cover page hereof or from
the Distributor or Merrill Lynch. Included in such services are the following:
Investment Account. Each shareholder whose account is maintained at the
Transfer Agent has an "Investment Account" and will receive statements, at least
quarterly, from the Transfer Agent. These statements will serve as transaction
confirmations for automatic investment purchases and the reinvestment of
ordinary income dividends and long-term capital gains distributions. These
statements also will show any other activity in the account since the preceding
statement. Shareholders will receive separate transaction confirmations for each
purchase or sale transaction other than automatic investment purchases and the
reinvestments of ordinary income dividends and long-term capital gains
distributions. A shareholder may make additions to his or her Investment Account
at any time by mailing a check directly to the Transfer Agent. Shareholders may
also maintain their accounts through Merrill Lynch. Upon the transfer of shares
out of a Merrill Lynch brokerage account, an Investment Account in the
transferring shareholder's name may be
33
<PAGE> 34
opened automatically at the Transfer Agent. Shareholders considering
transferring their Class A or Class D shares from Merrill Lynch to another
brokerage firm or financial institution should be aware that, if the firm to
which the Class A or Class D shares are to be transferred will not take delivery
of shares of the Fund, a shareholder either must redeem the Class A or Class D
shares (paying any applicable CDSC) so that the cash proceeds can be transferred
to the account at the new firm or such shareholder must continue to maintain an
Investment Account at the Transfer Agent for those Class A or Class D shares.
Shareholders interested in transferring their Class B or Class C shares from
Merrill Lynch and who do not wish to have an Investment Account maintained for
such shares at the Transfer Agent may request their new brokerage firm to
maintain such shares in an account registered in the name of the brokerage firm
for the benefit of the shareholder at the Transfer Agent.
Exchange Privilege. Shareholders of each class of shares of the Fund each
have an exchange privilege with certain other MLAM-advised mutual funds. There
is currently no limitation on the number of times a shareholder may exercise the
exchange privilege. The exchange privilege may be modified or terminated in
accordance with the rules of the Commission.
Under the Merrill Lynch Select Pricing System, Class A shareholders may
exchange Class A shares of the Fund for Class A shares of a second MLAM-advised
mutual fund if the shareholder holds any Class A shares of the second fund in
his or her account in which the exchange is made at the time of the exchange or
is otherwise eligible to purchase Class A shares of the second fund. If the
Class A shareholder wants to exchange Class A shares for shares of a second
MLAM-advised mutual fund, and the shareholder does not hold Class A shares of
the second fund in his or her account at the time of the exchange and is not
otherwise eligible to acquire Class A shares of the second fund, the shareholder
will receive Class D shares of the second fund as a result of the exchange.
Class D shares also may be exchanged for Class A shares of a second MLAM-advised
mutual fund at any time as long as, at the time of the exchange, the shareholder
holds Class A shares of the second fund in the account in which the exchange is
made or is otherwise eligible to purchase Class A shares of the second fund.
Exchanges of Class A and Class D shares are made on the basis of the
relative net asset values per Class A or Class D share, respectively, plus an
amount equal to the difference, if any, between the sales charge previously paid
on the Class A or Class D shares being exchanged and the sales charge payable at
the time of the exchange on the shares being acquired.
Class B, Class C and Class D shares are exchangeable with shares of the
same class of other MLAM-advised mutual funds.
Shares of the Fund which are subject to a CDSC are exchangeable on the
basis of relative net asset value per share without the payment of any CDSC that
might otherwise be due upon redemption of the shares of the Fund. For purposes
of computing the CDSC that may be payable upon a disposition of the shares
acquired in the exchange, the holding period for the previously owned shares of
the Fund is "tacked" to the holding period of the newly acquired shares of the
other Fund.
Class A, Class B, Class C and Class D shares also are exchangeable for
shares of certain MLAM-advised money market funds specifically designated as
available for exchange by holders of Class A, Class B, Class C or Class D
shares. The period of time that Class A, Class B, Class C or Class D shares are
held in a money market fund, however, will not count toward satisfaction of the
holding period requirement for reduction of
34
<PAGE> 35
any CDSC imposed on such shares, if any, and, with respect to Class B shares,
toward satisfaction of the Conversion Period.
Class B shareholders of the Fund exercising the exchange privilege will
continue to be subject to the Fund's CDSC schedule if such schedule is higher
than the CDSC schedule relating to the new Class B shares. In addition, Class B
shares of the Fund acquired through use of the exchange privilege will be
subject to the Fund's CDSC schedule if such schedule is higher than the CDSC
schedule relating to the Class B shares of the MLAM-advised mutual fund from
which the exchange has been made.
Exercise of the exchange privilege is treated as a sale for Federal income
tax purposes. For further information, see "Shareholder Services--Exchange
Privilege" in the Statement of Additional Information.
The Fund's exchange privilege is modified with respect to purchases of
Class A and Class D shares by non-retirement plan investors under the MFA
program. First, the initial allocation of assets is made under the MFA program.
Then, any subsequent exchange under the MFA program of Class A or Class D shares
of a MLAM-advised mutual fund for Class A or Class D shares of the Fund will be
made solely on the basis of the relative net asset values of the shares being
exchanged. Therefore, there will not be a charge for any difference between the
sales charge previously paid on the shares of the other MLAM-advised mutual fund
and the sales charge payable on the shares of the Fund being acquired in the
exchange under the MFA program.
Automatic Reinvestment of Dividends and Capital Gains Distributions. All
dividends and capital gains distributions are reinvested automatically in full
and fractional shares of the Fund, without a sales charge, at the net asset
value per share at the close of business on the monthly payment date for such
dividends and distributions. A shareholder may at any time, by notifying the
Transfer Agent in writing or by telephone (1-800-MER-FUND), elect to have
subsequent dividends or both dividends and capital gains distributions paid in
cash, rather than reinvested, in which event payment will be mailed. Cash
payments can also be directly deposited to the shareholders bank account. No
CDSC will be imposed on redemption of shares issued as a result of the automatic
reinvestment of dividends or capital gains distributions.
Systematic Withdrawal Plans. A Class A or Class D shareholder may elect to
receive systematic withdrawal payments from his or her Investment Account
through automatic payment by check or through automatic payment by direct
deposit to his or her bank account on either a monthly or quarterly basis.
Alternatively, a Class A or Class D shareholder whose shares are held within a
CMA(R) or CBA(R) account may elect to have shares redeemed on a monthly,
bimonthly, quarterly, semiannual or annual basis through the CMA(R)/CBA(R)
Systematic Redemption Program, subject to certain conditions.
Automatic Investment Plans. Regular additions of Class A, Class B, Class C
or Class D shares may be made to an investor's Investment Account by
pre-arranged charges of $50 or more to his or her regular bank account. The
Fund's Automatic Investment Program is not available to shareholders whose
shares are held in a brokerage account with Merrill Lynch. Alternatively,
investors who maintain CMA(R) or CBA(R) accounts may arrange to have periodic
investments made in the Fund in their CMA(R) or CBA(R) accounts or in certain
related accounts in amounts of $100 or more through the CMA(R)/CBA(R) Automated
Investment Program.
PORTFOLIO TRANSACTIONS
Subject to the policies established by the Trustees of the Trust, the
Manager is primarily responsible for the execution of the Fund's portfolio
transactions. The Trust has no obligation to deal with any dealer or group of
dealers in the execution of transactions in portfolio securities of the Fund.
Municipal Bonds and other
35
<PAGE> 36
securities in which the Fund invests are traded primarily in the
over-the-counter market. Where possible, the Trust deals directly with the
dealers who make a market in the securities involved except in those
circumstances where better prices and execution are available elsewhere. It is
the policy of the Trust to obtain the best net results in conducting portfolio
transactions for the Fund, taking into account such factors as price (including
the applicable dealer spread or commission), the size, type and difficulty of
the transaction involved, the firm's general execution and operational
facilities, the firm's risk in positioning the securities involved and the
provision of supplemental investment research by the firm. While reasonably
competitive spreads or commissions are sought, the Fund will not necessarily be
paying the lowest spread or commission available. The sale of shares of the Fund
may be taken into consideration as a factor in the selection of brokers or
dealers to execute portfolio transactions for the Fund. The portfolio securities
of the Fund are generally traded on a principal basis and do not normally
involve either brokerage commissions or transfer taxes. The cost of portfolio
securities transactions of the Fund primarily consists of dealer or underwriter
spreads. Under the 1940 Act, persons affiliated with the Trust, including
Merrill Lynch, are prohibited from dealing with the Trust as a principal in the
purchase and sale of securities unless such trading is permitted by an exemptive
order issued by the Commission. The Trust has obtained an exemptive order
permitting it to engage in certain principal transactions with Merrill Lynch
involving high quality short-term Municipal Bonds subject to certain conditions.
In addition, the Trust may not purchase securities, including Municipal Bonds,
for the Fund during the existence of any underwriting syndicate of which Merrill
Lynch is a member except pursuant to procedures approved by the Trustees of the
Trust which comply with rules adopted by the Commission. The Trust has applied
for an exemptive order, subject to certain conditions, permitting the Trust to,
among other things, (i) purchase investment grade tax-exempt securities from
Merrill Lynch when Merrill Lynch is a member of an underwriting syndicate for
such securities and (ii) purchase tax-exempt securities from and sell tax-exempt
securities to Merrill Lynch in secondary market transactions. Affiliated persons
of the Trust may serve as its broker in over-the-counter transactions conducted
by the Fund on an agency basis only.
Portfolio Turnover. Generally, the Fund does not purchase securities for
short-term trading profits. However, the Fund may dispose of securities without
regard to the time they have been held when such action, for defensive or other
reasons, appears advisable to its Manager. As a result of the investment
policies described herein, under certain market conditions the Fund's portfolio
turnover may be higher than that of other investment companies; however, it is
extremely difficult to predict portfolio turnover rates with any degree of
accuracy. Higher portfolio turnover may contribute to higher transactional costs
and negative tax consequences, such as an increase in capital gain dividends or
in ordinary income dividends of accrued market discount, as well as greater
difficulty meeting the requirement for qualifications as a regulated investment
company that less than 30% of its gross income be derived from the sale or other
disposition of securities held for less than three months. See "Distributions
and Taxes" on page 37. (The portfolio turnover rate is calculated by dividing
the lesser of purchases or sales of portfolio securities for the particular
fiscal year by the monthly average of the value of the portfolio securities
owned by the Fund during the particular fiscal year. For purposes of determining
this rate, all securities whose maturities at the time of acquisition are one
year or less are excluded.)
36
<PAGE> 37
DISTRIBUTIONS AND TAXES
DISTRIBUTIONS
The net investment income of the Fund is declared as dividends daily prior
to the determination of the net asset value, which is calculated 15 minutes
after the close of business on the New York Stock Exchange (generally, 4:00
P.M., New York time) on that day. The net investment income of the Fund for
dividend purposes consists of interest earned on portfolio securities, less
expenses, in each case computed since the most recent determination of net asset
value. Expenses of the Fund, including the management fees and the account
maintenance and distribution fees, are accrued daily. Dividends of net
investment income are declared daily and reinvested monthly in the form of
additional full and fractional shares of the Fund at net asset value unless the
shareholder elects to receive such dividends in cash. Shares will accrue
dividends as long as they are issued and outstanding. Shares are issued and
outstanding from the settlement date of a purchase order to the day prior to the
settlement date of a redemption order.
All net realized long- or short-term capital gains, if any, are declared
and distributed to the Fund's shareholders at least annually. Capital gains
distributions will be automatically invested in shares unless the shareholder
elects to receive such distributions in cash.
The per share dividends and distributions on each class of shares will be
reduced as a result of any account maintenance, distribution and transfer agency
fees applicable to that class. See "Additional Information--Determination of Net
Asset Value".
See "Shareholder Services" for information as to how to elect either
dividend reinvestment or cash payments. Portions of dividends and distributions
which are taxable to shareholders as described below are subject to income tax
whether they are reinvested in shares of the Fund or received in cash.
TAXES
The Trust intends to continue to qualify the Fund for the special tax
treatment afforded regulated investment companies ("RICs") under the Internal
Revenue Code of 1986, as amended (the "Code"). If it so qualifies, in any
taxable year in which it distributes at least 90% of its taxable net income and
90% of its tax-exempt net income, the Fund (but not its shareholders) will not
be subject to Federal income tax to the extent that it distributes (see below)
its net investment income and net realized capital gains. The Trust intends to
cause the Fund to distribute substantially all of such income.
To the extent that the dividends distributed to the Fund's Class A, Class
B, Class C and Class D shareholders (together the "shareholders") are derived
from interest income exempt from Federal income tax under Code Section 103(a)
and are properly designated as "exempt-interest dividends" by the Trust, they
will be excludable from a shareholder's gross income for Federal income tax
purposes. Exempt-interest dividends are included, however, in determining the
portion, if any, of a person's social security and railroad retirement benefits
subject to Federal income taxes. The portion of such exempt-interest dividends
paid from interest received by the Fund from California Municipal Bonds also
will be exempt from California income taxes if, at the close of each quarter of
the Fund's taxable year, at least 50% of the value of the Fund's total assets
consists of California Municipal Bonds. The Trust intends to invest at least 50%
of the Fund's assets in California Municipal Bonds at all times. Shareholders
subject to income taxation by states other than California will realize a lower
after-tax rate of return than California shareholders since the dividends
distributed by the Fund
37
<PAGE> 38
will generally not be exempt, to any significant degree, from income taxation by
such other states. The Trust will inform shareholders annually as to the portion
of the Fund's distributions which constitutes exempt-interest dividends and the
portion which is exempt from California income taxes. Interest on indebtedness
incurred or continued to purchase or carry Fund shares is not deductible for
Federal or California personal income tax purposes to the extent attributable to
exempt-interest dividends. Persons who may be "substantial users" (or "related
persons" of substantial users) of facilities financed by industrial development
bonds or private activity bonds held by the Fund should consult their tax
advisers before purchasing Fund shares.
Exempt-interest dividends paid to a corporate shareholder will be subject
to California state franchise tax.
To the extent that the Fund's distributions are derived from interest on
its taxable investments or from an excess of net short-term capital gains over
net long-term capital losses ("ordinary income dividends"), such distributions
are considered ordinary income for Federal and California state income tax
purposes. Distributions, if any, from an excess of net long-term capital gains
over net short-term capital losses derived from the sale of securities or from
certain transactions in futures or options ("capital gain dividends") are
taxable as long-term capital gains for Federal income tax purposes, regardless
of the length of time the shareholder has owned Fund shares and, for California
income tax purposes, are treated as capital gains which are taxed at ordinary
income tax rates. Distributions by the Fund, whether from exempt-interest
income, ordinary income or capital gains will not be eligible for the dividends
received deduction allowed to corporations under the Code.
All or a portion of the Fund's gain from the sale or redemption of
tax-exempt obligations purchased at a market discount will be treated as
ordinary income rather than capital gain. This rule may increase the amount of
ordinary income dividends received by shareholders. Distributions in excess of
the Fund's earnings and profits will first reduce the adjusted tax basis of a
holder's shares and, after such adjusted tax basis is reduced to zero, will
constitute capital gains to such holder (assuming the shares are held as a
capital asset). Any loss upon the sale or exchange of Fund shares held for six
months or less will be treated as long-term capital loss to the extent of any
capital gain dividends received by the shareholder. In addition, such loss will
be disallowed to the extent of any exempt-interest dividends received by the
shareholder. If the Fund pays a dividend in January which was declared in the
previous October, November or December to shareholders of record on a specified
date in one of such months, then such dividend will be treated for tax purposes
as being paid by the Fund and received by its shareholders on December 31 of the
year in which such dividend was declared.
The Code subjects interest received on certain otherwise tax-exempt
securities to an alternative minimum tax. The alternative minimum tax applies to
interest received on "private activity bonds" issued after August 7, 1986.
Private activity bonds are bonds which, although tax-exempt, are used for
purposes other than those generally performed by governmental units (e.g., bonds
used for industrial development or housing purposes). Income received on such
bonds is classified as an item of "tax preference", which could subject
investors in such bonds, including shareholders of the Fund, to an alternative
minimum tax. The Fund will purchase such "private activity bonds", and the Trust
will report to shareholders within 60 days after the Fund's taxable year-end,
the portion of the Fund's dividends declared during the year which constitutes
an item of tax preference for alternative minimum tax purposes. The Code further
provides that corporations are subject to an alternative minimum tax based, in
part, on certain differences between taxable income as adjusted for other tax
preferences and "adjusted current earnings", which more closely reflect a
corporation's economic income. Because an exempt-interest dividend paid by the
Fund will be included in adjusted current
38
<PAGE> 39
earnings, a corporate shareholder may be required to pay alternative minimum tax
on exempt-interest dividends paid by the Fund.
No gain or loss will be recognized by Class B shareholders on the
conversion of their Class B shares into Class D shares. A shareholder's basis in
the Class D shares acquired will be the same as such shareholder's basis in the
Class B shares converted, and the holding period of the acquired Class D shares
will include the holding period for the converted Class B shares.
If a shareholder exercises an exchange privilege within 90 days of
acquiring such shares, then the loss such shareholder can recognize on the
exchange will be reduced (or the gain increased) to the extent the sales charge
paid to the Fund reduces any sales charge such shareholder would have owed upon
purchase of the new shares in the absence of the exchange privilege. Instead,
such sales charge will be treated as an amount paid for the new shares.
A loss realized on a sale or exchange of shares of the Fund will be
disallowed if other Fund shares are acquired (whether through the automatic
reinvestment of dividends or otherwise) within a 61-day period beginning 30 days
before and ending 30 days after the date that the shares are disposed of. In
such a case, the basis of the shares acquired will be adjusted to reflect the
disallowed loss.
Under certain provisions of the Code, some shareholders may be subject to a
31% withholding tax on certain ordinary income dividends and on capital gain
dividends and redemption payments ("backup withholding"). Generally,
shareholders subject to backup withholding will be those for whom no certified
taxpayer identification number is on file with the Trust or who, to the Trust's
knowledge, have furnished an incorrect number. When establishing an account, an
investor must certify under penalty of perjury that such number is correct and
that such investor is not otherwise subject to backup withholding.
The Code provides that every person required to file a tax return must
include for information purposes on such return the amount of exempt-interest
dividends received from all sources (including the Fund) during the taxable
year.
The foregoing is a general and abbreviated summary of the applicable
provisions of the Code, Treasury regulations and applicable California income
tax laws. For the complete provisions, reference should be made to the pertinent
Code sections, Treasury regulations promulgated thereunder and California income
tax laws. The Code and the Treasury regulations, as well as the California tax
laws, are subject to change by legislative, judicial or administrative action
either prospectively or retroactively.
Shareholders are urged to consult their tax advisers regarding the
availability of any exemptions from state and local taxes (other than those
imposed by California) and with specific questions as to Federal, foreign, state
or local taxes.
PERFORMANCE DATA
From time to time the Fund may include its average annual total return,
yield and tax equivalent yield for various specified time periods in
advertisements or information furnished to present or prospective shareholders.
Average annual total return, yield and tax equivalent yield are computed
separately for Class A, Class B, Class C and Class D shares in accordance with
formulas specified by the Commission.
39
<PAGE> 40
Average annual total return quotations for the specified periods will be
computed by finding the average annual compounded rates of return (based on net
investment income and any realized and unrealized capital gains or losses on
portfolio investments over such periods) that would equate the initial amount
invested to the redeemable value of such investment at the end of each period.
Average annual total return will be computed assuming all dividends and
distributions are reinvested and taking into account all applicable recurring
and nonrecurring expenses, including any CDSC that would be applicable to a
complete redemption of the investment at the end of the specified period such as
in the case of Class B and Class C shares and the maximum sales charge in the
case of Class A and Class D shares. Dividends paid by the Fund with respect to
all shares, to the extent any dividends are paid, will be calculated in the same
manner at the same time on the same day and will be in the same amount, except
that account maintenance fees and distribution charges and any incremental
transfer agency costs relating to each class of shares will be borne exclusively
by that class. The Fund will include performance data for all classes of shares
of the Fund in any advertisement or information including performance data of
the Fund.
The Fund also may quote total return and aggregate total return performance
data for various specified time periods. Such data will be calculated
substantially as described above, except that (1) the rates of return calculated
will not be average annual rates, but rather, actual annual, annualized or
aggregate rates of return and (2) the maximum applicable sales charges will not
be included with respect to annual or annualized rates of return calculations.
Aside from the impact on the performance data calculations of including or
excluding the maximum applicable sales charges, actual annual or annualized
total return data generally will be lower than average annual total return data
since the average annual rates of return reflect compounding; aggregate total
return data generally will be higher than average annual total return data since
the aggregate rates of return reflect compounding over a longer period of time.
In advertisements distributed to investors whose purchases are subject to waiver
of the CDSC in the case of Class B and Class C shares or to reduced sales
charges in the case of Class A or Class D shares, the performance data may take
into account the reduced, and not the maximum, sales charge or may not take into
account the CDSC and therefore may reflect greater total return since, due to
the reduced sales charges or waiver of the CDSC, a lower amount of expenses is
deducted. See "Purchase of Shares". The Fund's total return may be expressed
either as a percentage or as a dollar amount in order to illustrate such total
return on a hypothetical $1,000 investment in the Fund at the beginning of each
specified period.
Yield quotations will be computed based on a 30-day period by dividing (a)
the net income based on the yield of each security earned during the period by
(b) the average daily number of shares outstanding during the period that were
entitled to receive dividends multiplied by the maximum offering price per share
on the last day of the period. Tax equivalent yield quotations will be computed
by dividing (a) the part of the Fund's yield that is tax-exempt by (b) one minus
a stated tax rate and (c) adding the result to that part, if any, of the Fund's
yield that is not tax-exempt. The yield for the 30-day period ended August 31,
1995 was 5.17% for Class A shares, 4.89% for Class B shares, 4.78% for Class C
shares and 5.08% for Class D shares and tax-equivalent yield for the same period
(based on a Federal income tax rate of 28%) was 7.18% for Class A shares, 6.79%
for Class B shares, 6.64% for Class C shares and 7.06% for Class D shares.
Total return, yield and tax equivalent yield figures are based on the
Fund's historical performance and are not intended to indicate future
performance. The Fund's total return, yield and tax equivalent yield will vary
depending on market conditions, the securities comprising the Fund's portfolio,
the Fund's operating expenses and the amount of realized and unrealized net
capital gains or losses during the period. The value of an
40
<PAGE> 41
investment in the Fund will fluctuate and an investor's shares, when redeemed,
may be worth more or less than their original cost.
On occasion, the Fund may compare its performance to performance data
published by Lipper Analytical Services, Inc., Morningstar Publications, Inc.
("Morningstar"), and CDA Investment Technology, Inc., or to data contained in
publications such as Money Magazine, U.S. News & World Report, Business Week,
Forbes Magazine and Fortune Magazine. From time to time, the Fund may include
the Fund's Morningstar risk-adjusted performance ratings in advertisements or
supplemental sales literature. As with other performance data, performance
comparisons should not be considered indicative of the Fund's relative
performance for any future period.
ADDITIONAL INFORMATION
DETERMINATION OF NET ASSET VALUE
The net asset value of the shares of all classes of the Fund is determined
by the Manager once daily, 15 minutes after the close of business on the New
York Stock Exchange (generally, 4:00 P.M., New York time), on each day during
which the New York Stock Exchange is open for trading. The net asset value per
share is computed by dividing the sum of the value of the securities held by the
Fund plus any cash or other assets minus all liabilities by the total number of
shares outstanding at such time, rounded to the nearest cent. Expenses,
including management fees and distribution fees, are accrued daily.
The per share net asset value of the Class A shares generally will be
higher than the per share net asset value of shares of the other classes,
reflecting the daily expense accruals of the account maintenance, distribution
and higher transfer agency fees applicable with respect to Class B and Class C
shares and the daily expense accruals of the account maintenance fees applicable
with respect to Class D shares; moreover, the per share net asset value of Class
D shares generally will be higher than the per share net asset value of Class B
and Class C shares, reflecting the daily expense accruals of the distribution
and higher transfer agency fees applicable with respect to Class B and Class C
shares. It is expected, however, that the per share net asset value of the
classes will tend to converge (although not necessarily meet) immediately after
the payment of dividends or distributions which will differ by approximately the
amount of the expense accrual differentials between the classes.
ORGANIZATION OF THE TRUST
The Trust is an unincorporated business trust organized on March 20, 1985
under the laws of Massachusetts. The Trust is an open-end investment company
comprised of separate series ("Series"), each of which is a separate portfolio
offering shares to selected groups of purchasers. On December 22, 1987, the Fund
changed its name from "Merrill Lynch California Tax-Exempt Fund" to "Merrill
Lynch California Municipal Bond Fund". The Trustees are authorized to create an
unlimited number of Series and, with respect to each Series, to issue an
unlimited number of full and fractional shares of different classes. Shareholder
approval is not required for the authorization of additional Series or classes
of a Series of the Trust. At the date of this Prospectus, the shares of the Fund
are divided into Class A, Class B, Class C and Class D Shares. Class A, Class B,
Class C and Class D shares represent interests in the same assets of the Fund
and are identical in all respects except that Class B, Class C and Class D
shares bear certain expenses
41
<PAGE> 42
related to the account maintenance associated with such shares, and Class B and
Class C shares bear certain expenses related to the distribution of such shares.
Each class has exclusive voting rights with respect to matters relating to
account maintenance and distribution expenditures as applicable. See "Purchase
of Shares". The Trust has received an order (the "Order") from the Commission
permitting the issuance and sale of multiple classes of shares. The Trustees of
the Trust may classify and reclassify the shares of any Series into additional
classes at a future date. The Order permits the Trust to issue additional
classes of shares of any Series if the Board of Trustees deems such issuance to
be in the best interests of the Trust.
Shareholders are entitled to one vote for each full share held and to
fractional votes for fractional shares held in the election of Trustees (to the
extent hereafter provided) and on other matters submitted to the vote of
shareholders. There normally will 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. Shareholders may, in accordance with the terms of the Declaration of
Trust cause a meeting of shareholders to be held for the purpose of voting on
the removal of Trustees. Also, the Trust will be required to call a special
meeting of shareholders of a Series in accordance with the requirements of the
1940 Act to seek approval of new management and advisory arrangements, of a
material increase in distribution fees or of a change in the fundamental
policies, objectives or restrictions of a Series. Except as set forth above, the
Trustees shall continue to hold office and appoint successor Trustees. Each
issued and outstanding share is entitled to participate equally in dividends and
distributions declared by the respective Series and in net assets of such Series
upon liquidation or dissolution remaining after satisfaction of outstanding
liabilities except that, as noted above, the Class B, Class C and Class D shares
bear certain additional expenses. The obligations and liabilities of a
particular Series are restricted to the assets of that Series and do not extend
to the assets of the Trust generally. The shares of each Series, when issued,
will be fully-paid and non-assessable by the Trust.
SHAREHOLDER REPORTS
Only one copy of each shareholder report and certain shareholder
communications will be mailed to each identified shareholder regardless of the
number of accounts such shareholder has. If a shareholder wishes to receive
copies of each report and communication for all of the shareholder's related
accounts the shareholder should notify in writing:
Merrill Lynch Financial Data Services, Inc.
P.O. Box 45289
Jacksonville, Florida 32232-5289
The written notification should include the shareholder's name, address, tax
identification number and Merrill Lynch, Pierce, Fenner & Smith Incorporated
and/or mutual fund account numbers. If you have any questions regarding this,
please call your Merrill Lynch financial consultant or Merrill Lynch Financial
Data Services, Inc. at 800-637-3863.
42
<PAGE> 43
SHAREHOLDER INQUIRIES
Shareholder inquiries may be addressed to the Trust at the address or
telephone number set forth on the cover page of this Prospectus.
------------------------------
The Declaration of Trust establishing the Trust, dated March 20, 1985, a
copy of which together with all amendments thereto (the "Declaration") is on
file in the office of the Secretary of the Commonwealth of Massachusetts,
provides that the name of "Merrill Lynch California Municipal Series Trust"
refers to the Trustees under the Declaration collectively as Trustees, but not
as individuals or personally; and no Trustee, shareholder, officer, employee or
agent of the Trust shall be held to any personal liability, nor shall resort be
had to their private property for the satisfaction of any obligation or claim of
the Trust, but the "Trust Property" (as defined in the Declaration) only shall
be liable.
43
<PAGE> 44
(This page intentionally left blank)
44
<PAGE> 45
MERRILL LYNCH CALIFORNIA MUNICIPAL BOND FUND--AUTHORIZATION FORM (PART 1)
1. SHARE PURCHASE APPLICATION
I, being of legal age, wish to purchase: (choose one)
/ / Class A shares / / Class B shares / / Class C shares / / Class D shares
of Merrill Lynch California Municipal Bond Fund and establish an Investment
Account as described in the Prospectus. In the event that I am not eligible to
purchase Class A shares, I understand that Class D shares will be purchased.
Basis for establishing an Investment Account:
A. I enclose a check for $.......... payable to Merrill Lynch Financial
Data Services, Inc., as an initial investment (minimum $1,000). I understand
that this purchase will be executed at the applicable offering price next to
be determined after this Application is received by you.
B. I already own shares of the following Merrill Lynch mutual funds that
would qualify for the right of accumulation as outlined in the Statement of
Additional Information: (Please list all funds. Use a separate sheet of paper
if necessary.)
<TABLE>
<S> <C>
1. .......................................................... 4. ..........................................................
2. .......................................................... 5. ..........................................................
3. .......................................................... 6. ..........................................................
</TABLE>
Name............................................................................
First Name Initial Last Name
Name of Co-Owner (if any).......................................................
First Name Initial Last Name
Address.........................................................................
............................................................. Date.............
(Zip Code)
<TABLE>
<S> <C>
Occupation ................................................... Name and Address of Employer..................................
............................................................. .............................................................
Signature of Owner Signature of Co-Owner (if any)
</TABLE>
(In the case of co-owner, a joint tenancy with right of survivorship will be
presumed unless otherwise specified.)
- --------------------------------------------------------------------------------
2. DIVIDEND AND CAPITAL GAIN DISTRIBUTION OPTION
<TABLE>
<S> <C>
Ordinary Income Dividends Long-Term Capital Gains
--------------------------------- ---------------------------------
SELECT / / Reinvest SELECT / / Reinvest
ONE: / / Cash ONE: / / Cash
--------------------------------- ---------------------------------
</TABLE>
If no election is made, dividends and capital gains will be automatically
reinvested at net asset value without a sales charge.
IF CASH, SPECIFY HOW YOU WOULD LIKE YOUR DISTRIBUTIONS PAID TO YOU: / / Check
or / / Direct Deposit to bank account
IF DIRECT DEPOSIT TO BANK ACCOUNT IS SELECTED, PLEASE COMPLETE BELOW:
I hereby authorize payment of dividend and capital gain distributions by direct
deposit to my bank account and, if necessary, debit entries and adjustments for
any credit entries made to my account in accordance with the terms I have
selected on the Merrill Lynch California Municipal Bond Fund Authorization Form.
SPECIFY TYPE OF ACCOUNT (CHECK ONE) / / checking / / savings
Name on your Account...........................................................
Bank Name......................................................................
Bank Number ..........................Account Number...........................
Bank Address...................................................................
I agree that this authorization will remain in effect until I provide written
notification to Merrill Lynch Financial Data Services, Inc. amending or
terminating this service.
Signature of Depositor.........................................................
Signature of Depositor .......................Date.............................
(if joint account, both must sign)
NOTE: IF DIRECT DEPOSIT TO BANK ACCOUNT IS SELECTED, YOUR BLANK, UNSIGNED CHECK
MARKED "VOID" OR A DEPOSIT SLIP FROM YOUR SAVINGS ACCOUNT SHOULD ACCOMPANY THIS
APPLICATION.
45
<PAGE> 46
MERRILL LYNCH CALIFORNIA MUNICIPAL BOND FUND--AUTHORIZATION FORM (PART
1)--(CONTINUED)
3. SOCIAL SECURITY NUMBER OR TAXPAYER IDENTIFICATION NUMBER
Social Security Number or Taxpayer Identification Number
Under penalty of perjury, I certify (1) that the number set forth above is my
correct Social Security Number or Taxpayer Identification Number and (2) that I
am not subject to backup withholding (as discussed in the prospectus under
"Distributions and Taxes--Taxes") either because I have not been notified that I
am subject thereto as a result of a failure to report all interest or dividends,
or the Internal Revenue Service ("IRS") has notified me that I am no longer
subject thereto.
INSTRUCTION: YOU MUST STRIKE OUT THE LANGUAGE IN (2) ABOVE IF YOU HAVE BEEN
NOTIFIED THAT YOU ARE SUBJECT TO BACKUP WITHHOLDING DUE TO UNDERREPORTING AND IF
YOU HAVE NOT RECEIVED A NOTICE FROM THE IRS THAT BACKUP WITHHOLDING HAS BEEN
TERMINATED. THE UNDERSIGNED AUTHORIZES THE FURNISHING OF THIS CERTIFICATION TO
OTHER MERRILL LYNCH SPONSORED MUTUAL FUNDS.
<TABLE>
<S> <C>
............................................................. ............................................................
Signature of Owner Signature of Co-Owner (if any)
- ----------------------------------------------------------------------
4. LETTER OF INTENTION--CLASS A AND D SHARES ONLY (SEE TERMS AND
CONDITIONS IN THE STATEMENT OF ADDITIONAL INFORMATION)
......................,19 . . . .
Dear Sir/Madam: Date of initial purchase
</TABLE>
Although I am not obligated to do so, I intend to purchase shares of Merrill
Lynch California Municipal Bond Fund or any other investment company with an
initial sales charge or deferred sales charge for which Merrill Lynch Funds
Distributor, Inc. acts as distributor over the next 13 month period which will
equal or exceed:
/ / $25,000 / / $50,000 / / $100,000 / / $250,000 / / $1,000,000
Each purchase will be made at the then reduced offering price applicable to
the amount checked above, as described in the Merrill Lynch California Municipal
Bond Fund Prospectus.
I agree to the terms and conditions of the Letter of Intention. I hereby
irrevocably constitute and appoint Merrill Lynch Funds Distributor, Inc., my
attorney, with full power of substitution, to surrender for redemption any or
all shares of Merrill Lynch California Municipal Bond Fund held as security.
<TABLE>
<S> <C>
By............................................................... ...............................................................
Signature of Owner Signature of Co-Owner
(If registered in joint names, both must sign)
</TABLE>
In making purchases under this letter, the following are the related accounts
on which reduced offering prices are to apply:
<TABLE>
<S> <C>
(1) Name ................................................... (2) Name....................................................
Account Number ............................................ Account Number..............................................
</TABLE>
- --------------------------------------------------------------------------------
5. FOR DEALER ONLY
- --- Branch Office, Address, Stamp. ---
- - -
- - -
- --- ---
This form when completed should be mailed to:
Merrill Lynch California Municipal Bond Fund
c/o Merrill Lynch Financial Data Services, Inc.
P.O. Box 45289
Jacksonville, Florida 32232-5289
We hereby authorize Merrill Lynch Funds Distributor, Inc. to act as our agent in
connection with transactions under this authorization form and agree to
notify the Distributor of any purchases made under a Letter of Intention or
Systematic Withdrawal Plan. We guarantee the Shareholder's signature.
...............................................................
Dealer Name and Address
By .............................................................................
Authorized Signature of Dealer
- --------- ------------
- --------- ------------ ..............................
Branch-Code F/C No. F/C Last Name
- --------- ---------------
- --------- ---------------
Dealer's Customer A/C No.
46
<PAGE> 47
MERRILL LYNCH CALIFORNIA MUNICIPAL BOND FUND--AUTHORIZATION FORM (PART 2)
- --------------------------------------------------------------------------------
NOTE: THIS FORM IS REQUIRED TO APPLY FOR THE SYSTEMATIC WITHDRAWAL OR AUTOMATIC
INVESTMENT PLANS ONLY.
- --------------------------------------------------------------------------------
1. ACCOUNT REGISTRATION
<TABLE>
<S> <C>
------------------------------------
Name of Owner.......................................................................
------------------------------------
Social Security No.
or Taxpayer Identification Number
Name of Co-Owner (if any)...........................................................
Address.............................................................................
.................................................................................... Account Number...........................
(if existing account)
</TABLE>
- --------------------------------------------------------------------------------
2. SYSTEMATIC WITHDRAWAL PLAN--CLASS A AND CLASS D SHARES ONLY (SEE TERMS AND
CONDITIONS IN THE STATEMENT OF ADDITIONAL INFORMATION)
MINIMUM REQUIREMENTS: $10,000 for monthly disbursements, $5,000 for
quarterly, of / / Class A or / / Class D shares in Merrill Lynch California
Municipal Bond Fund, at cost or current offering price. Withdrawals to be made
either (check one) / / Monthly on the 24th day of each month, or N Quarterly on
the 24th day of March, June, September and December. If the 24th falls on a
weekend or holiday, the next succeeding business day will be utilized. Begin
systematic withdrawal on ................(month) or as soon as possible
thereafter.
SPECIFY HOW YOU WOULD LIKE YOUR WITHDRAWAL PAID TO YOU (CHECK ONE): / / $......
or / / ......% of the current value of / / Class A or / / Class D shares in the
account.
SPECIFY WITHDRAWAL METHOD: / / check or / / direct deposit to bank account
(check one and complete part (a) or (b) below):
DRAW CHECKS PAYABLE (CHECK ONE)
(a) I hereby authorize payment by check
/ / as indicated in Item 1.
/ / to the order of..........................................................
Mail to (check one)
/ / the address indicated in Item 1.
/ / Name (Please Print)......................................................
Address.........................................................................
...........................................................................
Signature of Owner.......................... Date...............................
Signature of Co-Owner (if any)..................................................
(b) I HEREBY AUTHORIZE PAYMENT BY DIRECT DEPOSIT TO MY BANK ACCOUNT AND, IF
NECESSARY, DEBIT ENTRIES AND ADJUSTMENTS FOR ANY CREDIT ENTRIES MADE TO MY
ACCOUNT. I AGREE THAT THIS AUTHORIZATION WILL REMAIN IN EFFECT UNTIL I PROVIDE
WRITTEN NOTIFICATION TO MERRILL LYNCH FINANCIAL DATA SERVICES, INC. AMENDING OR
TERMINATING THIS SERVICE.
SPECIFY TYPE OF ACCOUNT (CHECK ONE): / / checking / / savings
Name of your Account............................................................
Bank Name.......................................................................
Bank Number ................................. Account Number....................
Bank Address....................................................................
......................................................................
Signature of Depositor........................ Date.............................
Signature of Depositor..........................................................
(if joint account, both must sign)
NOTE: IF DIRECT DEPOSIT IS ELECTED, YOUR BLANK, UNSIGNED CHECK MARKED "VOID" OR
A DEPOSIT SLIP FROM YOUR SAVINGS ACCOUNT SHALL ACCOMPANY THIS APPLICATION.
47
<PAGE> 48
MERRILL LYNCH CALIFORNIA MUNICIPAL BOND FUND--AUTHORIZATION FORM (PART
2)--(CONTINUED)
- --------------------------------------------------------------------------------
3. APPLICATION FOR AUTOMATIC INVESTMENT PLAN
I hereby request that Merrill Lynch Financial Data Services, Inc. draw an
automated clearing house ("ACH") debit on my checking account as described below
each month to purchase (choose one)
/ / Class A shares / / Class B shares / / Class C shares / / Class D shares
of Merrill Lynch California Municipal Bond Fund subject to the terms set forth
below. In the event that I am not eligible to purchase Class A shares, I
understand that Class D shares will be purchased.
MERRILL LYNCH FINANCIAL DATA SERVICES, INC.
You are hereby authorized to draw an ACH debit each month on my bank account for
investment in Merrill Lynch Healthcare Fund, Inc. as indicated below:
Amount of each check or ACH debit $..........................................
Account Number...............................................................
Please date and invest ACH debits on the 20th of each month beginning
.................................. or as soon thereafter as possible.
(month)
I agree that you are drawing these ACH debits voluntarily at my request and that
you shall not be liable for any loss arising from any delay in preparing or
failure to prepare any such debit. If I change banks or desire to terminate or
suspend this program, I agree to notify you promptly in writing. I hereby
authorize you to take any action to correct erroneous ACH debits of my bank
account or purchases of Fund shares including liquidating shares of the Fund and
crediting my bank account. I further agree that if a debit is not honored upon
presentation, Merrill Lynch Financial Data Services, Inc. is authorized to
discontinue immediately the Automatic Investment Plan and to liquidate
sufficient shares held in my account to offset the purchase made with the
dishonored debit.
................. .......................................
Date Signature of Depositor
.......................................
Signature of Depositor
(If joint account, both must sign)
AUTHORIZATION TO HONOR ACH DEBITS DRAWN BY
MERRILL LYNCH FINANCIAL DATA SERVICES, INC.
To..........................................................................Bank
(Investor's Bank)
Bank Address....................................................................
City .................... State ........ Zip Code...............................
As a convenience to me, I hereby request and authorize you to pay and charge to
my account ACH debits drawn on my account by and payable to Merrill Lynch
Financial Data Services, Inc., I agree that your rights in respect to each such
debit shall be the same as if it were a check drawn on you and signed personally
by me. This authority is to remain in effect until revoked by me in writing.
Until you receive such notice, you shall be fully protected in honoring any such
debit. I further agree that if any such debit be dishonored, whether with or
without cause and whether intentionally or inadvertently, you shall be under no
liability.
................. .......................................................
Date Signature of Depositor
................. .......................................................
Bank Account Signature of Depositor
Number (If joint account, both must sign)
NOTE: IF AUTOMATIC INVESTMENT PLAN IS ELECTED, YOUR BLANK, UNSIGNED CHECK MARKED
"VOID" SHOULD ACCOMPANY THIS APPLICATION.
48
<PAGE> 49
[This page intentionally left blank]
<PAGE> 50
[This page intentionally left blank]
<PAGE> 51
MANAGER
Fund Asset Management
Administrative Offices:
800 Scudders Mill Road
Plainsboro, New Jersey
Mailing Address:
P.O. Box 9011
Princeton, New Jersey 08543-9011
DISTRIBUTOR
Merrill Lynch Funds Distributor, Inc.
Administrative Offices:
800 Scudders Mill Road
Plainsboro, New Jersey
Mailing Address:
P.O. Box 9081
Princeton, New Jersey 08543-9081
CUSTODIAN
The Bank of New York
90 Washington Street, 12th Floor
New York, New York 10268
TRANSFER AGENT
Merrill Lynch Financial Data Services, Inc.
Administrative Offices:
4800 Deer Lake Drive East
Jacksonville, Florida 32246-6484
Mailing Address:
P.O. Box 45289
Jacksonville, Florida 32232-5289
INDEPENDENT AUDITORS
Deloitte & Touche LLP
117 Campus Drive
Princeton, New Jersey 08540-6400
COUNSEL
Brown & Wood
One World Trade Center
New York, New York 10048-0557
<PAGE> 52
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS, OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS, IN CONNECTION
WITH THE OFFER CONTAINED IN THIS PROSPECTUS, AND, IF GIVEN OR MADE, SUCH OTHER
INFORMATION OR REPRESENTATION MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED
BY THE TRUST, THE MANAGER OR THE DISTRIBUTOR. THIS PROSPECTUS DOES NOT
CONSTITUTE AN OFFERING IN ANY STATE IN WHICH SUCH OFFERING MAY NOT LAWFULLY BE
MADE.
-------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Fee Table...................................... 2
Merrill Lynch Select Pricing(SM) System........ 3
Financial Highlights........................... 8
Investment Objective and Policies.............. 11
Potential Benefits........................... 13
Special and Risk Considerations Relating to
Municipal Bonds............................ 13
Description of Municipal Bonds............... 14
Call Rights.................................. 16
When-Issued Securities and Delayed Delivery
Transactions............................... 17
Financial Futures Transaction and Options.... 17
Repurchase Agreements........................ 19
Investment Restrictions...................... 19
Management of the Trust........................ 21
Trustees..................................... 21
Management and Advisory Arrangements......... 21
Code of Ethics............................... 22
Transfer Agency Services..................... 22
Purchase of Shares............................. 23
Initial Sales Charge Alternatives--
Class A and Class D Shares................. 25
Deferred Sales Charge Alternatives--
Class B and Class C Shares................. 27
Distribution Plans........................... 29
Limitations on the Payment of Deferred Sales
Charges.................................... 31
Redemption of Shares........................... 32
Redemption................................... 32
Repurchase................................... 32
Reinstatement Privilege--
Class A and Class D Shares................. 33
Shareholder Services........................... 33
Portfolio Transactions......................... 35
Distributions and Taxes........................ 37
Distributions................................ 37
Taxes........................................ 37
Performance Data............................... 39
Additional Information......................... 41
Determination of Net Asset Value............. 41
Organization of the Trust.................... 41
Shareholder Reports.......................... 42
Shareholder Inquiries........................ 43
Authorization Form............................. 45
</TABLE>
Code #10327-1295
[MERRILL LYNCH LOGO]
Merrill Lynch
California Municipal
Bond Fund
Merrill Lynch California
Municipal Series Trust
PROSPECTUS
December 29, 1995
Distributor:
Merrill Lynch
Funds Distributor, Inc.
This prospectus should be
retained for future reference.
<PAGE> 53
STATEMENT OF ADDITIONAL INFORMATION
MERRILL LYNCH CALIFORNIA MUNICIPAL BOND FUND
MERRILL LYNCH CALIFORNIA MUNICIPAL SERIES TRUST
P.O. BOX 9011, PRINCETON, NEW JERSEY 08543-9011 - PHONE NO. (609) 282-2800
------------------------
Merrill Lynch California Municipal Bond Fund (the "Fund") is a series of
Merrill Lynch California Municipal Series Trust (the "Trust"), an open-end
investment company organized as a Massachusetts business trust. The investment
objective of the Fund is to provide shareholders with as high a level of income
exempt from Federal and California income taxes as is consistent with prudent
investment management. The Fund seeks to achieve its objective, while providing
investors with the opportunity to invest primarily in a diversified portfolio of
long-term obligations issued by or on behalf of the State of California, its
political subdivisions, agencies and instrumentalities and obligations of other
qualifying issuers, such as issuers located in Puerto Rico, the Virgin Islands
and Guam, which pay interest exempt, in the opinion of bond counsel to the
issuer, from Federal and California income taxes. There can be no assurance that
the investment objective of the Fund will be realized.
------------------------
Pursuant to the Merrill Lynch Select Pricing(SM) System, the Fund offers
four classes of shares, each with a different combination of sales charges,
ongoing fees and other features. The Merrill Lynch Select Pricing(SM) System
permits an investor to choose the method of purchasing shares that the investor
believes is most beneficial given the amount of the purchase, the length of
time the investor expects to hold the shares and other relevant circumstances.
------------------------
This Statement of Additional Information of the Fund is not a prospectus
and should be read in conjunction with the prospectus of the Fund, dated
December 29, 1995 (the "Prospectus"), which has been filed with the Securities
and Exchange Commission (the "Commission") and can be obtained, without charge,
by calling or by writing the Fund at the above telephone number or address. This
Statement of Additional Information has been incorporated by reference into the
Prospectus. Capitalized terms used but not defined herein have the same meanings
as in the Prospectus.
------------------------
FUND ASSET MANAGEMENT--MANAGER
MERRILL LYNCH FUNDS DISTRIBUTOR, INC.--DISTRIBUTOR
------------------------
The date of this Statement of Additional Information is December 29, 1995.
<PAGE> 54
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Fund is to provide shareholders with as
high a level of income exempt from Federal and California income taxes as is
consistent with prudent investment management. The Fund seeks to achieve its
objective while providing investors with the opportunity to invest in a
portfolio of securities consisting primarily of long-term obligations issued by
or on behalf of the State of California, its political subdivisions, agencies
and instrumentalities and obligations of other qualifying issuers, such as
issuers located in Puerto Rico, the Virgin Islands and Guam, which pay interest
exempt, in the opinion of bond counsel to the issuer, from Federal and
California income taxes. Obligations exempt from Federal income taxes are
referred to herein as "Municipal Bonds" and obligations exempt from both Federal
and California income taxes are referred to as "California Municipal Bonds".
Unless otherwise indicated, references to Municipal Bonds shall be deemed to
include California Municipal Bonds. Under normal circumstances, at least 65% of
the Fund's total assets will be invested in California Municipal Bonds. At
times, the Fund will seek to hedge its portfolio through the use of futures
transactions to reduce volatility in the net asset value of Fund shares.
Reference is made to "Investment Objective and Policies" in the Prospectus for a
discussion of the investment objective and policies of the Fund.
Municipal Bonds may include general obligation bonds of the State and its
political subdivisions, revenue bonds of utility systems, highways, bridges,
port and airport facilities, colleges, hospitals, housing facilities, etc., and
industrial development bonds or private activity bonds. The interest on such
obligations may bear a fixed rate or be payable at a variable or floating rate.
At least 80% of the Municipal Bonds purchased by the Fund will be what are
commonly referred to as "investment grade" securities, which are obligations
rated at the time of purchase within the four highest quality ratings as
determined by either Moody's Investors Service, Inc. ("Moody's") (currently Aaa,
Aa, A and Baa), Standard & Poor's Ratings Group ("Standard & Poor's") (currently
AAA, AA, A and BBB) or Fitch Investors Service, Inc. ("Fitch") (currently AAA,
AA, A and BBB). If unrated, such securities will possess creditworthiness
comparable, in the opinion of the manager of the Fund, Fund Asset Management,
L.P. (the "Manager"), to other obligations in which the Fund may invest.
The Fund ordinarily does not intend to realize investment income from
securities other than California Municipal Bonds. However, to the extent that
suitable California Municipal Bonds are not available for investment by the
Fund, the Fund may purchase Municipal Bonds issued by other states, their
agencies and instrumentalities, the interest income on which is exempt, in the
opinion of bond counsel, from Federal taxation. The Fund also may invest in
securities not issued by or on behalf of a state or territory or by an agency or
instrumentality thereof, if the Fund nevertheless believes such securities to be
exempt from Federal income taxation ("Non-Municipal Tax-Exempt Securities").
Non-Municipal Tax-Exempt Securities may include securities issued by other
investment companies that invest in municipal bonds, to the extent permitted by
applicable law. Non-Municipal Tax-Exempt Securities also could include trust
certificates or other derivative instruments evidencing interests in one or more
Municipal Bonds.
Except when acceptable securities are unavailable as determined by the
Manager, the Fund, under normal circumstances, will invest at least 65% of the
Fund's total assets in California Municipal Bonds. For temporary periods or to
provide liquidity, the Fund has the authority to invest as much as 35% of its
total assets in tax-exempt or taxable money market obligations with a maturity
of one year or less (such short-term obligations being referred to herein as
"Temporary Investments"), except that taxable Temporary Invest-
2
<PAGE> 55
ments shall not exceed 20% of the Fund's total assets. Accordingly, the Fund at
all times will have at least 80% of its total assets invested in securities
exempt from Federal income taxation. However, interest received on certain
otherwise tax-exempt securities which are classified as "private activity bonds"
(in general bonds that benefit non-governmental entities) may be subject to an
alternative minimum tax. The Fund may purchase such private activity bonds. See
"Distributions and Taxes". In addition, the Fund reserves the right to invest
temporarily a greater portion of its total assets in Temporary Investments for
defensive purposes, when, in the judgment of the Manager, market conditions
warrant. The investment objective of the Fund set forth in this paragraph are
fundamental policies of the Fund which may not be changed without a vote of a
majority of the outstanding voting securities, as defined in the 1940 Act, of
the Fund. The Fund's hedging strategies are not fundamental policies and may be
modified by the Trustees of the Trust without the approval of the Fund's
shareholders.
Municipal Bonds may at times be purchased or sold on a delayed delivery
basis or on a when-issued basis. These transactions arise when securities are
purchased or sold by the Fund with payment and delivery taking place in the
future, often a month or more after the purchase. The payment obligation and the
interest rate are each fixed at the time the buyer enters into the commitment.
The Fund will make only commitments to purchase such securities with the
intention of actually acquiring the securities, but the Fund may sell these
securities prior to the settlement date if it is deemed advisable. Purchasing
Municipal Bonds on a when-issued basis involves the risk that the yields
available in the market when the delivery takes place may actually be higher
than those obtained in the transaction itself; if yields so increase, the value
of the when-issued obligation generally will decrease. The Fund will maintain a
separate account at its custodian bank consisting of cash, cash equivalents or
high-grade, liquid Municipal Bonds or Temporary Investments (valued on a daily
basis) equal at all times to the amount of the when-issued commitment.
The Fund may invest in Municipal Bonds (and Non-Municipal Tax-Exempt
Securities) the return on which is based on a particular index of value or
interest rates. For example, the Fund may invest in Municipal Bonds that pay
interest based on an index of Municipal Bond interest rates or based on the
value of gold or some other commodity. The principal amount payable upon
maturity of certain Municipal Bonds also may be based on the value of an index.
Also, the Fund may invest in so-called "inverse floating obligations" or
residual interest bonds" on which the interest rates typically decline as market
rates increase and increase as market rates decline. To the extent the Fund
invests in these types of Municipal Bonds, the Fund's return on such Municipal
Bonds will be subject to risk with respect to the value of the particular index,
which may include reduced or eliminated interest payments and losses of invested
principal. Such securities have the effect of providing a degree of investment
leverage, since they may increase or decrease in value in response to changes,
as an illustration, in market interest rates at a rate which is a multiple
(typically two) of the rate at which fixed-rate long-term tax exempt securities
increase or decrease in response to such changes. As a result, the market values
of such securities will generally be more volatile than the market values of
fixed-rate tax exempt securities. To seek to limit the volatility of these
securities, the Fund may purchase inverse floating obligations with shorter term
maturities or which contain limitations on the extent to which the interest rate
may vary. Certain investments in such obligations may be illiquid. The Fund may
not invest in such illiquid obligations if such investments, together with other
illiquid investments, would exceed 15% (10% to the extent required by certain
state laws) of the Fund's total assets. The Manager, however, believes that
indexed and inverse floating obligations represent flexible portfolio management
instruments for the Fund which allow the Fund to seek potential investment
rewards, to hedge other portfolio positions or to vary the degree of investment
leverage relatively efficiently under different market conditions.
3
<PAGE> 56
The Fund may purchase a Municipal Bond issuer's right to call all or a
portion of such Municipal Bond for mandatory tender for purchase (a "Call
Right"). A holder of a Call Right may exercise such right to require a mandatory
tender for the purchase of related Municipal Bonds, subject to certain
conditions. A Call Right that is not exercised prior to maturity of the related
Municipal Bond will expire without value. The economic effect of holding both
the Call Right and the related Municipal Bond is identical to holding a
Municipal Bond as a non-callable security. Certain investments in such
obligations may be illiquid. The Fund may not invest in such illiquid
obligations if such investments, together with other illiquid investments, would
exceed 15% (10% to the extent required by certain state laws) of the Fund's
total assets.
The Fund may invest up to 20% of its total assets in Municipal Bonds which
are rated below Baa by Moody's or below BBB by Standard & Poor's or Fitch or
which, in the Manager's judgment, possess similar credit characteristics ("high
yield securities"). See Appendix II--"Ratings of Municipal Bonds" for additional
information regarding ratings of debt securities. The Manager considers the
ratings assigned by Standard & Poor's, Moody's or Fitch as one of several
factors in its independent credit analysis of issuers.
High yield securities are considered by Standard & Poor's, Moody's and
Fitch to have varying degrees of speculative characteristics. Consequently,
although high yield securities can be expected to provide higher yields, such
securities may be subject to greater market price fluctuations and risk of loss
of principal than lower yielding, higher rated debt securities. Investments in
high yield securities will be made only when, in the judgment of the Manager,
such securities provide attractive total return potential relative to the risk
of such securities, as compared to higher quality debt securities. The Fund
generally will not invest in debt securities in the lowest rating categories
(those rated CC or lower by Standard & Poor's or Fitch or Ca or lower by
Moody's) unless the Manager believes that the financial condition of the issuer
or the protection afforded the particular securities is stronger than would
otherwise be indicated by such low ratings. The Fund does not intend to purchase
debt securities that are in default or which the Manager believes will be in
default.
Issuers of high yield securities may be highly leveraged and may not have
available to them more traditional methods of financing. Therefore, the risks
associated with acquiring the securities of such issuers generally are greater
than is the case with higher rated securities. For example, during an economic
downturn or a sustained period of rising interest rates, issuers of high yield
securities may be more likely to experience financial stress, especially if such
issuers or obligors are highly leveraged. During such periods, such issuers may
not have sufficient revenues to meet their interest payment obligations. The
issuer's ability to service its debt obligations also may be adversely affected
by specific issuer developments, or the issuer's inability to meet specific
projected business forecasts, or the unavailability of additional financing. The
risk of loss due to default by the issuer is significantly greater for the
holders of high yield securities because such securities may be unsecured and
may be subordinated to other creditors of the issuer.
High yield securities frequently have call or redemption features that
would permit an issuer to repurchase the security from the Fund. If a call were
exercised by the issuer during a period of declining interest rates, the Fund
likely would have to replace such called security with a lower yielding
security, thus decreasing the net investment income to the Fund and dividends to
shareholders.
The Fund may have difficulty disposing of certain high yield securities
because there may be a thin trading market for such securities. Because not all
dealers maintain markets in all high yield securities, there is no established
secondary market for many of these securities, and the Fund anticipates that
such securities could be sold only to a limited number of dealers or
institutional investors. To the extent that a secondary
4
<PAGE> 57
trading market for high yield securities does exist, it generally is not as
liquid as the secondary market for higher rated securities. Reduced secondary
market liquidity may have an adverse impact on market price and the Fund's
ability to dispose of particular issues when necessary to meet the Fund's
liquidity needs or in response to a specific economic event such as a
deterioration in the creditworthiness of the issuer. Reduced secondary market
liquidity for certain securities also may make it more difficult for the Fund to
obtain accurate market quotations for purposes of valuing the Fund's portfolio.
Market quotations are generally available on many high yield securities only
from a limited number of dealers and may not necessarily represent firm bids of
such dealers or prices for actual sales.
It is expected that a significant portion of the high yield securities
acquired by the Fund will be purchased upon issuance, which may involve special
risks because the securities so acquired are new issues. In such instances the
Fund may be a substantial purchaser of the issue and therefore have the
opportunity to participate in structuring the terms of the offering. Although
this may enable the Fund to seek to protect itself against certain of such
risks, the considerations discussed herein would nevertheless remain applicable.
Adverse publicity and investor perceptions, which may not be based on
fundamental analysis, also may decrease the value and liquidity of high yield
securities, particularly in a thinly traded market. Factors adversely affecting
the market value of high yield securities are likely to adversely affect the
Fund's net asset value. In addition, the Fund may incur additional expenses to
the extent that it is required to seek recovery upon a default on a portfolio
holding or participate in the restructuring of the obligation.
The portfolio turnover rates for the years ended August 31, 1994 and 1995
were 75.66% and 53.40%, respectively. High portfolio turnover involves
correspondingly greater transaction costs in the form of dealer spreads and
brokerage commissions, which are borne directly by the Fund.
DESCRIPTION OF MUNICIPAL BONDS AND TEMPORARY INVESTMENTS
Set forth below is a description of the Municipal Bonds and Temporary
Investments in which the Fund may invest. A more complete discussion concerning
futures and options transactions is set forth under "Investment Objective and
Policies" in the Prospectus. Information with respect to ratings assigned to
tax-exempt obligations which the Fund may purchase is set forth in Appendix II
to this Statement of Additional Information.
DESCRIPTION OF MUNICIPAL BONDS
Municipal Bonds include debt obligations issued to obtain funds for various
public purposes, including construction of a wide range of public facilities,
refunding of outstanding obligations and obtaining funds for general operating
expenses and loans to other public institutions and facilities. In addition,
certain types of industrial development bonds ("IDBs") or private activity bonds
are issued by or on behalf of public authorities to finance or refinance various
privately owned or operated facilities, including certain facilities for the
local furnishing of electric energy or gas, sewage facilities, solid waste
disposal facilities and other specialized facilities. Such obligations are
included within the term California Municipal Bonds if the interest paid thereon
is, in the opinion of bond counsel, excluded from gross income for Federal
income tax purposes and such obligations are issued by the State of California,
its political subdivisions, agencies and instrumentalities or are obligations of
other qualifying issuers. Other types of IDBs or private activity bonds, the
proceeds of which are used for the construction, equipment or improvement of
privately operated industrial or
5
<PAGE> 58
commercial facilities, may constitute Municipal Bonds, although the current
Federal tax laws place substantial limitations on the size of such issues.
In the case of certain community facilities district special tax (or
"Mello-Roos"), tax increment (or tax allocation) and assessment bonds, the
payment of the special tax, tax increment and assessments may be secured solely
by remedies against the land (such as by foreclosure) and not against the
individual property owner, which could be time-consuming and costly.
The two principal classifications of Municipal Bonds are "general
obligation" bonds and "revenue" bonds. General obligation bonds are secured by
the issuer's pledge of faith, credit and taxing power for the repayment of
principal and the payment of interest. Revenue bonds are payable only from the
revenues derived from a particular facility or class of facilities or, in some
cases, from the proceeds of a special or limited tax or other specific revenue
source such as payments from the user of the facility being financed. IDBs and,
in the case of bonds issued after August 15, 1986, private activity bonds, are
in most cases revenue bonds and generally do not constitute the pledge of the
credit or taxing power of the issuer of such bonds. Generally, the repayment of
the principal of and the payment of the interest on such IDBs and private
activity bonds depends solely on the ability of the user of the facility
financed by the bonds to meet its financial obligations and the pledge, if any,
of real and personal property so financed as security for such payment unless a
line of credit, bond insurance or other security is furnished. The Fund also may
invest in "moral obligation" bonds. If an issuer of moral obligation bonds is
unable to meet its obligations, the repayment of such bonds becomes a moral
commitment, but not a legal obligation, of the state or municipality in
question.
Also included within the general category of Municipal Bonds are
participation certificates issued by government authorities or entities to
finance the acquisition or construction of equipment, land and/or facilities.
The certificates represent participations in a lease, an installment purchase
contract or a conditional sales contract (hereinafter collectively called "lease
obligations") relating to such equipment, land or facilities. Although lease
obligations do not constitute general obligations of the issuer for which the
issuer's unlimited taxing power is pledged, a lease obligation is frequently
backed by the issuer's covenant to budget for, appropriate and make the payments
due under the lease obligation. However, certain lease obligations contain
"non-appropriation" clauses, which provide that the issuer has no obligation to
make lease or installment purchase payments in future years unless money is
appropriated for such purpose on a yearly basis. Although "non-appropriation"
lease obligations are secured by the leased property, disposition of the
property in the event of foreclosure might prove difficult. These securities
represent a relatively new type of financing that has not yet developed the
depth of marketability associated with more conventional securities. Certain
investments in lease obligations may be illiquid. The Fund may not invest in
illiquid lease obligations if such investments together with all other illiquid
investments, would exceed 15% (10% to the extent required by certain state laws)
of the Fund's total assets. The Fund may, however, invest without regard to such
limitation in lease obligations which the Manager, pursuant to the guidelines
which have been adopted by the Trustees and subject to the supervision of the
Board of Trustees, determines to be liquid. The Manager will deem lease
obligations liquid if they are publicly offered and have received an investment
grade rating of Baa or better by Moody's, or BBB or better by Standard & Poor's
or Fitch. Unrated lease obligations, or those rated below investment grade, will
be considered liquid if the obligations come to the market through an
underwritten public offering and at least two dealers are willing to give
competitive bids. In reference to the latter, the Manager must, among other
things, also review the creditworthiness of the municipality obligated to make
payment under the lease obligation and make certain specified determinations
based on such factors as the
6
<PAGE> 59
existence of a rating or credit enhancement (such as insurance), the frequency
of trades or quotes for the obligation and the willingness of dealers to make a
market in the obligation.
Yields on Municipal Bonds are dependent on a variety of factors, including
the general condition of the money market and of the municipal bond market, the
size of a particular offering, the financial condition of the issuer, the
maturity of the obligation, and the rating of the issue. The ability of the Fund
to achieve its investment objective is also dependent on the continuing ability
of the issuers of the securities in which the Fund invests to meet their
obligations for the payment of interest and principal when due. There are
variations in the risks involved in holding Municipal Bonds, both within a
particular classification and between classifications, depending on numerous
factors. Furthermore, the rights of owners of Municipal Bonds and the
obligations of the issuer of such Municipal Bonds may be subject to applicable
bankruptcy, insolvency and similar laws and court decisions affecting the rights
of creditors generally and to general equitable principles, which may limit the
enforcement of certain remedies.
DESCRIPTION OF TEMPORARY INVESTMENTS
The Fund may invest in short-term tax-free and taxable securities subject
to the limitations set forth under "Investment Objective and Policies". The
tax-exempt money market securities may include municipal notes, municipal
commercial paper, municipal bonds with a remaining maturity of less than one
year, variable rate demand notes and participations therein. Municipal notes
include tax anticipation notes, bond anticipation notes and grant anticipation
notes. Anticipation notes are sold as interim financing in anticipation of tax
collection, bond sales, government grants or revenue receipts. Municipal
commercial paper refers to short-term unsecured promissory notes generally
issued to finance short-term credit needs. The taxable money market securities
in which the Fund may invest as Temporary Investments consist of U.S. Government
securities, U.S. Government agency securities, domestic bank or savings
institution certificates of deposit and bankers' acceptances, short-term
corporate debt securities such as commercial paper, and repurchase agreements.
These Temporary Investments must have a stated maturity not in excess of one
year from the date of purchase.
Variable rate demand obligations ("VRDOs") are tax-exempt obligations which
contain a floating or variable interest rate adjustment formula and an
unconditional right of demand on the part of the holder thereof to receive
payment of the unpaid principal balance plus accrued interest upon a short
notice period not to exceed seven days. There is, however, the possibility that
because of default or insolvency the demand feature of VRDOs and Participating
VRDOs, described below, may not be honored. The interest rates are adjustable at
intervals (ranging from daily to up to one year) to some prevailing market rate
for similar investments, such adjustment formula being calculated to maintain
the market value of the VRDO at approximately the par value of the VRDOs on the
adjustment date. The adjustments typically are based upon the prime rate of a
bank or some other appropriate interest rate adjustment index. The Fund may
invest in all types of tax-exempt instruments currently outstanding or to be
issued in the future which satisfy the short-term maturity and quality standards
of the Fund.
The Fund also may invest in VRDOs in the form of participation interests
("Participating VRDOs") in variable rate tax-exempt obligations held by a
financial institution, typically a commercial bank. Participating VRDOs provide
the Fund with a specified undivided interest (up to 100%) of the underlying
obligation and the right to demand payment of the unpaid principal balance plus
accrued interest on the Participating VRDOs from the financial institution upon
a specified number of days' notice, not to exceed seven days. In
7
<PAGE> 60
addition, a Participating VRDO is backed by an irrevocable letter of credit or
guaranty of the financial institution. The Fund would have an undivided interest
in the underlying obligation and thus participate on the same basis as the
financial institution in such obligation except that the financial institution
typically retains fees out of the interest paid on the obligation for servicing
the obligation, providing the letter of credit and issuing the repurchase
commitment. The Fund has been advised by its counsel that the Fund should be
entitled to treat the income received on Participating VRDOs as interest from
tax-exempt obligations.
VRDOs that contain an unconditional right of demand to receive payment of
the unpaid principal balance plus accrued interest on a notice period exceeding
seven days may be deemed to be illiquid securities. A VRDO with a demand notice
period exceeding seven days will therefore be subject to the Fund's restriction
on illiquid investments unless, in the judgment of the Trustees, such VRDO is
liquid. The Trustees may adopt guidelines and delegate to the Manager the daily
function of determining and monitoring liquidity of such VRDOs. The Trustees,
however, will retain sufficient oversight and will be ultimately responsible for
such determination.
The Trust has established the following standards with respect to money
market securities and VRDOs in which the Fund invests. Commercial paper
investments at the time of purchase must be rated A-1+ through A-3 by Standard &
Poor's, Prime-1 through Prime-3 by Moody's or F-1+ through F-3 by Fitch or, if
not rated, issued by companies having an outstanding debt issue rated at least
"A" by Standard & Poor's, Fitch or Moody's. Investments in corporate bonds and
debentures (which must have maturities at the date of purchase of one year or
less) must be rated at the time of purchase at least A by Standard & Poor's,
Moody's or Fitch. Notes and VRDOs at the time of purchase must be rated
SP-1+/A-1+ through SP-2/A-3 by Standard & Poor's, MIG-1/VMIG-1 through
MIG-4/VMIG-4 by Moody's or F-1+ through F-3 by Fitch. Temporary Investments, if
not rated, must be of comparable quality to securities rated in the above rating
categories in the opinion of the Manager. The Fund may not invest in any
security issued by a commercial bank or a savings institution unless the bank or
institution is organized and operating in the United States, has total assets of
at least one billion dollars and is a member of the Federal Deposit Insurance
Corporation (the "FDIC"), except that up to 10% of the Fund's total assets may
be invested in certificates of deposit of small institutions if such
certificates are fully insured by the FDIC.
REPURCHASE AGREEMENTS
The Fund may invest in securities pursuant to repurchase agreements.
Repurchase agreements may be entered into only with a member bank of the Federal
Reserve System or a primary dealer in U.S. Government securities, or an
affiliate thereof. Under such agreements, the seller agrees, upon entering into
the contract, to repurchase the security at a mutually agreed upon time and
price, thereby determining the yield during the term of the agreement. This
results in a fixed rate of return insulated from market fluctuations during such
period. In repurchase agreements, the prices at which the trades are conducted
do not reflect accrued interest on the underlying obligations. Such agreements
usually cover short periods, such as under one week. Repurchase agreements may
be construed to be collateralized loans by the purchaser to the seller secured
by the securities transferred to the purchaser. In a repurchase agreement, the
Fund will require the seller to provide additional collateral if the market
value of the securities falls below the repurchase price at any time during the
term of the repurchase agreement. In the event of default by the seller under a
repurchase agreement construed to be a collateralized loan, the underlying
securities are not owned by the Fund but only constitute collateral for the
seller's obligation to pay the repurchase price. Therefore, the Fund may suffer
time
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delays and incur costs or possible losses in connection with the disposition of
the collateral. In the event of a default under such a repurchase agreement,
instead of the contractual fixed rate of return, the rate of return to the Fund
will depend on intervening fluctuations of the market value of such security and
the accrued interest on the security. In such event, the Fund would have rights
against the seller for breach of contract with respect to any losses arising
from market fluctuations following the failure of the seller to perform. The
Fund may not invest in repurchase agreements maturing in more than seven days if
such investments, together with all other illiquid investments, would exceed 15%
(10% to the extent required by certain state laws) of the Fund's total assets.
In general, for Federal income tax purposes, repurchase agreements are
treated as collateralized loans secured by the securities "sold". Therefore,
amounts earned under such agreements will not be considered tax-exempt interest.
However, it is likely that income from such arrangements also will not be
considered tax-exempt interest.
FINANCIAL FUTURES TRANSACTIONS AND OPTIONS
Reference is made to the discussion concerning futures transactions under
"Investment Objective and Policies" in the Prospectus. Set forth below is
additional information concerning these transactions.
As described in the Prospectus, the Fund may purchase and sell
exchange-traded financial futures contracts ("financial futures contracts") to
hedge its portfolio of Municipal Bonds against declines in the value of such
securities and to hedge against increases in the cost of securities the Fund
intends to purchase. However, any transactions involving financial futures or
options (or puts and calls associated therewith) will be in accordance with the
Fund's investment policies and limitations. See "Investment Objective and
Policies--Investment Restrictions" in the Prospectus. To hedge its portfolio,
the Fund may take an investment position in a financial futures contract which
will move in the opposite direction from the portfolio position being hedged.
While the Fund's use of hedging strategies is intended to moderate capital
changes in portfolio holdings and thereby reduce the volatility of the net asset
value of Fund shares, the Fund anticipates that its net asset value will
fluctuate. Set forth below is information concerning futures transactions.
Description of Financial Futures Contracts. A financial futures contract
is an agreement between two parties to buy and sell a security, or in the case
of an index-based financial futures contract, to make and accept a cash
settlement for a set price on a future date. A majority of transactions in
financial futures contracts, however, do not result in the actual delivery of
the underlying instrument or cash settlement, but are settled through
liquidation, i.e., by entering into an offsetting transaction. Financial futures
contracts have been designed by boards of trade which have been designated
"contracts markets" by the Commodity Futures Trading Commission (the "CFTC").
The purchase or sale of a financial futures contract differs from the
purchase or sale of a security in that no price or premium is paid or received.
Instead, an amount of cash or securities acceptable to the broker and the
relevant contract market, which varies, but is generally about 5% of the
contract amount must be deposited with the broker. This amount is known as
"initial margin" and represents a "good faith" deposit assuring the performance
of both the purchaser and seller under the financial futures contract.
Subsequent payments to and from the broker, called "variation margin", are
required to be made on a daily basis as the price of the financial futures
contract fluctuates making the long and short positions in the financial futures
contract more or less valuable, a process known as "mark to the market". At any
time prior to the settlement date of the
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financial futures contract, the position may be closed out by taking an opposite
position which will operate to terminate the position in the financial futures
contract. A final determination of variation margin is then made, additional
cash is required to be paid to or released by the broker and the purchase
realizes a loss or gain. In addition, a nominal commission is paid on each
completed sale transaction.
The Fund deals in financial futures contracts based on a long-term
municipal bond index developed by the Chicago Board of Trade (the "CBT") and The
Bond Buyer (the "Municipal Bond Index"). The Municipal Bond Index is comprised
of 40 tax-exempt municipal revenue bonds and general obligation bonds. Each bond
included in the Municipal Bond Index must be rated A or higher by Moody's or
Standard & Poor's and must have a remaining maturity of 19 years or more. Twice
a month new issues satisfying the eligibility requirements are added to, and an
equal number of old issues are deleted from, the Municipal Bond Index. The value
of the Municipal Bond Index is computed daily according to a formula based on
the price of each bond in the Municipal Bond Index, as evaluated by six
dealer-to-dealer brokers.
The Municipal Bond Index financial futures contract is traded only on the
CBT. Like other contract markets, the CBT assures performance under financial
futures contracts through a clearing corporation, a non-profit organization
managed by the exchange membership which is also responsible for handling daily
accounting of deposits or withdrawals of margin.
As described in the Prospectus, the Fund may purchase and sell financial
futures contracts on U.S. Government securities as a hedge against adverse
changes in interest rates as described below. With respect to U.S. Government
securities, currently there are financial futures contracts based on long-term
U.S. Treasury bonds, U.S. Treasury notes, Government National Mortgage
Association ("GNMA") Certificates and three-month U.S. Treasury bills. The Fund
may purchase and write call and put options on financial futures contracts on
U.S. Government securities in connection with its hedging strategies.
Subject to policies adopted by the Trustees, the Fund also may engage in
other financial futures contracts transactions such as financial futures
contracts on other municipal bond indices which may become available if the
Manager and the Trustees should determine that there is normally a sufficient
correlation between the prices of such futures contracts and the Municipal Bonds
in which the Fund invests to make such hedging appropriate.
Futures Strategies. The Fund may sell a financial futures contract (i.e.,
assume a short position) in anticipation of a decline in the value of its
investments in Municipal Bonds resulting from an increase in interest rates or
otherwise. The risk of decline could be reduced without employing futures as a
hedge by selling such Municipal Bonds and either reinvesting the proceeds in
securities with shorter maturities or by holding assets in cash. This strategy,
however, entails increased transaction costs in the form of dealer spreads and
typically would reduce the average yield of the Fund's portfolio securities as a
result of the shortening of maturities. The sale of financial futures contracts
provides an alternative means of hedging against declines in the value of its
investments in Municipal Bonds. As such values decline, the value of the Fund's
positions in the financial futures contracts will tend to increase, thus
offsetting all or a portion of the depreciation in the market value of the
Fund's Municipal Bond investments which are being hedged. While the Fund will
incur commission expenses in selling and closing out financial futures
positions, commissions on financial futures transactions are lower than
transaction costs incurred in the purchase and sale of Municipal Bonds. In
addition, the ability of the Fund to trade in the standardized contracts
available in the financial futures markets may offer a more effective defensive
position than a program to reduce the average maturity of the
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portfolio securities due to the unique and varied credit and technical
characteristics of the municipal debt instruments available to the Fund.
Employing futures as a hedge also may permit the Fund to assume a defensive
posture without reducing the yield on its investments beyond any amounts
required to engage in futures trading.
When the Fund intends to purchase Municipal Bonds, the Fund may purchase
financial futures contracts as a hedge against any increase in the cost of such
Municipal Bonds resulting from a decrease in interest rates or otherwise, that
may occur before such purchases can be effected. Subject to the degree of
correlation between the Municipal Bonds and the financial futures contracts,
subsequent increases in the cost of Municipal Bonds should be reflected in the
value of the futures held by the Fund. As such purchases are made, an equivalent
amount of financial futures contracts will be closed out. Due to changing market
conditions and interest rate forecasts, however, a futures position may be
terminated without a corresponding purchase of portfolio securities.
Call Options on Financial Futures Contracts. The Fund also may purchase
and sell exchange-traded call and put options on financial futures contracts on
U.S. Government securities. The purchase of a call option on a financial futures
contract is analogous to the purchase of a call option on an individual
security. Depending on the pricing of the option compared to either the
financial futures contract on which it is based, or on the price of the
underlying debt securities, it may or may not be less risky than ownership of
the financial futures contract or underlying debt securities. Like the purchase
of a financial futures contract, the Fund will purchase a call option on a
financial futures contract to hedge against a market advance when the Fund is
not fully invested.
The writing of a call option on a financial futures contract constitutes a
partial hedge against declining prices of the securities which are deliverable
upon exercise of the financial futures contract. If the futures price at
expiration is below the exercise price, the Fund will retain the full amount of
the option premium which provides a partial hedge against any decline that may
have occurred in the Fund's portfolio holdings.
Put Options on Financial Futures Contracts. The purchase of a put option
on a financial futures contract is analogous to the purchase of a protective put
option on portfolio securities. The Fund will purchase put options on financial
futures contracts to hedge the Fund's portfolio against the risk of rising
interest rates.
The writing of a put option on a financial futures contract constitutes a
partial hedge against increasing prices of the securities which are deliverable
upon exercise of the financial futures contract. If the futures price at
expiration is higher than the exercise price, the Fund will retain the full
amount of the option premium which provides a partial hedge against any increase
in the price of Municipal Bonds which the Fund intends to purchase.
The writer of an option on a financial futures contract is required to
deposit initial and variation margin pursuant to requirements similar to those
applicable to financial futures contracts. Premiums received from the writing of
an option will be included in initial margin. The writing of an option on a
financial futures contract involves risks similar to those relating to financial
futures contracts.
------------------
The Trust has received an order from the Securities and Exchange Commission
(the "Commission") exempting it from the provisions of Section 17(f) and Section
18(f) of the Investment Company Act of 1940, as amended (the "1940 Act") in
connection with its strategy of investing in financial futures contracts.
Section 17(f) relates to the custody of securities and other assets of an
investment company and may be
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deemed to prohibit certain arrangements between the Trust and commodities
brokers with respect to initial and variation margin. Section 18(f) of the 1940
Act prohibits an open-end investment company such as the Trust from issuing a
"senior security" other than a borrowing from a bank. The staff of the
Commission has in the past indicated that a financial futures contract may be a
"senior security" under the 1940 Act.
Restrictions on Use of Futures Transactions. Regulations of the CFTC
applicable to the Fund require that all of the Fund's futures transactions
constitute bona fide hedging transactions and that the Fund purchase and sell
financial futures contracts and options thereon (i) for bona fide hedging
purposes, and (ii) for non-hedging purposes, if the aggregate initial margin and
premiums required to establish positions in such contracts and options does not
exceed 5% of the liquidation value of the Fund's portfolio assets after taking
into account unrealized profits and unrealized losses on any such contracts and
options. (However, the Fund intends to engage in options and futures
transactions only for hedging purposes.) Margin deposits may consist of cash or
securities acceptable to the broker and the relevant contract market.
When the Fund purchases financial futures contracts or a call option with
respect thereto or writes a put option on a financial futures contract, an
amount of cash, cash equivalents or short-term, high-grade, fixed income
securities will be deposited in a segregated account with the Fund's custodian
so that the amount so segregated, plus the amount of initial and variation
margin held in the account of its broker, equals the market value of the futures
contract, thereby ensuring that the use of such futures is unleveraged.
Risk Factors in Futures Transactions and Options. Investment in financial
futures contracts involves the risk of imperfect correlation between movements
in the price of the financial futures contract and the price of the security
being hedged. The hedge will not be fully effective when there is imperfect
correlation between the movements in the prices of two financial instruments.
For example, if the price of the financial futures contract moves more than the
price of the hedged security, the Fund will experience either a loss or gain on
the financial futures contract which is not completely offset by movements in
the price of the hedged securities. To compensate for imperfect correlations,
the Fund may purchase or sell financial futures contracts in a greater dollar
amount than the hedged securities if the volatility of the hedged securities is
historically greater than the volatility of the financial futures contracts.
Conversely, the Fund may purchase or sell fewer financial futures contracts if
the volatility of the price of the hedged securities is historically less than
that of the financial futures contracts.
The particular municipal bonds comprising the index underlying the
Municipal Bond Index financial futures contract may vary from the bonds held by
the Fund. As a result, the Fund's ability to hedge effectively all or a portion
of the value of its Municipal Bonds through the use of such financial futures
contracts will depend in part on the degree to which price movements in the
index underlying the financial futures contract correlate with the price
movements of Municipal Bonds held by the Fund. The correlation may be affected
by disparities in the average maturity, ratings, geographical mix or structure
of the Fund's investments as compared to those comprising the Municipal Bond
Index, and general economic or political factors. In addition, the correlation
between movements in the value of the Municipal Bond Index may be subject to
change over time as additions to and deletions from the Municipal Bond Index
alter its structure. The correlation between financial futures contracts on U.S.
Government securities and the Municipal Bonds held by the Fund may be adversely
affected by similar factors and the risk of imperfect correlation between
movements in the prices of such financial futures contracts and the prices of
the Municipal Bonds held by the Fund may be greater.
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The Fund expects to liquidate a majority of the financial futures contracts
it enters into through offsetting transactions on the applicable contract
market. There can be no assurance, however, that a liquid secondary market will
exist for any particular financial futures contract at any specific time. Thus,
it may not be possible to close out a futures position. In the event of adverse
price movements, the Fund would continue to be required to make daily cash
payments of variation margin. In such situations, if the Fund has insufficient
cash, it may be required to sell portfolio securities to meet daily variation
margin requirements at a time when it may be disadvantageous to do so. The
inability to close out futures positions also could have an adverse impact on
the Fund's ability to hedge effectively its investments in Municipal Bonds. The
Fund will enter into a financial futures position only if, in the judgment of
the Manager, there appears to be an actively traded secondary market for such
financial futures contracts.
The successful use of transactions in futures and related options also
depends on the ability of the Manager to forecast correctly the direction and
extent of interest rate movements within a given time frame. To the extent
interest rates remain stable during the period in which a financial futures
contract or option is held by the Fund or such rates move in a direction
opposite to that anticipated, the Fund may realize a loss on the hedging
transaction which is not fully or partially offset by an increase in the value
of portfolio securities. As a result, the Fund's total return for such period
may be less than if it had not engaged in the hedging transaction.
Because of low initial margin deposits made on the opening of a futures
position, futures transactions involve substantial leverage. As a result,
relatively small movements in the price of the financial futures contracts can
result in substantial unrealized gains or losses. Because the Fund will engage
in the purchase and sale of financial futures contracts solely for hedging
purposes, however, any losses incurred in connection therewith should, if the
hedging strategy is successful, be offset in whole or in part by increases in
the value of securities held by the Fund or decreases in the price of securities
the Fund intends to acquire.
The amount of risk the Fund assumes when it purchases an option on a
financial futures contract is the premium paid for the option plus related
transaction costs. In addition to the correlation risks discussed above, the
purchase of an option on a financial futures contract also entails the risk that
changes in the value of the underlying futures contract will not be fully
reflected in the value of the option purchased.
Municipal Bond Index financial futures contracts were approved for trading
in 1986. Trading in such financial futures contracts may tend to be less liquid
than that in other financial futures contracts. The trading of financial futures
contracts also is subject to certain market risks, such as inadequate trading
activity, which could at times make it difficult or impossible to liquidate
existing positions.
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INVESTMENT RESTRICTIONS
The Fund has adopted a number of fundamental and non-fundamental
restrictions and policies relating to the investment of its assets and its
activities. The fundamental policies set forth below may not be changed without
the approval of the holders of a majority of the Fund's outstanding voting
securities (which for this purpose and under the 1940 Act means the lesser of
(i) 67% of the Fund's shares present at a meeting at which more than 50% of the
outstanding shares of the Fund are represented or (ii) more than 50% of the
Fund's outstanding shares). The Fund may not:
1. Make any investment inconsistent with the Fund's classification as
a diversified company under the Investment Company Act.
2. Invest more than 25% of its assets, taken at market value at the
time of each investment, in the securities of issuers in any particular
industry (excluding the U.S. Government and its agencies and
instrumentalities). For purposes of this restriction, states,
municipalities and their political subdivisions are not considered part of
any industry.
3. Make investments for the purpose of exercising control or
management.
4. Purchase or sell real estate, except that, to the extent permitted
by applicable law, the Fund may invest in securities directly or indirectly
secured by real estate or interests therein or issued by companies which
invest in real estate or interests therein.
5. Make loans to other persons, except that the acquisition of bonds,
debentures or other corporate debt securities and investment in government
obligations, commercial paper, pass-through instruments, certificates of
deposit, bankers' acceptances, repurchase agreements or any similar
instruments shall not be deemed to be the making of a loan, and except
further that the Fund may lend its portfolio securities, provided that the
lending of portfolio securities may be made only in accordance with
applicable law and the guidelines set forth in the Fund's Prospectus and
Statement of Additional Information, as they may be amended from time to
time.
6. Issue senior securities to the extent such issuance would violate
applicable law.
7. Borrow money, except that (i) the Fund may borrow from banks (as
defined in the 1940 Act) in amounts up to 33 1/3% of its total assets
(including the amount borrowed), (ii) the Fund may borrow up to an
additional 5% of its total assets for temporary purposes, (iii) the Fund
may obtain short-term credit as may be necessary for the clearance of
purchases and sales of portfolio securities and (iv) the Fund may purchase
securities on margin to the extent permitted by applicable law. The Fund
may not pledge its assets other than to secure such borrowings or, to the
extent permitted by the Fund's investment policies as set forth in its
Prospectus and Statement of Additional Information, as they may be amended
from time to time, in connection with hedging transactions, short sales,
when-issued and forward commitment transactions and similar investment
strategies.
8. Underwrite securities of other issuers except insofar as the Fund
technically may be deemed an underwriter under the Securities Act of 1933,
as amended (the "Securities Act") in selling portfolio securities.
9. Purchase or sell commodities or contracts on commodities, except to
the extent that the Fund may do so in accordance with applicable law and
the Fund's Prospectus and Statement of Additional
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Information, as they may be amended from time to time, and without
registering as commodity pool operator under the Commodity Exchange Act.
Under the non-fundamental investment restrictions, the Fund may not:
a. Purchase securities of other investment companies, except to the
extent such purchases are permitted by applicable law.
b. Make short sales of securities or maintain a short position, except
to the extent permitted by applicable law. The Fund currently does not
intend to engage in short sales, except short sales "against the box".
c. Invest in securities that cannot be readily resold because of legal
or contractual restrictions or that cannot otherwise be marketed, redeemed
or put to the issuer or a third party, if at the time of acquisition more
than 15% of its total assets would be invested in such securities. This
restriction shall not apply to securities which mature within seven days or
securities which the Board of Trustees of the Trust has otherwise
determined to be liquid pursuant to applicable law. Notwithstanding the 15%
limitation herein, to the extent the laws of any state in which the Fund's
shares are registered or qualified for sale require a lower limitation, the
Fund will observe such limitation. As of the date hereof, therefore, the
Fund will not invest more than 10% of its total assets in securities which
are subject to this investment restriction (c).
d. Invest in warrants if, at the time of acquisition, its investments
in warrants, valued at the lower of cost or market value, would exceed 5%
of the Fund's net assets; included within such limitation, but not to
exceed 2% of the Fund's net assets, are warrants which are not listed on
the New York Stock Exchange or the American Stock Exchange or a major
foreign exchange. For purposes of this restriction, warrants acquired by
the Fund in units or attached to securities may be deemed to be without
value.
e. Invest in securities of companies having a record, together with
predecessors, of less than three years of continuous operation, if more
than 5% of the Fund's total assets would be invested in such securities.
This restriction shall not apply to mortgage-backed securities,
asset-backed securities or obligations issued or guaranteed by the U.S.
Government, its agencies or instrumentalities.
f. Purchase or retain the securities of any issuer, if those
individual officers and Trustees of the Trust, the officers and general
partner of the Manager, the directors of such general partner or the
officers and directors of any subsidiary thereof each owning beneficially
more than one-half of one percent of the securities of such issuer own in
the aggregate more than 5% of the securities of such issuer.
g. Invest in real estate limited partnership interests or interests in
oil, gas or other mineral leases, or exploration or development programs,
except that the Fund may invest in securities issued by companies that
engage in oil, gas or other mineral exploration or development activities.
h. Write, purchase or sell puts, calls, straddles, spreads or
combinations thereof, except to the extent permitted in the Fund's
Prospectus and Statement of Additional Information, as they may be amended
from time to time.
i. Notwithstanding fundamental investment restriction (7) above,
borrow amounts in excess of 20% of its total assets, taken at market value
(including the amount borrowed), and then only from banks as a temporary
measure for extraordinary or emergency purposes. In addition, the Fund will
not purchase securities while borrowings are outstanding.
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In addition, to comply with Federal income tax requirements for
qualification as a "regulated investment company", the Fund's investments will
be limited in a manner such that, at the close of each quarter of each fiscal
year, (a) no more than 25% of the Fund's total assets are invested in the
securities of a single issuer, and (b) with regard to at least 50% of the Fund's
total assets, no more than 5% of its total assets are invested in the securities
of a single issuer. For purposes of this restriction, the Fund will regard each
state and each political subdivision, agency or instrumentality of such state
and each multi-state agency of which such state is a member and each public
authority which issues securities on behalf of a private entity as a separate
issuer, except that if the security is backed only by the assets and revenues of
a non-governmental entity then the entity with the ultimate responsibility for
the payment of interest and principal may be regarded as the sole issuer. These
tax-related limitations may be changed by the Trustees of the Trust to the
extent necessary to comply with changes to the Federal income tax requirements.
Because of the affiliation of Merrill Lynch, Pierce, Fenner & Smith
Incorporated ("Merrill Lynch") with the Trust, the Trust is prohibited from
engaging in certain transactions involving such firm or its affiliates except
pursuant to a permissive order or otherwise in compliance with the provisions of
the 1940 Act and the rules and regulations thereunder. Included among such
restricted transactions are purchases from or sales to Merrill Lynch of
securities in transactions in which it acts as principal. See "Portfolio
Transactions". An exemptive order has been obtained which permits the Trust to
effect principal transactions with Merrill Lynch in high quality, short-term,
tax-exempt securities subject to conditions set forth in such order.
MANAGEMENT OF THE TRUST
TRUSTEES AND OFFICERS
Information about the Trustees, executive officers and the portfolio
manager of the Trust, including their ages and their principal occupations, for
at least the last five years, is set forth below. Unless otherwise noted, the
address of each Trustee and executive officer is P.O. Box 9011, Princeton, New
Jersey 08543-9011.
ARTHUR ZEIKEL (63) --President and Trustee (1)(2)--President of the Manager
(which term, as used herein, includes the Manager's corporate predecessors)
since 1977; President of Merrill Lynch Asset Management, L.P. ("MLAM," which
term, as used herein, includes MLAM's corporate predecessors) since 1977;
President and Director of Princeton Services, Inc. ("Princeton Services") since
1993; Executive Vice President of Merrill Lynch & Co., Inc. ("ML & Co.") since
1990; Director of Merrill Lynch Funds Distributor, Inc. (the "Distributor")
since 1991.
JAMES H. BODURTHA (51) --Trustee (2)--124 Long Pond Road, Plymouth,
Massachusetts 02360. Chairman and Chief Executive Officer, China Enterprise
Management Corporation since 1993; Chairman, Berkshire Corporation since 1980;
Partner, Squire, Sanders & Dempsey from 1980 to 1993.
HERBERT I. LONDON (56) --Trustee (2)--113-115 University Place, New York,
New York 10003. John M. Olin Professor of Humanities, New York University since
1993 and Professor thereof since 1973; Dean, Gallatin Division of New York
University from 1978 to 1993; Distinguished Fellow, Herman Kahn Chair, Hudson
Institute from 1984 to 1985; Director, Damon Corporation since 1991; Overseer,
Center for Naval Analyses from 1983 to 1993.
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ROBERT R. MARTIN (68) --Trustee (2)--513 Grand Hill, St. Paul, Minnesota
55102. Director, WTC Industries, Inc. since 1994 and Chairman thereof in 1994;
Chairman and Chief Executive Officer, Kinnard Investments, Inc. from 1990 to
1993; Executive Vice President, Dain Bosworth from 1974 to 1989; Director,
Carnegie Capital Management from 1977 to 1985 and Chairman thereof in 1979;
Director, Securities Industry Association from 1981 to 1982 and Public
Securities Association from 1979 to 1980; Trustee, Northland College since 1992.
JOSEPH L. MAY (66) --Trustee (2)--424 Church Street, Suite 2000, Nashville,
Tennessee 37219. Attorney in private practice since 1984; President, May and
Athens Hosiery Mills Division, Wayne-Gossard Corporation from 1954 to 1983; Vice
President, Wayne-Gossard Corporation from 1972 to 1983; Chairman, The May
Corporation (personal holding company) from 1972 to 1983; Director, Signal
Apparel Co. from 1972 to 1989.
ANDRE F. PEROLD (43) --Trustee (2)--Morgan Hall, Soldiers Field, Boston,
Massachusetts 02163. Professor, Harvard Business School since 1989 and Associate
Professor from 1983 to 1989; Trustee, The Common Fund, since 1989; Director,
Quantec Limited since 1991 and Teknekron Software Systems since 1994.
TERRY K. GLENN (55) --Executive Vice President (1)(2)--Executive Vice
President of the Manager and MLAM since 1983; Executive Vice President and
Director of Princeton Services since 1993; President of the Distributor since
1986 and Director thereof since 1991.
VINCENT R. GIORDANO (51) --Vice President (1)(2)--Portfolio Manager of the
Manager and MLAM since 1977 and Senior Vice President of the Manager and MLAM
since 1984; Vice President of MLAM from 1980 to 1984; Senior Vice President of
Princeton Services since 1993.
KENNETH A. JACOB (44) --Vice President (1)(2)--Vice President of the
Manager and MLAM since 1984.
WALTER O'CONNOR (34) --Portfolio Manager (1)(2) --Vice President of MLAM
since 1993; Assistant Vice President of MLAM from 1991 to 1993; Assistant Vice
President of Prudential Securities from 1984 to 1991.
DONALD C. BURKE (35) --Vice President (1)(2)--Vice President and Director
of Taxation of MLAM since 1990; Employee of Deloitte & Touche LLP from 1982 to
1990.
GERALD M. RICHARD (46) --Treasurer (1)(2)--Senior Vice President and
Treasurer of the Manager and MLAM since 1984; Senior Vice President and
Treasurer of Princeton Services since 1993; Treasurer of the Distributor since
1984 and Vice President thereof since 1981.
JERRY WEISS (37) --Secretary (1)(2)--Vice President of MLAM since 1990;
Attorney in private practice from 1982 to 1990.
- ------------------
(1) Interested person, as defined in the 1940 Act, of the Trust.
(2) Such Trustee or officer is a director or officer of certain other investment
companies for which the Manager or MLAM acts as investment adviser or
manager.
At November 30, 1995, the Trustees and officers of the Trust as a group (12
persons) owned an aggregate of less than 1/4 of 1% of the outstanding shares of
Common Stock of ML & Co. and owned an aggregate of less than 1% of the
outstanding shares of the Fund.
17
<PAGE> 70
COMPENSATION OF TRUSTEES
The Trust pays each Trustee not affiliated with the Manager a fee of $5,000
per year plus $500 per meeting attended. The Trust also compensates members of
its Audit and Nominating Committee, which consists of all of the non-affiliated
Trustees, a fee of $1,000 per year plus $250 per meeting attended. The Trust
reimburses each unaffiliated Trustee for his out-of-pocket expenses relating to
attendance at Board and committee meetings. The fees and expenses of the
Trustees are allocated to the respective series of the Trust on the basis of
asset size. For the fiscal year ended August 31, 1995, fees and expenses paid to
non-affiliated Trustees by the Fund aggregated $40,349.
The following table sets forth for the fiscal year ended August 31, 1995,
compensation paid by the Fund to the non-affiliated Trustees and, for the
calendar year ended December 31, 1995, the aggregate compensation paid by all
investment companies (including the Fund) advised by FAM and its affiliate, MLAM
("FAM/MLAM Advised Funds") to the non-affiliated Trustees:
<TABLE>
<CAPTION>
AGGREGATE
PENSION OR COMPENSATION
RETIREMENT FROM FUND AND
BENEFITS FAM/MLAM
ACCRUED AS ADVISED FUNDS
COMPENSATION PART OF FUND PAID TO
NAME OF TRUSTEE FROM FUND EXPENSE TRUSTEE(1)
--------------------------------------------- ------------ ------------ -------------
<S> <C> <C> <C>
James H. Bodurtha............................ $ 887 None $ 156,250
Herbert I. London............................ $8,062 None $ 157,500
Robert R. Martin............................. $8,062 None $ 157,500
Joseph L. May................................ $8,062 None $ 157,500
Andre F. Perold.............................. $8,062 None $ 157,500
</TABLE>
- ---------------
(1) In addition to the Fund, the Trustees serve on the boards of other FAM/MLAM
Advised Funds as follows: Mr. Bodurtha (46 funds); Mr. London (46 funds);
Mr. Martin (46 funds); Mr. May (46 funds); and Mr. Perold (46 funds). For
purposes of this table, each series of a series investment company,
including the Trust, is treated as a separate fund.
MANAGEMENT AND ADVISORY ARRANGEMENTS
Reference is made to "Management of the Trust--Management and Advisory
Arrangements" in the Prospectus for certain information concerning the
management and advisory agreements of the Trust.
Securities may be held by, or be appropriate investments for, the Fund as
well as other funds or investment advisory clients of the Manager or MLAM.
Because of different objectives or other factors, a particular security may be
bought for one or more clients when one or more clients are selling the same
security. If purchases or sales of securities for the Fund or other funds for
which they act as manager or for their advisory clients and such sales and
purchases arise for consideration at or about the same time, transactions in
such securities will be made, insofar as feasible, for the respective funds and
clients in a manner deemed equitable to all. To the extent that transactions on
behalf of more than one client of the Manager or MLAM during the same period may
increase the demand for securities being purchased or the supply of securities
being sold, there may be an adverse effect on price.
18
<PAGE> 71
The Trust has entered into a management agreement (the "Management
Agreement") with the Manager. As discussed in the Prospectus, the Manager
receives for its services to the Fund monthly compensation at the annual rate of
0.55% of the average daily net assets of the Fund. As discussed in the
Prospectus, effective December 23, 1987, the Manager has voluntarily agreed to
waive the amount of compensation set forth in the Management Agreement and
instead has agreed to receive from the Fund a monthly fee based upon the average
daily net assets of the Fund at the following annual rates: 0.55% of the portion
of the average daily net assets not exceeding $500 million; 0.525% of the
portion of the average daily net assets exceeding $500 million but not exceeding
$1.0 billion and 0.50% of the portion of the average daily net assets exceeding
$1.0 billion. For the fiscal years ended August 31, 1993, 1994 and 1995, the
total advisory fees paid by the Fund to the Manager aggregated $4,391,540,
$4,567,938 and $3,828,093, respectively.
The State of California imposes limitations on the expenses of the Fund. At
the date of this Statement of Additional Information, these annual expense
limitations require that the Manager reimburse the Fund in an amount necessary
to prevent the aggregate ordinary operating expenses (excluding taxes, brokerage
fees and commissions, distribution fees and extraordinary charges such as
litigation costs) from exceeding in any fiscal year 2.5% of the Fund's first
$30,000,000 of average daily net assets, 2.0% of the next $70,000,000 of average
daily net assets and 1.5% of the remaining average net assets. The Manager's
obligation to reimburse the Fund is limited to the amount of the management fee.
Expenses not covered by the limitation are interest, taxes, brokerage
commissions and other items such as extraordinary legal expenses. No fee
payments will be made to the Manager during any fiscal year which will cause
such expenses to exceed the expense limitation at the time of such payment. No
fee reimbursements were made during the years ended August 31, 1993, 1994 and
1995 pursuant to these operating expense limitations.
The Management Agreement obligates the Manager to provide investment
advisory services and to pay all compensation of and furnish office space for
officers and employees of the Trust connected with investment and economic
research, trading and investment management of the Trust, as well as the fees of
all Trustees of the Trust who are affiliated persons of ML & Co. or any of its
affiliates. The Fund pays all other expenses incurred in its operation and, if
other series should be added ("Series"), a portion of the Trust's general
administrative expenses will be allocated on the basis of the asset size of the
respective Series. Expenses that will be borne directly by the Series include
redemption expenses, expenses of portfolio transactions, expenses of registering
the shares under Federal and state securities laws, pricing costs (including the
daily calculation of net asset value), expenses of printing shareholder reports,
prospectuses and statements of additional information (except to the extent paid
by the Distributor as described below), fees for legal and auditing services,
Commission fees, interest, certain taxes, and other expenses attributable to a
particular Series. Expenses which will be allocated on the basis of asset size
of the respective Series include fees and expenses of unaffiliated Trustees,
state franchise taxes, costs of printing proxies and other expenses related to
shareholder meetings, and other expenses properly payable by the Trust. The
organizational expenses of the Trust were paid by the Trust, and if additional
Series are added to the Trust, the organizational expenses will be allocated
among the Series in a manner deemed equitable by the Trustees. Depending upon
the nature of a lawsuit, litigation costs may be assessed to the specific Series
to which the lawsuit relates or allocated on the basis of the asset size of the
respective Series. The Trustees have determined that this is an appropriate
method of allocation of expenses. Accounting services are provided to the Trust
by the Manager and the Trust reimburses the Manager for its costs in connection
with such services. For the year ended August 31, 1995, the Trust paid the
Manager $64,518 for such services. As required by the Fund's distribution
agreements, the Distributor will pay the promotional expenses of the Fund
incurred in connection with the offering of shares of
19
<PAGE> 72
the Fund. Certain expenses in connection with the account maintenance and
distribution of Class B and Class C shares will be financed by the Trust
pursuant to the Distribution Plans in compliance with Rule 12b-1 under the 1940
Act. See "Purchase of Shares--Deferred Sales Charge Alternatives--Class B and
Class C Shares--Distribution Plan".
The Manager is a limited partnership, the partners of which are ML & Co.
and Princeton Services. ML & Co. and Princeton Services are "controlling
persons" of the Manager as defined under the 1940 Act because of their ownership
of its voting securities or their power to exercise a controlling influence over
its management or policies.
Duration and Termination. Unless earlier terminated as described below,
the Management Agreement will remain in effect from year to year if approved
annually (a) by the Trustees of the Trust or by a majority of the outstanding
shares of the Fund and (b) by a majority of the Trustees who are not parties to
such contract or interested persons (as defined in the 1940 Act) of any such
party. Such contracts are not assignable and may be terminated without penalty
on 60 days' written notice at the option of either party thereto or by vote of
the shareholders of the Fund.
PURCHASE OF SHARES
Reference is made to "Purchase of Shares" in the Prospectus for certain
information as to the purchase of Fund shares.
ALTERNATIVE SALES ARRANGEMENTS
The Fund issues four classes of shares under the Merrill Lynch Select
Pricing System: shares of Class A and Class D are sold to investors choosing the
initial sales charge alternatives and shares of Class B and Class C are sold to
investors choosing the deferred sales charge alternatives. Each Class A, Class
B, Class C and Class D share of the Fund represents an identical interest in the
investment portfolio of the Fund and has the same rights, except that Class B,
Class C, and Class D shares bear the expenses of the ongoing account maintenance
fees, and Class B and Class C shares bear the expenses of the ongoing
distribution fees and the additional incremental transfer agency costs resulting
from the deferred sales charge arrangements. Class B, Class C and Class D shares
each have exclusive voting rights with respect to the Rule 12b-1 distribution
plan adopted with respect to such class pursuant to which account maintenance
and/or distribution fees are paid. Each class has different exchange privileges.
See "Shareholder Services--Exchange Privilege".
The Merrill Lynch Select Pricing(SM) System is used by more than 50 mutual
funds advised by the Manager or its affiliate, FAM. Funds advised by the Manager
or FAM are referred to herein as "MLAM-advised mutual funds".
The Fund has entered into separate distribution agreements with the
Distributor in connection with the continuous offering of each class of shares
of the Fund (the "Distribution Agreements"). The Distribution Agreements
obligate the Distributor to pay certain expenses in connection with the offering
of each class of shares of the Fund. After the prospectuses, statements of
additional information and periodic reports have been prepared, set in type and
mailed to shareholders, the Distributor pays for the printing and distribution
of copies thereof used in connection with the offering to dealers and investors.
The Distributor also pays for other
20
<PAGE> 73
supplementary sales literature and advertising costs. The Distribution
Agreements are subject to the same renewal requirements and termination
provisions as the Management Agreement described above.
INITIAL SALES CHARGE ALTERNATIVE--CLASS A AND CLASS D SHARES
The gross sales charges for the sale of Class A shares for the year ended
August 31, 1994 were $132,664, of which the Distributor received $13,053 and
Merrill Lynch received $119,611. The gross sales charges for the sale of Class A
shares for the year ended August 31, 1995 were $30,995, of which the Distributor
received $2,220 and Merrill Lynch received $28,775. The gross sales charges for
the sale of Class D shares for the period October 21, 1994 (commencement of
operations) to August 31, 1995, were $22,241, of which the Distributor received
$1,704 and Merrill Lynch received $20,537.
The term "purchase", as used in the Prospectus and in this Statement of
Additional Information in connection with an investment in Class A and Class D
shares of the Fund, refers to a single purchase by an individual, or to
concurrent purchases, which in the aggregate are at least equal to the
prescribed amounts, by an individual, his or her spouse and their children under
the age of 21 years purchasing shares for his or her or their own account and to
single purchases by a trustee or other fiduciary purchasing shares for a single
trust estate or single fiduciary account although more than one beneficiary is
involved. The term "purchase" also includes purchases by any "company" as that
term is defined in the 1940 Act, but does not include purchases by any such
company which has not been in existence for at least six months or which has no
purpose other than the purchase of shares of the Fund or shares of other
registered investment companies at a discount; provided, however, that it shall
not include purchases by any group of individuals whose sole organizational
nexus is that the participants therein are credit cardholders of a company,
policyholders of an insurance company, customers of either a bank or
broker-dealer or clients of an investment adviser.
REDUCED INITIAL SALES CHARGES
Right of Accumulation. Reduced sales charges are applicable through a
right of accumulation under which eligible investors are permitted to purchase
shares of the Fund subject to an initial sales charge at the offering price
applicable to the total of (a) the public offering price of the shares then
being purchased plus (b) an amount equal to the then current net asset value or
cost, whichever is higher, of the purchaser's combined holdings of all classes
of shares of the Fund and of other MLAM-advised mutual funds. For any such right
of accumulation to be made available, the Distributor must be provided at the
time of purchase, by the purchaser or the purchaser's securities dealer, with
sufficient information to permit confirmation of qualification. Acceptance of
the purchase order is subject to such confirmation. The right of accumulation
may be amended or terminated at any time. Shares held in the name of a nominee
or custodian under pension, profit-sharing or other employee benefit plans may
not be combined with other shares to qualify for the right of accumulation.
Letter of Intention. Reduced sales charges are applicable to purchases
aggregating $25,000 or more of the Class A or Class D shares of the Fund or any
other MLAM-advised mutual funds made within a thirteen-month period starting
with the first purchase pursuant to a Letter of Intention in the form provided
in the Prospectus. The Letter of Intention is available only to investors whose
accounts are maintained at the Fund's transfer agent. The Letter of Intention is
not available to employee benefit plans for which Merrill Lynch provides plan
participant record-keeping services. The Letter of Intention is not a binding
obligation to purchase any amount of Class A or Class D shares, however, its
execution will result in the purchaser paying a
21
<PAGE> 74
lower sales charge at the appropriate quantity purchase level. A purchase not
originally made pursuant to a Letter of Intention may be included under a
subsequent Letter of Intention executed within 90 days of such purchase if the
Distributor is informed in writing of this intent within such 90-day period. The
value of Class A and Class D shares of the Fund and of other MLAM-advised mutual
funds presently held, at cost or maximum offering price (whichever is higher),
on the date of the first purchase under the Letter of Intention, may be included
as a credit toward the completion of such Letter, but the reduced sales charge
applicable to the amount covered by such Letter will be applied only to new
purchases. If the total amount of shares does not equal the amount stated in the
Letter of Intention (minimum of $25,000), the investor will be notified and must
pay, within 20 days of the expiration of such Letter, the difference between the
sales charge on the Class A or Class D shares purchased at the reduced rate and
the sales charge applicable to the shares actually purchased through the Letter.
Class A or Class D shares equal to at least five percent of the intended amount
will be held in escrow during the thirteen-month period (while remaining
registered in the name of the purchaser) for this purpose. The first purchase
under the Letter of Intention must be at least five percent of the dollar amount
of such Letter. If during the term of such Letter, a purchase brings the total
amount invested to an amount equal to or in excess of the amount indicated in
the Letter, the purchaser will be entitled on that purchase and subsequent
purchases to the reduced percentage sales charge which would be applicable to a
single purchase equal to the total dollar value of the Class A or Class D shares
then being purchased under such Letter, but there will be no retroactive
reduction of the sales charge on any previous purchase. The value of any shares
redeemed or otherwise disposed of by the purchaser prior to termination or
completion of the Letter of Intention will be deducted from the total purchases
made under such Letter. An exchange from a MLAM-advised money market fund into
the Fund that creates a sales charge will count toward completing a new or
existing Letter of Intention from the Fund.
Employee Access Accounts(SM). Class A or Class D shares are offered at net
asset value to Employee Access Accounts available through employers that provide
employer sponsored retirement or savings plans that are eligible to purchase
such shares at net asset value. The initial minimum for such accounts is $500,
except that the initial minimum for shares purchased for such accounts pursuant
to the Automatic Investment Program is $50.
TMA(SM) Managed Trusts. Class A shares are offered to TMA(SM) Managed
Trusts to which Merrill Lynch Trust Company provides discretionary trustee
services at net asset value plus a reduced sales charge of 0.50% of the
offering price, which is 0.50% of the net amount invested.
Purchase Privilege of Certain Persons. Trustees of the Trust, directors
and trustees of other directors and employees of ML & Co. and its subsidiaries
(the term "subsidiaries," when used herein with respect to ML & Co., includes
MLAM, the Manager and certain other entities directly or indirectly wholly-owned
and controlled by ML & Co.), and any trust, pension, profit sharing or other
benefit plan for such persons, may purchase Class A shares of the Fund at net
asset value.
Class D shares of the Fund are offered at net asset value, without a sales
charge, to an investor who has a business relationship with a financial
consultant who joined Merrill Lynch from another investment firm within six
months prior to the date of purchase by such investor, if the following
conditions are satisfied: first, the investor must advise Merrill Lynch that it
will purchase Class D shares of the Fund with proceeds from a redemption of a
mutual fund that was sponsored by the financial consultant's previous firm and
was subject to a sales charge either at the time of purchase or on a deferred
basis; and second, the investor also must establish
22
<PAGE> 75
that such redemption had been made within 60 days prior to the investment in the
Fund, and the proceeds from the redemption had been maintained in the interim in
cash or a money market fund.
Class D shares of the Fund are also offered at net asset value, without
sales charge, to an investor who has a business relationship with a Merrill
Lynch financial consultant and who has invested in a mutual fund sponsored by a
non-Merrill Lynch company for which Merrill Lynch has served as a selected
dealer and where Merrill Lynch has either received or given notice that such
arrangement will be terminated ("notice"), if the following conditions are
satisfied: first, the investor must purchase Class D shares of the Fund with
proceeds from a redemption of shares of such other mutual fund and the shares of
such other fund were subject to a sales charge either at the time of purchase or
on a deferred basis; and second, such purchase of Class D shares must be made
within 90 days after such notice.
Class D shares of the Fund are offered at net asset value, without a sales
charge, to an investor who has a business relationship with a Merrill Lynch
financial consultant and who has invested in a mutual fund for which Merrill
Lynch has not served as a selected dealer if the following conditions are
satisfied: first, the investor must advise Merrill Lynch that it will purchase
Class D shares of the Fund with proceeds from the redemption of shares of such
other mutual fund and that such shares have been outstanding for a period of no
less than six months; and second, such purchase of Class D shares must be made
within 60 days after the redemption and the proceeds from the redemption must be
maintained in the interim in cash or a money market fund.
Closed-End Fund Investment Option. Class A shares of the Fund and other
MLAM-advised mutual funds (the "Eligible Class A Shares") are offered at net
asset value to shareholders of certain closed-end funds advised by the Manager
or MLAM who purchased such closed-end fund shares prior to October 21, 1994, the
date the Merrill Lynch Select Pricing(SM) System commenced operations, and wish
to reinvest the net proceeds of a sale of their closed-end fund shares of
common stock in Eligible Class A Shares, if the conditions set forth below are
satisfied. Alternatively, closed-end fund shareholders who purchased such
shares on or after October 21, 1994 and wish to reinvest the net proceeds from
a sale of their closed-end fund shares are offered Class A shares (if eligible
to buy Class A shares) or Class D shares of the Fund and other MLAM-advised
mutual funds ("Eligible Class D Shares"), if the following conditions are met.
First, the sale of closed-end fund shares must be made through Merrill Lynch,
and the net proceeds therefrom must be immediately reinvested in Eligible Class
A or Class D Shares. Second, the closed-end fund shares must have either been
acquired in the initial public offering or be shares representing dividends
from shares of common stock acquired in such offering. Third, the closed-end
fund shares must have been continuously maintained in a Merrill Lynch
securities account. Fourth, there must be a minimum purchase of $250 to be
eligible for the investment option. Class A shares of the Fund are offered at
net asset value to shareholders of Merrill Lynch Senior Floating Rate Fund,
Inc. ("Senior Floating Rate Fund") who wish to reinvest the net proceeds from a
sale of certain of their shares of common stock of Senior Floating Rate Fund in
shares of the Fund. In order to exercise this investment option, Senior
Floating Rate Fund shareholders must sell their Senior Floating Rate Fund
shares to the Senior Floating Rate Fund in connection with a tender offer
conducted by the Senior Floating Rate Fund and reinvest the proceeds
immediately in the Fund. This investment option is available only with respect
to the proceeds of Senior Floating Rate Fund shares as to which no Early
Withdrawal Charge (as defined in the Senior Floating Rate Fund prospectus) is
applicable. Purchase orders from Senior Floating Rate Fund shareholders wishing
to exercise this investment option will be accepted only on the day that the
related Senior Floating Rate Fund tender offer terminates and will be effected
at the net asset value of
23
<PAGE> 76
the Fund on such day. Similarly, Class D shares of the Fund are offered at net
asset value to shareholders of either Merrill Lynch Municipal Strategy Fund,
Inc. ("Municipal Strategy Fund") or Merrill Lynch High Income Municipal Bond
Fund, Inc. ("High Income Municipal Bond Fund") who wish to purchase shares of
the Fund with the net proceeds from a sale of certain of their shares of common
stock pursuant to a tender offer by Municipal Strategy Fund or by High Income
Municipal Bond Fund. This investment option is available only with respect to
the proceeds of Municipal Strategy Fund shares as to which no CDSC (as defined
in the Municipal Strategy Fund's prospectus) is applicable or to the proceeds of
High Income Municipal Bond Fund shares as to which no Early Withdrawal Charge
(as defined in the High Income Municipal Bond Fund's prospectus) is applicable.
Acquisition of Certain Investment Companies. The public offering price of
Class D shares may be reduced to the net asset value per Class D share in
connection with the acquisition of the assets of or merger or consolidation with
a public or private investment company. The value the assets or company acquired
in a tax-free transaction may be adjusted in appropriate cases to reduce
possible adverse tax consequences to the Fund which might result from an
acquisition of assets having net unrealized appreciation which is
disproportionately higher at the time of acquisition than the realized or
unrealized appreciation of the Fund. The issuance of Class D shares for
consideration other than cash is limited to bona fide reorganizations, statutory
mergers or other acquisitions of portfolio securities which (i) meet the
investment objectives and policies of the Fund; (ii) are required for investment
and not for resale (subject to the understanding that the disposition of the
Fund's portfolio securities shall at all times remain within its control); and
(iii) are liquid securities, the value of which is readily ascertainable, which
are not restricted as to transfer either by law or liquidity of market (except
that the Fund may acquire through such transactions restricted or illiquid
securities to the extent the Fund does not exceed the applicable limits on
acquisition of such securities set forth under "Investment Objective and
Policies" herein).
Reductions in or exemptions from the imposition of a sale load are due to
the nature of the investors and/ or the reduced sales efforts that will be
needed in obtaining such investments.
DISTRIBUTION PLANS
Reference is made to "Purchase of Shares--Distribution Plans" in the
Prospectus for certain information with respect to the separate distribution
plans for Class B, Class C and Class D shares pursuant to Rule 12b-1 under the
1940 Act (each a "Distribution Plan") with respect to the account maintenance
and/or distribution fees paid by the Fund to the Distributor with respect to
such classes.
Payments of the account maintenance fees and/or distribution fees are
subject to the provisions of Rule 12b-1 under the 1940 Act. Among other things,
each Distribution Plan provides that the Distributor shall provide and the
Trustees shall review quarterly reports of the disbursement of the account
maintenance fees and/or distribution fees paid to the Distributor. In their
consideration of each Distribution Plan, the Trustees must consider all factors
they deem relevant, including information as to the benefits of the Distribution
Plan to the Fund and its related class of shareholders. Each Distribution Plan
further provides that, so long as the Distribution Plan remains in effect, the
selection and nomination of Trustees who are not "interested persons" of the
Trust, as defined in the 1940 Act (the "Independent Trustee"), shall be
committed to the discretion of the Independent Trustees then in office. In
approving each Distribution Plan in accordance with Rule 12b-1, the Independent
Trustees concluded that there is reasonable likelihood that such Distribution
Plan will benefit the Fund and its related class of shareholders. Each
Distribution Plan can be terminated at any time, without
24
<PAGE> 77
penalty, by the vote of a majority of the Independent Trustees or by the vote of
the holders of a majority of the outstanding related class of voting securities
of the Fund. A Distribution Plan cannot be amended to increase materially the
amount to be spent by the Fund without the approval of the related class of
shareholders, and all material amendments are required to be approved by the
vote of Trustees, including a majority of the Independent Trustees who have no
direct or indirect financial interest in such Distribution Plan, cast in person
at a meeting called for that purpose. Rule 12b-1 further requires that the Trust
preserve copies of each Distribution Plan and any report made pursuant to such
plan for a period of not less than six years from the date of such Distribution
Plan or such report, the first two years in an easily accessible place.
LIMITATIONS ON THE PAYMENT OF DEFERRED SALES CHARGES
The maximum sales charge rule in the Rules of Fair Practice of the National
Association of Securities Dealers, Inc. (the "NASD") imposes a limitation of
certain asset-based sales charges such as the distribution fee and the
contingent deferred sales charge ("CDSC") borne by the Class B and Class A
shares but not the account maintenance fee. The maximum sales charge rule is
applied separately to each class. As applicable to the Fund, the maximum sales
charge rule limits the aggregate of distribution fee payments and CDSCs payable
by the Fund to (1) 6.25% of eligible gross sales of Class B shares and Class C
shares, computed separately (defined to exclude shares issued pursuant to
dividend reinvestments and exchanges), plus (2) interest on the unpaid balance
for the respective class, computed separately, at the prime rate plus 1% (the
unpaid balance being the maximum amount payable minus amounts received from the
payment of the distribution fee and the CDSC). In connection with the Class B
shares, the Distributor has voluntarily agreed to waive interest charges on the
unpaid balance in excess of 0.50% of eligible gross sales. Consequently, the
maximum amount payable to the Distributor (referred to as the "voluntary
maximum") in connection with the Class B shares is 6.75% of eligible gross
sales. The Distributor retains the right to stop waiving the interest charges at
any time. To the extent payments would exceed the voluntary maximum, the Fund
will not make further payments of the distribution fees with respect to Class B
shares, and any CDSCs will be paid to the Fund rather than to the Distributor;
however, the Fund will continue to make payments of the account maintenance fee.
In certain circumstances the amount payable pursuant to the voluntary maximum
may exceed the amount payable under the NASD formula. In such circumstances
payment in excess of the amount payable under the NASD formula will not be made.
The following table sets forth comparative information as of August 31,
1995 with respect to the Class B and Class C shares of the Fund, indicating the
maximum allowable payments that can be made under the
25
<PAGE> 78
NASD maximum sales charge rule and, with respect to the Class B shares, the
Distributor's voluntary maximum for the period September 30, 1985 (commencement
of operations) to August 31, 1995.
<TABLE>
<CAPTION>
DATA CALCULATED AS OF AUGUST 31, 1995
-----------------------------------------------------------------------------------------
(IN THOUSANDS)
ANNUAL
DISTRIBUTION
ALLOWABLE AMOUNTS FEE AT
ELIGIBLE AGGREGATE INTEREST MAXIMUM PREVIOUSLY AGGREGATE CURRENT
GROSS SALES ON UNPAID AMOUNT PAID TO UNPAID NET ASSET
SALES(1) CHARGES BALANCE(2) PAYABLE DISTRIBUTOR(3) BALANCE LEVEL(4)
-------------- --------- ---------- -------- -------------- --------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
CLASS B
Under NASD Rule as Adopted............ $1,396,330 $ 87,271 $ 63,709 $150,980 $28,860 $122,120 $ 1,540
Under Distributor's Voluntary
Waiver.............................. $1,396,330 $ 87,271 $ 6,982 $94,253 $28,860 $ 65,393 $ 1,540
<CAPTION>
(NOT IN THOUSANDS)
CLASS C
<S> <C> <C> <C> <C> <C> <C> <C>
Under NASD Rule as Adopted............ $3,277,018 $204,814 $ 8,163 $212,977 $ 8,664 $204,313 $10,957
</TABLE>
- ------------------
(1) Purchase price of all eligible Class B shares sold since September 30, 1985
(commencement of operations) other than shares acquired through dividend
reinvestment and the exchange privilege. Purchase price of all eligible
Class C shares sold since October 21, 1994 (commencement of operations)
other than shares acquired through dividend reinvestment and the exchange
privilege.
(2) Interest is computed on a monthly basis based upon the prime rate, as
reported in The Wall Street Journal, plus 1.0% as permitted under the NASD
Rule.
(3) Consists of CDSC payments, distribution fee payments and accruals.
(4) Provided to illustrate the extent to which the current level of distribution
fee payments (not including any CDSC payments) is amortizing the unpaid
balance. No assurance can be given that payments of the distribution fee
will reach either the voluntary maximum (with respect to Class B shares) or
the NASD maximum (with respect to Class B and Class C shares).
REDEMPTION OF SHARES
Reference is made to "Redemption of Shares" in the Prospectus for certain
information as to the redemption and repurchase of Fund shares.
The right to redeem shares or to receive payment with respect to any such
redemption may be suspended only for any period during which trading on the New
York Stock Exchange is restricted as determined by the Commission or such
Exchange is closed (other than customary weekend and holiday closings), for any
period during which an emergency exists as defined by the Commission as a result
of which disposal of portfolio securities or determination of the net asset
value of the Fund is not reasonably practicable, and for such other periods as
the Commission may by order permit for the protection of shareholders of the
Fund.
DEFERRED SALES CHARGE--CLASS B AND CLASS C SHARES
As discussed in the Prospectus under "Purchase of Shares--Deferred Sales
Charge Alternatives-- Class B and Class C Shares", while Class B shares redeemed
within four years of purchase are subject to a CDSC under most circumstances,
the charge is waived on redemptions of Class B shares following the death or
disability of a Class B shareholder. Redemptions for which the waiver applies
are any partial or complete redemptions following the death or disability (as
defined in the Internal Revenue Code of 1986, as amended (the "Code")) of a
Class B shareholder (including one who owns the Class B shares as joint tenant
with his or her spouse), provided the redemption is requested within one year of
the death or initial determination of disability. For the years ended August 31,
1993, 1994 and 1995, the Distributor received CDSCs of $591,941, $704,845 and
$866,830, respectively, with respect to redemptions of Class B shares, all of
which were paid to
26
<PAGE> 79
Merrill Lynch. For the period October 21, 1994 (commencement of operations) to
August 31, 1995, the Distributor received CDSCs of $3,844 with respect to
redemptions of Class C shares, all of which were paid to Merrill Lynch.
The CDSC is also waived for any Class B shares that were acquired and held
at the time of redemption by Employee Access Accounts available through
employers that provide Eligible 401(k) Plans. The initial minimum for such
accounts of $500, except that the initial minimum for shares purchased for such
accounts pursuant to the Automatic Investment Program is $50.
PORTFOLIO TRANSACTIONS
Reference is made to "Investment Objective and Policies--Other Investment
Policies and Practices" in Prospectus.
Under the 1940 Act, persons affiliated with the Trust are prohibited from
dealing with the Fund as principal in the purchase and sale of securities unless
such trading is permitted by an exemptive order issued by the Commission. Since
over-the-counter transactions are usually principal transactions, affiliated
persons of the Fund, including Merrill Lynch, may not serve as dealer in
connection with transactions with the Fund, absent an exemptive order from the
Commission. The Trust has obtained an exemptive order permitting it to engage in
certain principal transactions with Merrill Lynch involving high quality
short-term Municipal Bonds subject to certain conditions. During the years ended
August 31, 1993 and 1994, the Fund engaged in no transactions pursuant to such
order. During the year ended August 31, 1995, the Fund engaged in 60
transactions pursuant to such order aggregating approximately $138.3 million.
The Trust has applied for an exemptive order, subject to certain conditions,
permitting the Trust to, among other things, (i) purchase investment grade
tax-exempt securities from Merrill Lynch when Merrill Lynch is a member of an
underwriting syndicate for such securities and (ii) purchase tax-exempt
securities from and sell tax-exempt securities to Merrill Lynch in secondary
market transactions. Affiliated persons of the Fund may serve as its broker in
over-the-counter transactions conducted on an agency basis. Certain court
decisions have raised questions as to the extent to which investment companies
should seek exemptions under the 1940 Act in order to seek to recapture
underwriting and dealer spreads from affiliated entities. The Trustees have
considered all factors deemed relevant and have made a determination not to seek
such recapture at this time. The Trustees will reconsider this matter from time
to time.
As a non-fundamental restriction, the Trust will prohibit the purchase or
retention by the Fund of the securities of any issuer if the officers and
Trustees of the Trust, the officers and general partner of the Manager, the
directors of such general partner or the officers and directors of any
subsidiary thereof each owning beneficially more than one-half of one percent of
the securities of an issuer together own beneficially more than five percent of
the securities of that issuer. In addition, under the 1940 Act, the Fund may not
purchase securities during the existence of any underwriting syndicate of which
Merrill Lynch is a member except pursuant to an exemptive order or rules adopted
by the Commission. Rule 10f-3 under the 1940 Act sets forth conditions under
which the Fund may purchase municipal bonds in such transactions. The rule sets
forth requirements relating to, among other things, the terms of an issue of
municipal bonds purchased by the Fund, the amount of municipal bonds which may
be purchased in any one issue and the assets of the Fund which may be invested
in a particular issue. As indicated above, the Trust has applied for a
conditional exemption from these restrictions.
27
<PAGE> 80
The Fund does not expect to use any particular dealer in the execution of
transactions but, subject to obtaining the best net results, dealers who provide
supplemental investment research (such as information concerning tax-exempt
securities, economic data and market forecasts) to the Manager may receive
orders for transactions by the Fund. Information so received will be in addition
to and not in lieu of the services required to be performed by the Manager under
its Management Agreement and the expense of the Manager will not necessarily be
reduced as a result of the receipt of such supplemental information.
The Trust has no obligation to deal with any broker in the execution of
transactions for the Fund's portfolio securities. In addition, consistent with
the Rules of Fair Practice of the National Association of Securities Dealers,
Inc. and policies established by the Trustees of the Trust, the Manager may
consider sales of shares of the Fund as a factor in the selection of brokers or
dealers to execute portfolio transactions for the Fund.
Generally, the Fund does not purchase securities for short-term trading
profits. However, the Fund may dispose of securities without regard to the time
they have been held when such action, for defensive or other reasons, appears
advisable to its Manager. As a result of the investment policies described in
the Prospectus, under certain market conditions the Fund's portfolio turnover
may be higher than that of other investment companies; however, it is extremely
difficult to predict portfolio turnover rates with any degree of accuracy.
Higher portfolio turnover may contribute to higher transactional costs and
negative tax consequences, such as an increase in capital gain dividends or in
ordinary income dividends of accrued market discount, as well as greater
difficulty meeting the requirement for qualifications as a regulated investment
company that less than 30% of its gross income be derived from the sale or other
disposition of securities held for less than three months. See "Distribution and
Taxes" on page 45. High portfolio turnover involves correspondingly higher
transaction costs in the form of dealer spreads and brokerage commissions, which
are borne directly by the Fund. Such turnover also has certain tax consequences
for the Fund. See "Distributions and Taxes". (The portfolio turnover rate is
calculated by dividing the lesser of purchases or sales of portfolio securities
for the particular fiscal year by the monthly average of the value of the
portfolio securities owned by the Fund during the particular fiscal year. For
purposes of determining this rate, all securities whose maturities at the time
of acquisition are one year or less are excluded.) The portfolio turnover rates
for the years ended August 31, 1994 and 1995 were 75.66% and 53.40%,
respectively.
Section 11(a) of the Securities Exchange Act of 1934, as amended, generally
prohibits members of the U.S. national securities exchanges from executing
exchange transactions for their affiliates and institutional accounts which they
manage unless the member (i) has obtained prior express authorization from the
account to effect such transactions, (ii) at least annually furnishes the
account with a statement setting forth the aggregate compensation received by
the member in effecting such transactions, and (iii) complies with any rules the
Commission has prescribed with respect to the requirements of clauses (i) and
(ii). To the extent Section 11(a) would apply to Merrill Lynch acting as a
broker for the Fund in any of its portfolio transactions executed on any such
securities exchange of which it is a member, appropriate consents have been
obtained from the Fund and annual statements as to aggregate compensation will
be provided to the Fund.
DETERMINATION OF NET ASSET VALUE
The net asset value of the shares of all classes of the Fund is determined
by the Manager once daily, Monday through Friday, as of 15 minutes after the
close of business on the New York Stock Exchange
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<PAGE> 81
(generally, 4:00 P.M. New York time), on each day during which the New York
Stock Exchange is open for trading. The New York Stock Exchange is not open on
New Year's Day, Presidents' Day, Good Friday, Memorial Day, Independence Day,
Labor Day, Thanksgiving Day and Christmas Day. Net asset value per share is
computed by dividing the sum of the value of the securities held by the Fund
plus any cash or other assets minus all liabilities by the total number of
shares outstanding at such time, rounded to the nearest cent. Expenses,
including the fees payable to the Manager and any account maintenance and/or
distribution fees, are accrued daily. The per share net asset value of the Class
B, Class C and Class D shares generally will be lower than the per share net
asset value of the Class A shares, reflecting the higher daily expense accruals
of the account maintenance, distribution and higher transfer agency fees
applicable with respect to the Class B and Class C shares and the daily expense
accruals of the account maintenance fees applicable with respect to the Class D
shares; moreover, the per share net asset value of the Class B and Class C
shares generally will be lower than the per share net asset value of its Class D
shares, reflecting the daily expense accruals of the distribution fees and
higher transfer agency fees applicable with respect to the Class B and Class C
shares of the Fund. It is expected, however, that the per share net asset value
of the four classes eventually will tend to converge (although not necessarily
meet) immediately after the payment of dividends, which will differ by
approximately the amount of the expense accrual differential between the
classes.
The Municipal Bonds and other portfolio securities in which the Fund
invests are traded primarily in over-the-counter municipal bond and money
markets and are valued at the last available bid price in the over-the-counter
market or on the basis of yield equivalents as obtained from one or more dealers
that make markets in the securities. One bond is the "yield equivalent" of
another bond when, taking into account market price, maturity, coupon rate,
credit rating and ultimate return of principal, both bonds will theoretically
produce an equivalent return to the bondholder. Financial futures contracts and
options thereon, which are traded on exchanges, are valued at their settlement
prices as of the close of such exchanges. Short-term investments with a
remaining maturity of 60 days or less are valued on an amortized cost basis,
which approximates market value. Securities and assets for which market
quotations are not readily available are valued at fair value as determined in
good faith by or under the direction of the Trustees of the Trust, including
valuations furnished by a pricing service retained by the Trust, which may
utilize a matrix system for valuations. The procedures of the pricing service
and its valuations are reviewed by the officers of the Trust under the general
supervision of the Trustees.
SHAREHOLDER SERVICES
The Trust offers a number of shareholder services described below which are
designed to facilitate investment in shares of the Fund. Full details as to each
of such services and copies of the various plans described below can be obtained
from the Trust, the Distributor or Merrill Lynch.
INVESTMENT ACCOUNT
Each shareholder whose account is maintained at the Transfer Agent has an
"Investment Account" and will receive, at least quarterly, statements from the
Transfer Agent. The statements will serve as transaction confirmations for
automatic investment purchases and the reinvestment of ordinary income
dividends, and long-term capital gains distributions. These statements also will
show any other activity in the account since the previous statement.
Shareholders will receive separate transaction confirmations for each purchase
or sale
29
<PAGE> 82
transaction other than automatic investment purchases and the reinvestment of
ordinary income dividends, and long-term capital gains distributions. A
shareholder may make additions to his or her Investment Account at any time by
mailing a check directly to the Transfer Agent.
Share certificates are issued only for full shares and only upon the
specific request of a shareholder who has an Investment Account. Issuance of
certificates representing all or only part of the full shares in an Investment
Account may be requested by a shareholder directly from the Transfer Agent.
Shareholders considering transferring their Class A or Class D shares from
Merrill Lynch to another brokerage firm or financial institution should be aware
that, if the firm to which the Class A or Class D shares are to be transferred
will not take delivery of shares of the Fund, a shareholder either must redeem
the Class A or Class D shares (paying any applicable CDSC) so that the cash
proceeds can be transferred to the account at the new firm or such shareholder
must continue to maintain an Investment Account at the Transfer Agent for those
Class A or Class D shares. Shareholders interested in transferring their Class B
or Class C shares from Merrill Lynch and who do not wish to have an Investment
Account maintained for such shares at the Transfer Agent may request their new
brokerage firm to maintain such shares in an account registered in the name of
the brokerage firm for the benefit of the shareholder at the Transfer Agent. If
the new brokerage firm is willing to accommodate the shareholder in this manner,
the shareholder must request that he or she be issued certificates for his or
her shares, and then must turn the certificates over to the new firm for re-
registration as described in the preceding sentence.
AUTOMATIC INVESTMENT PLANS
A shareholder may make additions to an Investment Account at any time by
purchasing Class A shares (if an eligible Class A investor as described in the
Prospectus) or Class B, Class C or Class D shares at the applicable public
offering price either through the shareholder's securities dealer, or by mail
directly to the Transfer Agent, acting as agent for such securities dealer.
Voluntary accumulation can also be made through a service known as the Automatic
Investment Plan whereby the Fund is authorized through pre-authorized checks or
automated clearing house debits of $50 or more to charge the regular bank
account of the shareholder on a regular basis to provide systematic additions to
the Investment Account of such shareholder. The Fund's Automatic Investment Plan
is not available to shareholders whose shares are held in brokerage accounts
with Merrill Lynch. Alternatively, investors who maintain CMA(R) or CBA(R)
accounts may arrange to have periodic investments made in the Fund, in the
CMA(R) or CBA(R) accounts or in certain related accounts in amounts of $100 or
more through the CMA(R)/CBA(R) Automated Investment Program.
AUTOMATIC REINVESTMENT OF DIVIDENDS AND CAPITAL GAINS DISTRIBUTIONS
Unless specific instructions are given as to the method of payment of
dividends and capital gains distributions, dividends and distributions will be
reinvested automatically in additional shares of the Fund. Such reinvestment
will be at the net asset value of shares of the Fund as of the close of business
on the monthly payment date for such dividends and distributions. Shareholders
may elect in writing to receive either their income dividends or capital gains
distributions, or both, in cash, in which event payment will be mailed or direct
deposited on or about the payment date. Cash payments also can be direct
deposited to the shareholder's bank account.
Shareholders may, at any time, notify the Transfer Agent in writing or by
telephone (1-800-MER-FUND) that they no longer wish to have their dividends
and/or capital gains distributions reinvested in shares
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<PAGE> 83
of the Fund or vice versa and, commencing ten days after the receipt by the
Transfer Agent of such notice, those instructions will be effected.
SYSTEMATIC WITHDRAWAL PLANS--CLASS A AND CLASS D SHARES
A Class A or Class D shareholder may elect to make systematic withdrawals
from an Investment Account in the form of payments by check or through automatic
payment by direct deposit to such shareholder's bank account on either a monthly
or quarterly basis as provided below. Quarterly withdrawals are available for
shareholders who have acquired Class A or Class D shares of the Fund having a
value, based on cost or the current offering price, of $5,000 or more, and
monthly withdrawals are available for shareholders with Class A or Class D
shares with such a value of $10,000 or more.
At the time of each withdrawal payment, sufficient Class A or Class D
shares are redeemed from those on deposit in the shareholder's account to
provide the withdrawal payment specified by the shareholder. The shareholder may
specify either a dollar amount or a percentage of the value of his or her Class
A or Class D shares. Redemptions will be made at net asset value as determined
15 minutes after the close of business on the New York Stock Exchange
(generally, 4:00 P.M., New York time) on the 24th day of each month or the 24th
day of the last month of each quarter, whichever is applicable. If the New York
Stock Exchange is not open for business on such date, the Class A or Class D
shares will be redeemed at the close of business on the following business day.
The check for the withdrawal payment will be mailed, or the direct deposit for
the withdrawal payment will be made, on the next business day following
redemption. When a shareholder is making systematic withdrawals, dividends and
distributions on all Class A or Class D shares in the Investment Account are
reinvested automatically in the Fund's Class A or Class D shares, respectively.
A shareholder's Systematic Withdrawal Plan may be terminated at any time,
without charge or penalty, by the shareholder, the Fund, the Transfer Agent or
the Distributor. Withdrawal payments should not be considered as dividends,
yield or income. Each withdrawal is a taxable event. If periodic withdrawals
continuously exceed reinvested dividends, the shareholder's original investment
may be reduced correspondingly. Purchases of additional Class A or Class D
shares concurrent with withdrawals are ordinarily disadvantageous to the
shareholder because of sales charges and tax liabilities. The Fund will not
knowingly accept purchase orders for Class A or Class D shares of the Fund from
investors who maintain a Systematic Withdrawal Plan unless such purchase is
equal to at least one year's scheduled withdrawals or $1,200, whichever is
greater. Periodic investments may not be made into an Investment Account in
which the shareholder has elected to make systematic withdrawals.
Alternatively, Class A or Class D shareholder whose shares are held within
a CMA(R) or CBA(R) Account may elect to have shares redeemed on a monthly,
bimonthly, quarterly, semiannual or annual basis through the CMA(R)/CBA(R)
Systematic Redemption Program. The minimum fixed dollar amount redeemable is
$25. The proceeds of systematic redemptions will be posted to the shareholder's
account five business days after the date the shares are redeemed. Monthly
systematic redemptions will be made at net asset value on the first Monday of
each month, bimonthly systematic redemptions will be made at net asset value on
the first Monday of every other month, and quarterly, semiannual or annual
redemptions are made at net asset value on the first Monday of months selected
at the shareholder's option. If the first Monday of the month is a holiday, the
redemption will be processed at net asset value on the next business day. The
CMA(R)/CBA(R) Systematic Redemption Program is not available if Fund shares are
being purchased within the account pursuant to the CMA(R)/CBA(R) Automatic
Investment Program. For more information on the CMA(R)/CBA(R) Systematic
Redemption Program, eligible shareholders should contact their Merrill Lynch
financial consultant.
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<PAGE> 84
EXCHANGE PRIVILEGE
Shareholders of each class of shares of the Fund have an exchange privilege
with certain other MLAM-advised mutual funds listed below. Under the Merrill
Lynch Select(SM) Pricing System, Class A shareholders may exchange Class A
shares of the Fund for Class A shares of a second MLAM-advised mutual fund if
the shareholder holds any Class A shares of the second fund in his or her
account in which the exchange is made at the time of the exchange or is
otherwise eligible to purchase Class A shares of the second fund. If the Class
A shareholder wants to exchange Class A shares for shares of a second
MLAM-advised mutual fund, but does not hold Class A shares of the second fund
in his account at the time of the exchange and is not otherwise eligible to
acquire Class A shares of the second fund, the shareholder will receive Class D
shares of the second fund as a result of the exchange. Class D shares also may
be exchanged for Class A shares of a second MLAM-advised mutual fund at any
time as long as, at the time of the exchange, the shareholder holds Class A
shares of the second fund in the account in which the exchange is made or is
otherwise eligible to purchase Class A shares of the second fund. Class B,
Class C and Class D shares are exchangeable with shares of other MLAM-advised
mutual funds. For purposes of computing the CDSC that may be payable upon a
disposition of the shares acquired in the exchange, the holding period for the
previously owned shares of the Fund is "tacked" to the holding period of the
newly acquired shares of the other Fund as more fully described below. Class A,
Class B, Class C and Class D shares also are exchangeable for shares of certain
MLAM-advised money market funds specifically designated below as available for
exchange by holders of Class A, Class B, Class C or Class D shares. Shares with
a net asset value of at least $100 are required to qualify for the exchange
privilege, and any shares utilized in an exchange must have been held by the
shareholder for 15 days.
Exchanges of Class A or Class D shares outstanding ("outstanding Class A or
Class D shares") for Class A or Class D shares of another MLAM-advised mutual
fund ("new Class A or Class D shares") are transacted on the basis of relative
net asset value per Class A or Class D share, respectively, plus an amount equal
to the difference, if any, between the sales charge previously paid on the
outstanding Class A or Class D shares and the sales charge payable at the time
of the exchange on the new Class A or Class D shares. With respect to
outstanding Class A or Class D shares as to which previous exchanges have taken
place, the "sales charge previously paid" shall include the aggregate of the
sales charges paid with respect to such Class A or Class D shares in the initial
purchase and any subsequent exchange. Class A or Class D shares issued pursuant
to dividend reinvestment are sold on a no-load basis in each of the funds
offering Class A or Class D shares. For purposes of the exchange privilege,
Class A or Class D shares acquired through dividend reinvestment will be
exchanged into the Class A or Class D shares of the other funds or into shares
of the Class A or Class D money market funds without a sales charge.
In addition, each of the funds with Class B and Class C shares outstanding
("outstanding Class B or Class C shares") offers to exchange its outstanding
Class B or Class C shares for Class B or Class C shares, respectively ("new
Class B shares") of another MLAM-advised mutual fund on the basis of relative
net asset value per Class B or Class C share, without the payment of any CDSC
that might otherwise be due on redemption of the outstanding shares. Class B
shareholders of the Fund exercising the exchange privilege will continue to be
subject to the Fund's CDSC schedule if such schedule is higher than the CDSC
schedule relating to the new Class B shares acquired through use of the exchange
privilege. In addition, Class B shares of the Fund acquired through use of the
exchange privilege will be subject to the Fund's CDSC schedule if such schedule
is higher than the deferred sales charge schedule relating to the Class B shares
of the fund from which the exchange has been made. For purposes of computing the
sales load that may be payable on a
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<PAGE> 85
disposition of the new Class B shares, the holding period for the outstanding
Class B shares is "tacked" to the holding period of the new Class B shares. For
example, an investor may exchange Class B shares of the Fund for those of
Merrill Lynch Global Resources Trust after having held the Fund's Class B shares
for two and a half years. The 2% CDSC that generally would apply to a redemption
would not apply to the exchange. Three years later the investor may decide to
redeem the Class B shares of Merrill Lynch Global Resources Trust and receive
cash. There will be no contingent deferred sales load due on this redemption,
since by "tacking" the two and a half year holding period of the Fund's Class B
shares to the three year holding period for the Merrill Lynch Global Resources
Trust Class B shares, the investor will be deemed to have held the new Class B
shares for more than five years.
Shareholders also may exchange shares of the Fund into shares of a money
market fund advised by the Manager or its affiliates, but the period of time
that Class B or Class C shares are held in a money market fund will not count
towards satisfaction of the holding period requirement for purposes of reducing
the CDSC or, with respect to Class B shares, toward satisfaction of the
conversion period. However, shares of a money market fund which were acquired as
a result of an exchange for Class B or Class C shares of the Fund may, in turn,
be exchanged back into Class B or Class C shares, respectively, of any fund
offering such shares, in which event the holding period for Class B or Class C
shares of the Fund will be aggregated with previous holding periods for purposes
of reducing the CDSC. Thus, for example, an investor may exchange Class B shares
of the Fund for shares of Merrill Lynch Institutional Fund after having held the
Class B shares for two and a half years and three years later decide to redeem
the shares of Merrill Lynch Institutional Fund for cash. At the time of this
redemption, the 2% CDSC that would have been due had the Class B shares of the
Fund been redeemed for cash rather than exchanged for shares of Merrill Lynch
Institutional Fund will be payable. If, instead of such redemption the
shareholder exchanged such shares for Class B shares of a fund which the
shareholder continued to hold for an additional two and a half years, any
subsequent redemption will not incur a CDSC.
Set forth below is a description of the investment objectives of the other
funds into which exchanges can be made:
Funds Issuing Class A, Class B, Class C and Class D Shares:
<TABLE>
<S> <C>
MERRILL LYNCH ADJUSTABLE RATE
SECURITIES FUND, INC. ........... High current income, consistent with a policy of
limiting the degree of fluctuation in net asset value,
by investing primarily in a portfolio of adjustable
rate securities, consisting principally of
mortgage-backed and asset-backed securities.
MERRILL LYNCH AMERICAS INCOME FUND,
INC. ............................ A high level of current income, consistent with prudent
investment risk, by investing primarily in debt
securities denominated in a currency of a country
located in the Western Hemisphere (i.e., North and
South America and the surrounding waters).
</TABLE>
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<PAGE> 86
<TABLE>
<S> <C>
MERRILL LYNCH ARIZONA LIMITED
MATURITY MUNICIPAL
BOND FUND........................ A portfolio of Merrill Lynch Multi-State Limited
Maturity Municipal Series Trust, a series fund, whose
objective is to provide as high a level of income
exempt from Federal and Arizona income taxes as is
consistent with prudent investment management through
investment in a portfolio primarily of
intermediate-term investment grade Arizona Municipal
Bonds.
MERRILL LYNCH ARIZONA MUNICIPAL
BOND FUND........................ A portfolio of Merrill Lynch Multi-State Municipal
Series Trust, a series fund, whose objective is to
provide as high a level of income exempt from Federal
and Arizona income taxes as is consistent with prudent
investment management.
MERRILL LYNCH ARKANSAS MUNICIPAL
BOND FUND........................ A portfolio of Merrill Lynch Multi-State Municipal
Series Trust, a series fund, whose objective is to
provide as high a level of income exempt from Federal
and Arkansas income taxes as is consistent with
prudent investment management.
MERRILL LYNCH ASSET GROWTH FUND,
INC. ............................ High total investment return, consistent with prudent
risk, from investment in United States and foreign
equity, debt and money market securities the
combination of which will be varied both with respect
to types of securities and markets in response to
changing market and economic trends.
MERRILL LYNCH ASSET INCOME FUND,
INC. ............................ A high level of current income through investment
primarily in United States fixed income securities.
MERRILL LYNCH BALANCED FUND FOR
INVESTMENT AND
RETIREMENT, INC.................. As high a level of total investment return as is
consistent with a reasonable and relatively low level of
risk by investing in common stocks and other types of
securities, including fixed income securities and
convertible securities.
MERRILL LYNCH BASIC VALUE FUND,
INC. ............................ Capital appreciation and, secondarily, income, by
investing in securities, primarily equities, that are
undervalued and therefore represent basic investment
value.
</TABLE>
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<PAGE> 87
<TABLE>
<S> <C>
MERRILL LYNCH CALIFORNIA INSURED
MUNICIPAL BOND
FUND............................. A portfolio of Merrill Lynch California Municipal Series
Trust, a series fund whose objective is to provide as
high a level of income exempt from Federal and
California income taxes as is consistent with prudent
investment management through investment in a
portfolio primarily of insured California Municipal
Bonds.
MERRILL LYNCH CALIFORNIA LIMITED
MATURITY MUNICIPAL BOND FUND..... A portfolio of Merrill Lynch Multi-State Limited
Maturity Municipal Series Trust, a series fund, whose
objective is to provide as high a level of income
exempt from Federal and California income taxes as is
consistent with prudent investment management through
investment in a portfolio primarily of
intermediate-term investment grade California
Municipal Bonds.
MERRILL LYNCH CAPITAL FUND,
INC. ............................ The highest total investment return consistent with
prudent risk through a fully managed investment policy
utilizing equity, debt and convertible securities.
MERRILL LYNCH COLORADO MUNICIPAL
BOND FUND........................ A portfolio of Merrill Lynch Multi-State Municipal
Series Trust, a series fund, whose objective is to
provide as high a level of income exempt from Federal
and Colorado income taxes as is consistent with
prudent investment management.
MERRILL LYNCH CONNECTICUT MUNICIPAL
BOND FUND........................ A portfolio of Merrill Lynch Multi-State Municipal
Series Trust, a series fund, whose objective is to
provide as high a level of income exempt from Federal
and Connecticut income taxes as is consistent with
prudent investment management.
MERRILL LYNCH CORPORATE BOND FUND,
INC. ............................ Current income from three separate diversified
portfolios of fixed income securities.
MERRILL LYNCH DEVELOPING CAPITAL
MARKETS FUND, INC. .............. Long-term capital appreciation through investment in
securities, principally equities, of issuers in
countries having smaller capital markets.
</TABLE>
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<PAGE> 88
<TABLE>
<S> <C>
MERRILL LYNCH DRAGON FUND, INC. ... Capital appreciation primarily through investment in
equity and debt securities of issuers domiciled in
developing Asia-Pacific countries, which include all
countries in Asia and the Pacific Basin.
MERRILL LYNCH EUROFUND............. Capital appreciation primarily through investment in
equity securities of corporations domiciled in Europe.
MERRILL LYNCH FEDERAL SECURITIES
TRUST............................ High current return through investment in U.S.
Government and Government agency securities, including
GNMA mortgage-backed certificates and other
mortgage-backed Government securities.
MERRILL LYNCH FLORIDA LIMITED
MATURITY MUNICIPAL BOND
FUND............................. A portfolio of Merrill Lynch Multi-State Limited
Maturity Municipal Series Trust, a series fund, whose
objective is to provide as high a level of income
exempt from Federal income taxes as is consistent with
prudent investment management while seeking to offer
shareholders the opportunity to own securities exempt
from Florida intangible personal property taxes
through investment in a portfolio primarily of
intermediate-term investment grade Florida Municipal
Bonds.
MERRILL LYNCH FLORIDA MUNICIPAL
BOND FUND........................ A portfolio of Merrill Lynch Multi-State Municipal
Series Trust, a series fund, whose objective is to
provide as high a level of income exempt from Federal
income taxes as is consistent with prudent investment
management while seeking to offer shareholders the
opportunity to own securities exempt from Florida
intangible personal property taxes.
MERRILL LYNCH FUND FOR TOMORROW,
INC. ............................ Long-term growth through investment in a portfolio of
good quality securities, primarily common stock,
potentially positioned to benefit from demographic and
cultural changes as they affect consumer markets.
MERRILL LYNCH FUNDAMENTAL GROWTH
FUND, INC. ...................... Long-term growth of capital through investment in a
diversified portfolio of equity securities placing
particular emphasis on companies that have exhibited
an above-average growth rate in earnings.
</TABLE>
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<TABLE>
<S> <C>
MERRILL LYNCH FUNDAMENTAL VALUE
PORTFOLIO (available only for
exchanges by certain individual
retirement accounts for which
Merrill Lynch acts as
custodian)....................... A portfolio of Merrill Lynch Asset Builder Program,
Inc., a series fund, whose objective is to provide
capital appreciation and income by investing in
securities, with at least 65% of the portfolio's
assets being invested in equities.
MERRILL LYNCH GLOBAL ALLOCATION
FUND, INC. ...................... High total return consistent with prudent risk, through
a fully managed investment policy utilizing United
States and foreign equity, debt and money market
securities, the combination of which will be varied
from time to time both with respect to the types of
securities and markets in response to changing market
and economic trends.
MERRILL LYNCH GLOBAL BOND FUND FOR
INVESTMENT AND RETIREMENT........ High total investment return from investment in a global
portfolio of debt instruments denominated in various
currencies and multi-national currency units.
MERRILL LYNCH GLOBAL CONVERTIBLE
FUND, INC. ...................... High total return from investment primarily in an
internationally diversified portfolio of convertible
debt securities, convertible preferred stock and
"synthetic" convertible securities consisting of a
combination of debt securities or preferred stock and
warrants or options.
MERRILL LYNCH GLOBAL HOLDINGS, INC.
(residents of Arizona must meet
investor suitability
standards)....................... The highest total investment return consistent with
prudent risk through worldwide investment in an
internationally diversified portfolio of securities.
</TABLE>
37
<PAGE> 90
<TABLE>
<S> <C>
MERRILL LYNCH GLOBAL OPPORTUNITY
PORTFOLIO (available only for
exchanges by certain individual
retirement accounts for which
Merrill Lynch acts as
custodian)....................... A portfolio of Merrill Lynch Asset Builder Program,
Inc., a series fund, whose objective is to provide a
high total investment return through an investment
policy utilizing United States and foreign equity,
debt and money market securities, the combination of
which will vary depending upon changing market and
economic trends.
MERRILL LYNCH GLOBAL RESOURCES
TRUST............................ Long-term growth and protection of capital from
investment in securities of foreign and domestic
companies that possess substantial natural resource
assets.
MERRILL LYNCH GLOBAL SMALLCAP FUND,
INC. ............................ Long-term growth of capital by investing primarily in
equity securities of companies with relatively small
market capitalizations located in various foreign
countries and in the United States.
MERRILL LYNCH GLOBAL UTILITY FUND,
INC. ............................ Capital appreciation and current income through
investment of at least 65% of its total assets in equity
and debt securities issued by domestic and foreign
companies that are primarily engaged in the ownership
or operation of facilities used to generate, transmit
or distribute electricity, telecommunications, gas or
water.
MERRILL LYNCH GROWTH FUND FOR
INVESTMENT AND RETIREMENT........ Growth of capital and, secondarily, income from
investment in a diversified portfolio of equity
securities placing principal emphasis on those
securities which management of the fund believes to be
undervalued.
MERRILL LYNCH HEALTHCARE FUND, INC.
(residents of Wisconsin must meet
investor suitability
standards)....................... Capital appreciation through worldwide investment in
equity securities of companies that derive or are
expected to derive a substantial portion of their sale
from products and services in healthcare.
</TABLE>
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<PAGE> 91
<TABLE>
<S> <C>
MERRILL LYNCH INTERNATIONAL EQUITY
FUND............................. Capital appreciation and, secondarily, income by
investing in a diversified portfolio of equity
securities of issuers located in countries other than
the United States.
MERRILL LYNCH LATIN AMERICA FUND,
INC. ............................ Capital appreciation by investing primarily in Latin
American equity and debt securities.
MERRILL LYNCH MARYLAND MUNICIPAL
BOND FUND........................ A portfolio of Merrill Lynch Multi-State Municipal
Series Trust, a series fund, whose objective is to
provide as high a level of income exempt from Federal
and Maryland income taxes as is consistent with
prudent investment management.
MERRILL LYNCH MASSACHUSETTS LIMITED
MATURITY MUNICIPAL BOND FUND..... A portfolio of Merrill Lynch Multi-State Limited
Maturity Municipal Series Trust, a series fund, whose
objective is to provide as high a level of income
exempt from Federal and Massachusetts income taxes as
is consistent with prudent investment management
through investment in a portfolio primarily of
intermediate-term investment grade Massachusetts
Municipal Bonds.
MERRILL LYNCH MASSACHUSETTS
MUNICIPAL BOND FUND.............. A portfolio of Merrill Lynch Multi-State Municipal
Series Trust, a series fund, whose objective is to
provide as high a level of income exempt from Federal
and Massachusetts income taxes as is consistent with
prudent investment management.
MERRILL LYNCH MICHIGAN LIMITED
MATURITY MUNICIPAL BOND
FUND............................. A portfolio of Merrill Lynch Multi-State Limited
Maturity Municipal Series Trust, a series fund, whose
objective is to provide as high a level of income
exempt from Federal and Michigan income taxes as is
consistent with prudent investment management through
investment in a portfolio primarily of
intermediate-term investment grade Michigan Municipal
Bonds.
MERRILL LYNCH MICHIGAN MUNICIPAL
BOND FUND........................ A portfolio of Merrill Lynch Multi-State Municipal
Series Trust, a series fund, whose objective is to
provide as high a level of income exempt from Federal
and Michigan income taxes as is consistent with
prudent investment management.
</TABLE>
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<PAGE> 92
<TABLE>
<S> <C>
MERRILL LYNCH MINNESOTA MUNICIPAL
BOND FUND........................ A portfolio of Merrill Lynch Multi-State Municipal
Series Trust, a series fund, whose objective is to
provide as high a level of income exempt from Federal
and Minnesota income taxes as is consistent with
prudent investment management.
MERRILL LYNCH MUNICIPAL BOND FUND,
INC. ............................ Tax-exempt income from three separate diversified
portfolios of municipal bonds.
MERRILL LYNCH MUNICIPAL
INTERMEDIATE TERM FUND........... Currently the only portfolio of Merrill Lynch Municipal
Series Trust, a series fund, whose objective is to
provide as high a level as possible of income exempt
from Federal income taxes by investing in investment
grade obligations with a dollar weighted average
maturity of five to twelve years.
MERRILL LYNCH NEW JERSEY LIMITED
MATURITY MUNICIPAL BOND FUND..... A portfolio of Merrill Lynch Multi-State Limited
Maturity Municipal Series Trust, a series fund, whose
objective is to provide as high a level of income
exempt from Federal and New Jersey income taxes as is
consistent with prudent investment management through
investment in a portfolio primarily of
intermediate-term investment grade New Jersey
Municipal Bonds.
MERRILL LYNCH NEW JERSEY MUNICIPAL
BOND FUND........................ A portfolio of Merrill Lynch Multi-State Municipal
Series Trust, a series fund, whose objective is to
provide as high a level of income exempt from Federal
and New Jersey income taxes as is consistent with
prudent investment management.
MERRILL LYNCH NEW MEXICO MUNICIPAL
BOND FUND........................ A portfolio of Merrill Lynch Multi-State Municipal
Series Trust, a series fund, whose objective is to
provide as high a level of income exempt from Federal
and New Mexico income taxes as is consistent with
prudent investment management.
</TABLE>
40
<PAGE> 93
<TABLE>
<S> <C>
MERRILL LYNCH NEW YORK LIMITED
MATURITY MUNICIPAL BOND FUND..... A portfolio of Merrill Lynch Multi-State Limited
Maturity Municipal Series Trust, a series fund, whose
objective is to provide as high a level of income
exempt from Federal, New York State and New York City
income taxes as is consistent with prudent investment
management through investment in a portfolio primarily
of intermediate-term investment grade New York
Municipal Bonds.
MERRILL LYNCH NEW YORK MUNICIPAL
BOND FUND........................ A portfolio of Merrill Lynch Multi-State Municipal
Series Trust, a series fund, whose objective is to
provide as high a level of income exempt from Federal,
New York State and New York City income taxes as is
consistent with prudent investment management.
MERRILL LYNCH NORTH CAROLINA
MUNICIPAL BOND FUND.............. A portfolio of Merrill Lynch Multi-State Municipal
Series Trust, a series fund, whose objective is to
provide as high a level of income exempt from Federal
and North Carolina income taxes as is consistent with
prudent investment management.
MERRILL LYNCH OHIO MUNICIPAL BOND
FUND............................. A portfolio of Merrill Lynch Multi-State Municipal
Series Trust, a series fund, whose objective is to
provide as high a level of income exempt from Federal
and Ohio income taxes as is consistent with prudent
investment management.
MERRILL LYNCH OREGON MUNICIPAL BOND
FUND............................. A portfolio of Merrill Lynch Multi-State Municipal
Series Trust, a series fund, whose objective is to
provide as high a level of income exempt from Federal
and Oregon income taxes as is consistent with prudent
investment management.
MERRILL LYNCH PACIFIC FUND,
INC. ............................ Capital appreciation by investing in equity securities
of corporations domiciled in Far Eastern and Western
Pacific countries, including Japan, Australia, Hong
Kong and Singapore.
</TABLE>
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<PAGE> 94
<TABLE>
<S> <C>
MERRILL LYNCH PENNSYLVANIA LIMITED
MATURITY MUNICIPAL BOND FUND..... A portfolio of Merrill Lynch Multi-State Limited
Maturity Municipal Series Trust, a series fund, whose
objective is to provide as high a level of income
exempt from Federal and Pennsylvania income taxes as
is consistent with prudent investment management
through investment in a portfolio primarily of
intermediate-term investment grade Pennsylvania
Municipal Bonds.
MERRILL LYNCH PENNSYLVANIA
MUNICIPAL BOND FUND.............. A portfolio of Merrill Lynch Multi-State Municipal
Series Trust, a series fund, whose objective is to
provide as high a level of income exempt from Federal
and Pennsylvania income taxes as is consistent with
prudent investment management.
MERRILL LYNCH PHOENIX FUND,
INC. ............................ Long-term growth of capital by investing in equity and
fixed income securities, including tax-exempt
securities, of issuers in weak financial condition or
experiencing poor operating results believed to be
undervalued relative to the current or prospective
condition of such issuer.
MERRILL LYNCH QUALITY BOND
PORTFOLIO (available only for
exchanges by certain individual
retirement accounts for which
Merrill Lynch acts as
custodian)....................... A portfolio of Merrill Lynch Asset Builder Program,
Inc., a series fund, whose objective is to provide a
high level of current income through investment in a
diversified portfolio of debt obligations, such as
corporate bonds and notes, convertible securities,
preferred stocks and governmental obligations.
MERRILL LYNCH SHORT-TERM GLOBAL
INCOME FUND, INC. ............... As high a level of current income as is consistent with
prudent investment management from a global portfolio of
high quality debt securities denominated in various
currencies and multi-national currency units and
having remaining maturities not exceeding three years.
MERRILL LYNCH SPECIAL VALUE FUND,
INC. ............................ Long-term growth of capital from investment in
securities, primarily common stocks, of relatively small
companies believed to have special investment value
and emerging growth companies regardless of size.
</TABLE>
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<PAGE> 95
<TABLE>
<S> <C>
MERRILL LYNCH STRATEGIC DIVIDEND
FUND............................. Long-term total return from investment in dividend
paying common stocks that yield more than Standard &
Poor's 500 Composite Stock Price Index.
MERRILL LYNCH TECHNOLOGY FUND,
INC. ............................ Capital appreciation through worldwide investment in
equity securities of companies that derive or are
expected to derive a substantial portion of their
sales from products and services in technology.
MERRILL LYNCH TEXAS MUNICIPAL BOND
FUND............................. A portfolio of Merrill Lynch Multi-State Municipal
Series Trust, a series fund, whose objective is to
provide as high a level of income exempt from Federal
income taxes as is consistent with prudent investment
management by investing primarily in a portfolio of
long-term, investment grade obligations issued by the
State of Texas, its political subdivisions, agencies
and instrumentalities.
MERRILL LYNCH U.S. GOVERNMENT
SECURITIES PORTFOLIO (available
only for exchanges by certain
individual retirement accounts
for which Merrill Lynch acts as
custodian)....................... A portfolio of Merrill Lynch Asset Builder Program,
Inc., a series fund, whose objective is to provide a
high current return through investments in U.S.
Government and government agency securities, including
GNMA mortgage-backed certificates and other
mortgage-backed government securities.
MERRILL LYNCH UTILITY INCOME FUND,
INC. ............................ High current income through investment in equity and
debt securities issued by companies that are primarily
engaged in the ownership or operation of facilities
used to generate, transmit or distribute electricity,
telecommunications, gas or water.
MERRILL LYNCH WORLD INCOME FUND,
INC. ............................ High current income by investing in a global portfolio
of fixed income securities denominated in various
currencies, including multinational currencies.
</TABLE>
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<PAGE> 96
<TABLE>
<CAPTION>
Class A Share Money Market Funds:
<S> <C>
MERRILL LYNCH READY ASSETS TRUST... Preservation of capital, liquidity and the highest
possible current income consistent with the foregoing
objectives from the short-term money market securities
in which the Fund invests.
MERRILL LYNCH RETIREMENT RESERVES
MONEY FUND
(available only for exchanges
within certain retirement
plans)........................... Currently the only portfolio of Merrill Lynch Retirement
Series Trust, a series fund, whose objectives are to
provide current income, preservation of capital and
liquidity available from investment in a diversified
portfolio of short-term money market securities.
MERRILL LYNCH U.S.A. GOVERNMENT
RESERVES......................... Preservation of capital, current income and liquidity
available from investing in direct obligations of the
U.S. Government and repurchase agreements relating to
such securities.
MERRILL LYNCH U.S TREASURY MONEY
FUND............................. Preservation of capital, liquidity and current income
through investment exclusively in a diversified
portfolio of short-term marketable securities which
are direct obligations of the U.S. Treasury.
<CAPTION>
Class B, Class C and Class D Share Money Market Funds:
<S> <C>
MERRILL LYNCH GOVERNMENT FUND...... A portfolio of Merrill Lynch Funds for Institutions
Series, a series fund, whose objective is to provide
current income consistent with liquidity and security
of principal from investment in securities issued or
guaranteed by the U.S. Government, its agencies and
instrumentalities and in repurchase agreements secured
by such obligations.
MERRILL LYNCH INSTITUTIONAL FUND... A portfolio of Merrill Lynch Funds for Institutions
Series, a series fund, whose objectives is to provide
maximum current income consistent with liquidity and
the maintenance of a high quality portfolio of money
market securities.
</TABLE>
44
<PAGE> 97
<TABLE>
<S> <C>
MERRILL LYNCH INSTITUTIONAL
TAX-EXEMPT FUND.................. A portfolio of Merrill Lynch Funds for Institutions
Series, a series fund, whose objectives is to provide
current income exempt from Federal income taxes,
preservation of capital and liquidity available from
investment in a diversified portfolio of short- term,
high quality municipal bonds.
MERRILL LYNCH TREASURY FUND........ A portfolio of Merrill Lynch Funds for Institutions
Series, a series fund, whose objectives is to provide
current income consistent with liquidity and security
of principal from investment in direct obligations of
the U.S. Treasury and up to 10% of its total assets in
repurchase agreements secured by such obligations.
</TABLE>
Before effecting an exchange, shareholders should obtain a currently
effective prospectus of the fund into which the exchange is to be made. Exercise
of the exchange privilege is treated as a sale for Federal income tax purposes
and, depending on the circumstances, a short- or long-term capital gain or loss
may be realized. In addition, a shareholder exchanging shares of any of the
funds may be subject to a backup withholding tax unless such shareholder
certifies under penalty of perjury that the taxpayer identification number on
file with any such fund is correct and that such investor is not otherwise
subject to backup withholding. See "Dividends, Distributions and Taxes" below.
To exercise the exchange privilege, shareholders should contact their
Merrill Lynch financial consultant, who will advise the Fund of the exchange,
or, if the exchange does not involve a money market fund, the shareholder may
write to the Transfer Agent requesting that the exchange be effected. Such
letter must be signed exactly as the account is registered with signatures
guaranteed by an "eligible guarantor institution" as such is defined in Rule
17Ad-15 under the Securities Exchange Act of 1934, as amended, the existence and
validity of which may be verified by the Transfer Agent through the use of
industry publications. Shareholders of the Fund, and shareholders of the other
funds described above with shares for which certificates have not been issued,
may exercise the exchange privilege by wire through their securities dealers.
The Fund reserves the right to require a properly completed Exchange
Application. This exchange privilege may be modified or terminated in accordance
with the rules of the Commission. The Fund reserves the right to limit the
number of times an investor may exercise the exchange privilege. Certain funds
may suspend the continuous offering of their shares to the general public at any
time and may thereafter resume such offering from time to time. The exchange
privilege is available only to U.S. shareholders in states where the exchange
legally may be made.
DISTRIBUTIONS AND TAXES
The Trust intends to continue to qualify the Fund for the special tax
treatment afforded regulated investment companies ("RICs") under the Internal
Revenue Code of 1986, as amended (the "Code"). If it so qualifies, in any
taxable year in which it distributes at least 90% of its taxable net income and
90% of its tax exempt net income (see below), the Fund (but not its
shareholders) will not be subject to Federal income tax to the extent that it
distributes its net investment income and net realized capital gains. The Trust
intends to cause the Fund to distribute substantially all of such income.
45
<PAGE> 98
As discussed in the Fund's Prospectus, the Trust has established another
series in addition to the Fund (together with the Fund, the "Series"). Each
Series of the Trust is treated as a separate corporation for Federal income tax
purposes. Each Series therefore is considered to be a separate entity in
determining its treatment under the rules for RICs described in the Prospectus.
Losses in one Series do not offset gains in another Series and the requirements
(other than certain organizational requirements) for qualifying for RIC status
will be determined at the Series level rather than at the Trust level.
The Code requires a RIC to pay a nondeductible 4% excise tax to the extent
the RIC does not distribute, during each calendar year, 98% of its ordinary
income, determined on a calendar year basis, and 98% of its capital gains,
determined, in general, on an October 31 year end, plus certain undistributed
amounts from previous years. The required distributions, however, are based only
on the taxable income of a RIC. The excise tax, therefore, generally will not
apply to the tax-exempt income of a RIC, such as the Fund, that pays
exempt-interest dividends.
The Trust intends to qualify the Fund to pay "exempt-interest dividends" as
defined in Section 852(b)(5) of the Code. Under such section if, at the close of
each quarter of its taxable year, at least 50% of the value of the Fund's total
assets consists of obligations exempt from Federal income tax ("tax-exempt
obligations") under Section 103(a) of the Code (relating generally to
obligations of a state or local governmental unit), the Fund shall be qualified
to pay exempt-interest dividends to its Class A, Class B, Class C and Class D
shareholders (together the "shareholders"). Exempt-interest dividends are
dividends or any part thereof paid by the Fund which are attributable to
interest on tax-exempt obligations and designated by the Trust as
exempt-interest dividends in a written notice mailed to the Fund's shareholders
within 60 days after the close of the Fund's taxable year. For this purpose, the
Fund will allocate interest from tax-exempt obligations (as well as ordinary
income, capital gains and tax preference items discussed below) among the Class
A, Class B, Class C and Class D shareholders according to a method (which it
believes is consistent with the Securities and Exchange Commission's exemptive
order permitting the issuance and sale of multiple classes of stock) that is
based on the gross income allocable to the Class A, Class B, Class C and Class D
shareholders during the taxable year, or such other method as the Internal
Revenue Service may prescribe. To the extent that the dividends distributed to
the Fund's shareholders are derived from interest income exempt from Federal
income tax under Code Section 103(a) and are properly designated as
"exempt-interest dividends", they will be excludable from a shareholder's gross
income for Federal income tax purposes. Exempt-interest dividends are included,
however, in determining the portion, if any, of a person's social security
benefits and railroad retirement benefits subject to Federal income taxes.
Interest on indebtedness incurred or continued to purchase or carry shares of a
RIC paying exempt-interest dividends, such as the Fund, will not be deductible
by the investor for Federal or California personal income tax purposes to the
extent attributable to exempt-interest dividends. Shareholders are advised to
consult their tax advisers with respect to whether exempt-interest dividends
retain the exclusion under Code Section 103(a) if a shareholder would be treated
as a "substantial user" or "related person" under Code Section 147(a) with
respect to property financed with the proceeds of an issue of "industrial
development bonds" or "private activity bonds", if any, held by the Fund.
The portion of the Fund's exempt-interest dividends paid from interest
received by the Fund from California Municipal Bonds will be exempt from
California income taxes if, at the close of each quarter of the Fund's taxable
year, at least 50% of the value of the Fund's total assets consists of
California Municipal Bonds. The Trust intends to invest at least 50% of the
Fund's assets in California Municipal Bonds at all times.
46
<PAGE> 99
Shareholders subject to income taxation in states other than California will
realize a lower after tax rate of return than California shareholders since the
dividends distributed by the Fund will generally not be exempt, to any
significant degree, from taxation by such other states. The Trust will inform
shareholders annually regarding the portion of the Fund's distributions which
constitutes exempt-interest dividends and the portion which is exempt from
California income taxes. The Fund will allocate exempt-interest dividends among
the Class A, Class B, Class C and Class D shareholders for California income tax
purposes based on a method similar to that described above for Federal income
tax purposes.
Distributions from investment income and capital gains, including
exempt-interest dividends, may be subject to the California state franchise tax
if received by a corporation subject to such tax, and may be subject to state
taxes in states other than California and to local taxes in cities other than
those in California. Accordingly, investors in the Fund including, in
particular, corporate investors which may be subject to the California franchise
tax should consult their tax advisers with respect to the application of such
taxes to Fund dividends and as to their California tax situation in general.
To the extent the Fund's distributions are derived from interest on its
taxable investments or from an excess of net short-term capital gains over net
long-term capital losses ("ordinary income dividends"), such distributions are
considered ordinary income for Federal income tax purposes. Distributions, if
any, from an excess of net long-term capital gains over net short-term capital
losses derived from the sale of securities or from certain transactions in
futures or options ("capital gain dividends") are taxable as long-term capital
gains for Federal income tax purposes, regardless of the length of time the
shareholder has owned Fund shares and, for California income tax purposes, will
be treated as capital gains which are taxed at ordinary income tax rates.
Distributions by the Fund, whether from exempt-interest income, ordinary income
or capital gains will not be eligible for the dividends received deduction
allowed to corporations under the Code.
All or a portion of the Fund's gain from the sale or redemption of
tax-exempt obligations purchased at a market discount will be treated as
ordinary income rather than capital gain. This rule may increase the amount of
ordinary income dividends received by shareholders. Any loss upon the sale or
exchange of Fund shares held for six months or less will be treated as long-term
capital loss to the extent of any capital gain dividends received by the
shareholder. In addition, such loss will be disallowed to the extent of any
exempt-interest dividends received by the shareholder. Distributions in excess
of the Fund's earnings and profits will first reduce the adjusted tax basis of a
holder's shares and, after such adjusted tax basis is reduced to zero, will
constitute capital gains to such holder (assuming the shares are held as a
capital asset). If the Fund pays a dividend in January which was declared in the
previous October, November or December to shareholders of record on a specified
date in one of such months, then such dividend will be treated for tax purposes
as being paid by the Fund and received by its shareholders on December 31, of
such year.
The Code subjects interest received on certain otherwise tax-exempt
securities to an alternative minimum tax. The alternative minimum tax applies to
interest received on "private activity bonds" issued after August 7, 1986.
Private activity bonds are bonds which, although tax-exempt, are used for
purposes other than those generally performed by governmental units and which
benefit non-governmental entities (e.g., bonds used for industrial development
or housing purposes). Income received on such bonds is classified as an item of
"tax preference", which could subject investors in such bonds, including
shareholders of the Fund, to an alternative minimum tax. The Fund will purchase
such "private activity bonds", and the Trust will report to shareholders within
60 days after the Fund's taxable year-end, the portion of the Fund's dividends
declared during the year which are a tax preference item for alternative minimum
tax purposes. The Code further
47
<PAGE> 100
provides that corporations are subject to an alternative minimum tax based, in
part, on certain differences between taxable income as adjusted for other tax
preferences and the corporation's "adjusted current earnings", which more
closely reflect a corporation's economic income. Because an exempt-interest
dividend paid by the Fund will be included in adjusted current earnings, a
corporate shareholder may be required to pay alternative minimum tax on
exempt-interest dividends paid by the Fund.
No gain or loss will be recognized by Class B shareholders on the
conversion of their Class B shares into Class D shares. A shareholder's basis in
the Class D shares acquired will be the same as such shareholder's basis in the
Class B shares converted, and the holding period of the acquired Class D shares
will include the holding period for the converted Class B shares.
If a shareholder exercises an exchange privilege within 90 days of
acquiring such shares, then the loss such shareholder can recognize on the
exchange will be reduced (or the gain increased) to the extent the sales charge
paid to the Fund reduces any sales charge such shareholder would have owed upon
purchase of the new shares in the absence of the exchange privilege. Instead,
such sales charge will be treated as an amount paid for the new shares.
A loss realized on a sale or exchange of shares of the Fund will be
disallowed if other Fund shares are acquired (whether through the automatic
reinvestment of dividends or otherwise) within a 61-day period beginning 30 days
before and ending 30 days after the date that the shares are disposed of. In
such a case, the basis of the shares acquired will be adjusted to reflect the
disallowed loss.
Ordinary income dividends paid to shareholders who are nonresident aliens
or foreign entities will be subject to a 30% United States withholding tax under
existing provisions of the Code applicable to foreign individuals and entities
unless a reduced rate of withholding or a withholding exemption is provided
under applicable treaty law. Nonresident shareholders are urged to consult their
own advisers concerning the applicability of the United States withholding tax.
Under certain provisions of the Code, some shareholders may be subject to a
31% withholding tax on certain ordinary income dividends and on capital gain
dividends and redemption payments ("backup withholding"). Generally,
shareholders subject to backup withholding will be those for whom no certified
taxpayer identification number is on file with the Trust or who, to the Trust's
knowledge, have furnished an incorrect number. When establishing an account, an
investor must certify under penalty of perjury that such number is correct and
that such investor is not otherwise subject to backup withholding.
The Code provides that every person required to file a tax return must
include for information purposes on such return the amount of exempt-interest
dividends received from all sources (including the Fund) during the taxable
year.
ENVIRONMENTAL TAX
The Code imposes a deductible tax (the "Environmental Tax") on a
corporation's alternative minimum taxable income (computed without regard to the
alternative tax net operating loss deduction and the deduction for the
Environmental Tax) at a rate of $12 per $10,000 (0.12%) of alternative minimum
taxable income in excess of $2,000,000. The Environmental Tax will be imposed
for taxable years beginning after December 31, 1986 and before January 1, 1996
unless extended. The Environmental Tax will be imposed even if the corporation
is not required to pay an alternative minimum tax because the corporation's
regular income
48
<PAGE> 101
tax liability exceeds its minimum tax liability. The Code provides, however,
that a RIC such as the Fund is not subject to the Environmental Tax. However,
exempt-interest dividends paid by the Fund that create alternative minimum
taxable income for corporate shareholders under the Code (as described above)
may subject corporate shareholders of the Fund to the Environmental Tax.
TAX TREATMENT OF FUTURES AND OPTION TRANSACTIONS
The Fund may write, purchase or sell municipal bond index futures contracts
and interest rate futures contracts on U.S. Government securities ("financial
futures contracts"). The Fund may also purchase and write call and put options
on such financial futures contracts. In general, unless an election is available
to the Fund or an exception applies, such options and financial futures
contracts that are "Section 1256 contracts" will be "marked to market" for
Federal income tax purposes at the end of each taxable year, i.e., each such
option or financial futures contract will be treated as sold for its fair market
value on the last day of the taxable year, and any gain or loss attributable to
Section 1256 contracts will be 60% long-term and 40% short-term capital gain or
loss. Application of these rules to Section 1256 contracts held by the Fund may
alter the timing and character of distributions to shareholders. The
mark-to-market rules outlined above, however, will not apply to certain
transactions entered into by the Fund solely to reduce the risk of changes in
price or interest rates with respect to its investments.
Code Section 1092, which applies to certain "straddles", may affect the
taxation of the Fund's transactions in financial futures contracts and related
options. Under Section 1092, the Fund may be required to postpone recognition
for tax purposes of losses incurred in certain closing transactions in financial
futures contracts or the related options.
One of the requirements for qualification as a RIC is that less than 30% of
the Fund's gross income be derived from gains from the sale or other disposition
of securities held for less than three months. Accordingly, the Fund may be
restricted in effecting closing transactions within three months after entering
into an option or financial futures contract.
------------------
The foregoing is a general and abbreviated summary of the applicable
provisions of the Code, Treasury regulations and applicable California tax laws
presently in effect. For the complete provisions, reference should be made to
the pertinent Code sections, the Treasury regulations promulgated thereunder and
the applicable California tax laws. The Code and the Treasury regulations, as
well as the California tax laws, are subject to change by legislative, judicial
or administrative action either prospectively or retroactively.
Shareholders are urged to consult their tax advisers regarding the
availability of any exemptions from state or local taxes (other than those
imposed by California) and with specific questions as to Federal, foreign, state
or local taxes.
PERFORMANCE DATA
From time to time the Fund may include its average annual total return and
other total return data, as well as yield and tax-equivalent yield, in
advertisements or information furnished to present or prospective shareholders.
From time to time, the Fund may include the Fund's Morningstar risk-adjusted
performance ratings in advertisements or supplemental sales literature. Total
return, yield and tax-equivalent yield figures
49
<PAGE> 102
are based on the Fund's historical performance and are not intended to indicate
future performance. Average annual total return, yield and tax equivalent yield
are determined separately for Class A, Class B, Class C and Class D shares in
accordance with formulas specified by the Commission.
Average annual total return quotations for the specified periods are
computed by finding the average annual compounded rates of return (based on net
investment income and any realized and unrealized capital gains or losses on
portfolio investments over such periods) that would equate the initial amount
invested to the redeemable value of such investment at the end of each period.
Average annual total return is computed assuming all dividends and distributions
are reinvested and taking into account all applicable recurring and nonrecurring
expenses, including the maximum sales charge in the case of Class A and Class D
shares and the CDSC that would be applicable to a complete redemption of the
investment at the end of the specified period in the case of Class B and Class C
shares.
The Fund also may quote annual, average annual and annualized total return
and aggregate total return performance data, both as a percentage and as a
dollar amount based on a hypothetical $1,000 investment for various periods
other than those noted below. Such data will be computed as described above,
except that (1) as required by the periods of the quotations, actual annual,
annualized or aggregate data, rather than average annual data, may be quoted and
(2) the maximum applicable sales charges will not be included with respect to
annual or annualized rates of return calculations. Aside from the impact on the
performance data calculations of including or excluding the maximum applicable
sales charges, actual annual or annualized total return data generally will be
lower than average annual total return data since the average rates of return
reflect compounding of return; aggregate total return data generally will be
higher than average annual total return data since the aggregate rates of return
reflect compounding over a longer period of time.
Set forth below is total return, yield and tax-equivalent yield information
for Class A, Class B, Class C and Class D shares of the Fund for the periods
indicated.
<TABLE>
<CAPTION>
CLASS A SHARES* CLASS B SHARES
------------------------------- -------------------------------
REDEEMABLE REDEEMABLE
VALUE OF A VALUE OF A
EXPRESSED AS HYPOTHETICAL EXPRESSED AS HYPOTHETICAL
A PERCENTAGE $1,000 A PERCENTAGE $1,000
BASED ON A INVESTMENT BASED ON A INVESTMENT
HYPOTHETICAL AT THE END HYPOTHETICAL AT THE END
$1,000 OF $1,000 OF
INVESTMENT THE PERIOD INVESTMENT THE PERIOD
------------ ------------ ------------ ------------
AVERAGE ANNUAL TOTAL RETURN
(including maximum applicable sales charges)
<S> <C> <C> <C> <C>
One Year Ended August 31, 1995..... 2.50 % $ 1,025.00 2.28 % $ 1,022.80
Five Years Ended August 31, 1995... 7.01 % $ 1,403.10 7.34 % $ 1,424.80
Inception (September 30, 1985) to
August 31, 1995................... 8.15 % $ 2,175.60
Inception (October 25, 1988) to
August 31, 1995................... 7.04 % $ 1,593.70
Inception (October 21, 1994) to
August 31, 1995...................
<CAPTION>
CLASS C SHARES** CLASS D SHARES**
------------------------------- -------------------------------
REDEEMABLE REDEEMABLE
VALUE OF A VALUE OF A
EXPRESSED AS HYPOTHETICAL EXPRESSED AS HYPOTHETICAL
A PERCENTAGE $1,000 A PERCENTAGE $1,000
BASED ON A INVESTMENT BASED ON A INVESTMENT
HYPOTHETICAL AT THE END HYPOTHETICAL AT THE END
$1,000 OF $1,000 OF
INVESTMENT THE PERIOD INVESTMENT THE PERIOD
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
One Year Ended August 31, 1995.....
Five Years Ended August 31, 1995...
Inception (September 30, 1985) to
August 31, 1995...................
Inception (October 25, 1988) to
August 31, 1995...................
Inception (October 21, 1994) to
August 31, 1995................... 9.31 % $ 1,079.60 5.88 % $ 1,050.40
</TABLE>
(Footnotes on the following page)
50
<PAGE> 103
<TABLE>
<CAPTION>
CLASS A SHARES* CLASS B SHARES
------------------------------- -------------------------------
REDEEMABLE REDEEMABLE
VALUE OF A VALUE OF A
EXPRESSED AS HYPOTHETICAL EXPRESSED AS HYPOTHETICAL
A PERCENTAGE $1,000 A PERCENTAGE $1,000
BASED ON A INVESTMENT BASED ON A INVESTMENT
HYPOTHETICAL AT THE END HYPOTHETICAL AT THE END
$1,000 OF $1,000 OF
INVESTMENT THE PERIOD INVESTMENT THE PERIOD
------------ ------------ ------------ ------------
ANNUAL TOTAL RETURN
(excluding maximum applicable sales charges)
<S> <C> <C> <C> <C>
Year Ended August 31,
1995.............................. 6.77% $1,067.70 6.28% $1,062.80
1994.............................. (.92)% $ 990.80 (1.50)% $ 985.00
1993.............................. 13.19% $1,131.90 12.62% $1,126.20
1992.............................. 10.23% $1,102.30 9.68% $1,096.80
1991.............................. 10.73% $1,107.30 10.18% $1,101.80
1990.............................. 5.21% $1,052.10 4.58% $1,045.80
1989.............................. 11.14% $1,111.40
1988.............................. 5.05% $1,050.50
1987.............................. 1.52% $1,015.20
Inception (September 30, 1985) to
August 31, 1986................... 23.19% $1,231.90
Inception (October 25, 1988) to
August 31, 1989................... 7.96% $1,079.60
Inception (October 21, 1994) to
August 31, 1995...................
<CAPTION>
AGGREGATE TOTAL RETURN
(including maximum applicable sales charges)
<S> <C> <C> <C> <C>
Inception (September 30, 1985) to
August 31, 1995.................. 117.56% $2,175.60
Inception (October 25, 1988) to
August 31, 1995................... 59.37% $1,593.70
Inception (October 21, 1994) to
August 31, 1995...................
<CAPTION>
YIELD
<S> <C> <C> <C> <C>
30 days ended on August 31, 1995... 5.17% 4.89%
<CAPTION>
TAX-EQUIVALENT YIELD***
<S> <C> <C> <C> <C>
30 days ended on August 31, 1995... 7.18% 6.79%
<CAPTION>
CLASS C SHARES** CLASS D SHARES**
------------------------------- -------------------------------
REDEEMABLE REDEEMABLE
VALUE OF A VALUE OF A
EXPRESSED AS HYPOTHETICAL EXPRESSED AS HYPOTHETICAL
A PERCENTAGE $1,000 A PERCENTAGE $1,000
BASED ON A INVESTMENT BASED ON A INVESTMENT
HYPOTHETICAL AT THE END HYPOTHETICAL AT THE END
$1,000 OF $1,000 OF
INVESTMENT THE PERIOD INVESTMENT THE PERIOD
------------ ------------ ------------ ------------
ANNUAL TOTAL RETURN
(excluding maximum applicable sales charges)
<S> <C> <C> <C> <C>
Year Ended August 31,
1995..............................
1994..............................
1993..............................
1992..............................
1991..............................
1990..............................
1989..............................
1988..............................
1987..............................
Inception (September 30, 1985) to
August 31, 1986...................
Inception (October 25, 1988) to
August 31, 1989...................
Inception (October 21, 1994) to
August 31, 1995................... 8.96% $1,089.60 9.42% $1,094.20
<CAPTION>
AGGREGATE TOTAL RETURN
(including maximum applicable sales charges)
<S> <C> <C> <C> <C>
Inception (September 30, 1985) to
August 31, 1995..................
Inception (October 25, 1988) to
August 31, 1995...................
Inception (October 21, 1994) to
August 31, 1995................... 7.96% $1,079.60 5.04% $1,050.40
<CAPTION>
YIELD
<S> <C> <C> <C> <C>
30 days ended on August 31, 1995... 4.78% 5.08%
<CAPTION>
TAX-EQUIVALENT YIELD***
<S> <C> <C> <C> <C>
30 days ended on August 31, 1995... 6.64% 7.06%
</TABLE>
- ---------------
* Information as to Class A shares is presented only for the period October
25, 1988 to August 31, 1995. Prior to October 25, 1988, no Class A shares
were publicly issued.
** Information as to Class C and Class D shares is presented only for the
period October 21, 1994 (commencement of operations) to August 31, 1995.
Prior to October 21, 1994, no Class C or Class D shares had been publicly
issued.
*** Based on a Federal income tax rate of 28%.
In order to reflect the reduced sales charges in the case of Class A or
Class D shares or the waiver of the contingent deferred sales charge in the case
of Class B or Class C shares applicable to certain investors, as described under
"Purchase of Shares" and "Redemption of Shares", respectively, the total return
data quoted by the Fund in advertisements directed to such investors may take
into account the reduced, and not the maximum, sales charge or may take into
account the CDSC and therefore may reflect greater total return since, due to
the reduced sales charges or the waiver of sales charges, a lower amount of
expenses is deducted.
51
<PAGE> 104
GENERAL INFORMATION
DESCRIPTION OF SERIES AND SHARES
The Declaration of Trust provides that the Trust shall be comprised of
separate series ("Series") each of which will consist of a separate portfolio
which will issue separate shares. The Trust is presently comprised of the Fund
and Merrill Lynch California Insured Municipal Bond Fund. The Trustees are
authorized to create an unlimited number of Series and, with respect to each
Series, to issue an unlimited number of full and fractional shares of beneficial
interest, par value $.10 per share, of different classes and to divide or
combine the shares into a greater or lesser number of shares without thereby
changing the proportionate beneficial interests in the Series. Shareholder
approval is not necessary for the authorization of additional Series or classes
of a Series of the Trust. At the date of this Statement of Additional
Information, the shares of the Fund are divided into Class A, Class B, Class C
and Class D shares. Class A, Class B, Class C and Class D shares represent
interests in the same assets of the Fund and are identical in all respects
except that the Class B, Class C and Class D shares bear certain expenses
related to the account maintenance and/or distribution of such shares and have
exclusive voting rights with respect to matters relating to such account
maintenance and/or distribution expenditures. See "Purchase of Shares". The
Trust has received an order from the Commission permitting the issuance and sale
of multiple classes of shares. The order permits the Trust to issue additional
Classes of shares of any Series if the Board of Trustees deems such issuance to
be in the best interests of the Trust.
All shares of the Trust have equal voting rights, except that only shares
of the respective Series are entitled to vote on matters concerning only that
Series and, as noted above, Class B, Class C and Class D shares have exclusive
voting rights with respect to matters relating to the account maintenance and/or
distribution expenses being borne solely by such class. Each issued and
outstanding share is entitled to one vote and to participate equally in
dividends and distributions declared by the respective Series and in net assets
of such Series upon liquidation or dissolution remaining after satisfaction of
outstanding liabilities, except that, as noted above, expenses related to the
account maintenance and/or distribution of the Class B, Class C and Class D
shares are borne solely by such class. 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. Shareholders may, in
accordance with the terms of the Declaration of Trust, cause a meeting of
shareholders to be held for the purpose of voting on the removal of Trustees.
Also, the Trust will be required to call a special meeting of shareholders in
accordance with the requirements of the 1940 Act to seek approval of new
management and advisory arrangements, of a material increase in distribution
fees or of a change in the fundamental policies, objectives or restrictions of a
Series.
The obligations and liabilities of a particular Series are restricted to
the assets of that Series and do not extend to the assets of the Trust
generally. The shares of each Series, when issued, will be fully paid and
nonassessable, have no preference, preemptive, conversion, exchange or similar
rights, and are freely transferable. Holders of shares of any Series are
entitled to redeem their shares as set forth elsewhere herein and in the
Prospectus. Shares do not have cumulative voting rights and the holders of more
than 50% of the shares of the Trust voting for the election of Trustees can
elect all of the Trustees if they choose to do so and in such event the holders
of the remaining shares would not be able to elect any Trustees. No amendments
may
52
<PAGE> 105
be made to the Declaration of Trust without the affirmative vote of a majority
of the outstanding shares of the Trust.
The Manager provided the initial capital for the Fund by purchasing 10,000
shares of the Fund for $100,000. Such shares were acquired for investment and
can only be disposed of by redemption. The organizational expenses of the Fund
were paid by the Fund and were amortized over a period not exceeding five years.
The proceeds realized by the Manager upon the redemption of any of the shares
initially purchased by it will be reduced by the proportionate amount of any
remaining unamortized organizational expenses which the number of shares
redeemed bears to the number of shares initially purchased. Such organizational
expenses include certain of the initial organizational expenses of the Trust
which have been allocated to the Fund by the Trustees. If additional Series are
added to the Trust, the organizational expenses will be allocated among the
Series in a manner deemed equitable by the Trustees.
COMPUTATION OF OFFERING PRICE PER SHARE
An illustration of the computation of the offering price for Class A, Class
B, Class C and Class D shares of the Fund, based on the value of the Fund's net
assets and number of shares outstanding as of August 31, 1995, is set forth
below.
<TABLE>
<CAPTION>
AUGUST 31, 1995
----------------------------------------------------------
CLASS A CLASS B CLASS C CLASS D
----------- ------------ ---------- ----------
<S> <C> <C> <C> <C>
Net Assets............................. $44,228,256 $616,198,905 $3,130,524 $3,846,498
========== =========== ========= =========
Number of Shares Outstanding........... 3,880,999 54,055,554 274,709 337,469
========== =========== ========= =========
Net Asset Value Per Share (net assets
divided by number of shares
outstanding)......................... $ 11.40 $ 11.40 $ 11.40 $ 11.40
Sales Charge (for Class A and Class D
shares: 4.00% of offering price
(4.17% of net asset value per
share))*............................. .48 ** ** .48
----------- ------------ ---------- ----------
Offering Price......................... $ 11.88 $ 11.40 $ 11.40 $ 11.88
========== =========== ========= =========
</TABLE>
- ---------------
* Rounded to the nearest one-hundredth percent; assumes maximum sales charge is
applicable.
** Class B and Class C shares are not subject to an initial sales charge but may
be subject to a CDSC on redemption. See "Purchase of Shares--Deferred Sales
Charge Alternatives--Class B and Class C Shares" in the Prospectus.
INDEPENDENT AUDITORS
Deloitte & Touche LLP, 117 Campus Drive, Princeton, New Jersey 08540-6400,
has been selected as the independent auditors of the Trust. The independent
auditors are responsible for auditing the annual financial statements of the
Trust.
CUSTODIAN
The Bank of New York, 90 Washington Street, 12th Floor, New York, New York
10286, acts as the Custodian of the Fund's assets. The Custodian is responsible
for safeguarding and controlling the Fund's cash and securities, handling the
receipt and delivery of securities and collecting interest on the Fund's
investments.
53
<PAGE> 106
TRANSFER AGENT
Merrill Lynch Financial Data Services, Inc., 4800 Deer Lake Drive East,
Jacksonville, Florida 32246-6484, acts as the Fund's Transfer Agent. The
Transfer Agent is responsible for the issuance, transfer and redemption of
shares and the opening, maintenance and servicing of shareholder accounts. See
"Management of the Trust--Transfer Agency Services" in the Prospectus.
LEGAL COUNSEL
Brown & Wood, One World Trade Center, New York, New York 10048-0557, is
counsel for the Trust.
REPORTS TO SHAREHOLDERS
The fiscal year of the Fund ends on August 31 of each year. The Trust sends
to its shareholders at least semi-annually reports showing the Fund's portfolio
and other information. An annual report, containing financial statements audited
by independent auditors, is sent to shareholders each year. After the end of
each year shareholders will receive Federal income tax information regarding
dividends and capital gains distributions.
ADDITIONAL INFORMATION
The Prospectus and this Statement of Additional Information do not contain
all of the information set forth in the Registration Statement and the exhibit
relating thereto, which the Trust has filed with the Commission, Washington,
D.C., under the Securities Act of 1933 and the Investment Company Act of 1940,
to which reference is hereby made.
------------------
The Declaration of Trust establishing the Trust dated March 20, 1985, a
copy of which, together with all amendments thereto (the "Declaration"), is on
file in the office of the Secretary of the Commonwealth of Massachusetts,
provides that the name "Merrill Lynch California Municipal Series Trust" refers
to the Trustees under the Declaration collectively as Trustees, but not as
individuals or personally; and no Trustee, shareholder, officer, employee or
agent of the Trust shall be held to any personal liability, nor shall resort be
had to their private property for the satisfaction of any obligation or claim of
the Trust, but the "Trust Property" (as defined in the Declaration) only shall
be liable.
To the knowledge of the Trust, no person or entity owned beneficially 5% or
more of the Fund's shares on December 1, 1995.
54
<PAGE> 107
APPENDIX I
ECONOMIC AND OTHER CONDITIONS IN CALIFORNIA
The following information is a brief summary of factors affecting the
economy of the State and does not purport to be a complete description of such
factors. Other factors will affect issuers. The summary is based primarily upon
one or more publicly available offering statements relating to debt offerings of
state issuers, however, it has not been updated nor will it be updated during
the year. The Trust has not independently verified the information.
ECONOMIC CONDITIONS
The economy of the State of California (sometimes referred to as the
"State") is the largest among the 50 states and one of the largest in the world.
Total employment is about 14 million, with major employment in the agriculture,
manufacturing, high technology, services, trade, entertainment and construction
sectors. Total gross domestic product of about $835 billion in 1994 was larger
than all but six nations in the world.
California's July 1, 1994 population of over 32 million represented over 12
percent of the total United States population. The official 1990 Census
population was 29,760,021 as of April 1, 1990, which represented an increase of
over 6 million persons, or 26 percent, during the decade of the 1980's. As of
the April 1, 1990 census, the median age of California's population was 31.5
years, younger than the 1990 U.S. median of 32.9 years.
California's population is concentrated in metropolitan areas. As of the
April 1, 1990 Census, 96 percent resided in the 23 Metropolitan Statistical
Areas in the State. Overall, California's population per square mile was 191 in
1990. As of July 1, 1994, 69 percent of the population of the State was located
in the two consolidated Metropolitan Statistical Areas in California. The
5-county Los Angeles area accounted for 48 percent, with 15.6 million residents.
The 10-county San Francisco Bay Area represented 21 percent, with a population
of 6.7 million.
Recent studies indicate changes in the State's population dynamics. Since
1990, population growth has shifted to depend on births and foreign immigration.
Net movements within the U.S. were negative during the State's economic
recession in 1991-94, but domestic immigration to the State has increased as the
State's economy has improved. The population is expected to become more
ethnically diverse into the next century, with the Latino and Asian populations
growing faster than other groups.
California. Starting in mid-1990, the State entered a sustained economic
recession, somewhat later than the rest of the nation. It was the most severe
recession in the State since the 1930's, with job losses estimated at over
800,000, particularly in the manufacturing (predominately aerospace), services
and construction sectors. The greatest effects were felt in Southern California.
A significant portion of these losses are linked to post-Cold War cuts in the
federal defense budget and military base closures. The trough of the recession
is estimated to have occurred in late 1993, again later than for the nation as a
whole. Although a steady recovery has been underway since 1994, pre-recession
employment levels are not expected to be reached until later in the decade.
Northridge Earthquake. On January 17, 1994, a major earthquake measuring
an estimated 6.8 on the Richter Scale struck the Los Angeles metropolitan area,
centered in the Northridge area of the City of Los Angeles. Significant property
damage, estimated at $15-20 billion, occurred to private and public facilities
in a
55
<PAGE> 108
four-county area including northern Los Angeles County, Ventura County and parts
of Orange and San Bernardino Counties. These counties were declared as State and
federal disaster areas by January 18. Much of this damage will be compensated by
insurance or government aid; although the remaining losses total several billion
dollars, this amount is small compared to the overall wealth of the region. The
effects of the earthquake are not expected to have a material impact on the
State's overall economic performance.
The State. In the years following enactment of the federal Tax Reform Act
of 1986, and conforming changes to the State's tax laws, taxpayer behavior
became much more difficult to predict, and the State experienced a series of
fiscal years in which revenue came in significantly higher or lower than
original estimates. The 1989-90 Fiscal Year ended with revenues below estimates,
so that the State's budget reserve (the Special Fund for Economic Uncertainties
or "SFEU") was fully depleted by June 30, 1990. This date essentially coincided
with the start of the current recession, which severely affected State General
Fund revenues, and increased expenditures above initial budget appropriations
due to greater health and welfare costs. The State's budget problems in recent
years have also been caused by a structural imbalance which has been identified
by the current and previous Administrations. The largest General Fund
Programs --K-14 education, health, welfare and corrections --were increasing
faster than the revenue base, driven by the State's rapid population growth.
These pressures will continue as population trends maintain strong demand for
health and welfare services, as the school age population continues to grow, and
as the State's corrections program responds to a "Three Strikes" law enacted in
1994, which requires mandatory life prison terms for certain third-time felony
offenders.
As a result of these factors and others, from the late 1980's until
1992-93, the State had a period of budget imbalance. During this period,
expenditures exceeded revenues in four out of six years, and the State
accumulated and sustained a budget deficit in the SFEU approaching $2.8 billion
at its peak at June 30, 1993. Starting in the 1990-91 Fiscal Year and for each
fiscal year thereafter, each budget required multibillion dollar actions to
bring projected revenues and expenditures into balance and to close large
"budget gaps" which were identified. Despite budget actions by the Legislature,
the effects of the recession led to large, unanticipated deficits in the budget
reserve, the SFEU, as compared to projected positive balances. By the 1993-94
Fiscal Year, the accumulated deficit was so large that it was impractical to
budget to retire it in one year, so a two-year program was implemented, using
the issuance of revenue anticipation warrants to carry a portion of the deficit
over the end of the fiscal year. When the economy failed to recover sufficiently
in 1993-94, a second two-year plan was implemented in 1994-95.
Another consequence of the accumulated budget deficits, together with other
factors such as disbursement of funds to local school districts "borrowed" from
future fiscal years and hence not shown in the annual budget, was to
significantly reduce the State's cash resources available to pay its ongoing
obligations. The State's cash condition became so serious in late spring of 1992
that the State Controller was required to issue revenue anticipation warrants
maturing in the following fiscal year in order to pay the State's continuing
obligations. The State was forced to rely increasingly on external debt markets
to meet its cash needs, as a succession of notes and warrants were issued in the
period from June 1992 to July 1994, often needed to pay previously maturing
notes or warrants. These borrowings were used also in part to spread out the
repayment of the accumulated budget deficit over the end of a fiscal year.
The 1994-95 Fiscal Year represented the fourth consecutive year the
Governor and Legislature were faced with a very difficult budget environment to
produce a balanced budget. Many program cuts and budgetary adjustments had
already been made in the last three years. The Governor's Budget Proposal, as
56
<PAGE> 109
updated in May and June, 1994, recognized that the accumulated deficit could not
be repaid in one year, and proposed a two-year solution. The budget proposal set
forth revenue and expenditure forecasts and revenue and expenditure proposals
which result in operating surpluses for the budget for both 1994-95 and 1995-96,
and lead to the elimination of the accumulated budget deficit, estimated at
about $1.8 billion at June 30, 1994, by June 30, 1996.
Reports by the Department of Finance in May, 1995 indicate that, with
economic recovery well underway in the State, General Fund revenues for the
entire 1994-95 Fiscal Year were above projections, and expenditures were below
projections because of slower than anticipated health/welfare caseload growth
and school enrollments. The aggregate effect improved the budget picture by
about $500 million, leaving an estimated budget deficit of about $630 million at
June 30, 1995.
Analysis of the federal Fiscal Year 1995 budget by the Department of
Finance indicates that about $98 million was appropriated for California to
offset costs of incarceration of illegal immigrants, less than the $356 million
which was assumed in the State's 1994-95 Budget Act. Because of timing
considerations in applying for these federal funds, the Department of Finance
estimates that about $33 million of these funds will have been received during
the State's 1994-95 Fiscal Year, with the balance received in the current fiscal
year. It does not appear that the federal budget contains any of the additional
$400 million in funding for refugee assistance and health costs which were also
assumed in the 1994-95 Budget Act.
Pursuant to the Budget Adjustment Law (the "Law"), the State Controller was
required to make a report by November 15, 1994 on whether the projected cash
resources for the General Fund as of June 30, 1995 would decrease more than $430
million from the amount projected by the State in its Official Statement in
July, 1994 for the sale of $4,000,000,000 of Revenue Anticipation Warrants. On
November 15, 1994, the State Controller issued the report on the State's cash
position required by the Law. The report indicated that the cash position of the
General Fund on June 30, 1995 would be $581 million better than was estimated in
the July, 1994 cash flow projections and therefore, no budget adjustment
procedures will be invoked for the 1994-95 Fiscal Year.
The second step in the process was for the Director of Finance to include
updated cash-flow statements for the 1994-95 and 1995-96 Fiscal Years in the May
revision to the 1995-96 Fiscal Year budget proposal and for the State Controller
to either concur with these updated statements or provide a report to the
Governor and the Legislature identifying specific corrections, objections or
concerns and the State Controller's estimate of the cash condition of the
General Fund for the 1994-95 and 1995-96 Fiscal Years. On June 1, 1995, the
State Controller issued a report assessing the May 1995 Revision of the
Governor's Budget (the "May Revision"). The May Revision had projected that by
June 30, 1996, the General Fund would have about $1.8 billion in borrowable
resources. The State Controller noted that this estimate was based on a number
of assumptions, which might not be fulfilled, including a relatively high
estimate of economic growth, reliance on a level of federal funds that might not
be forthcoming and federal government actions regarding welfare and health
waivers that might not be approved, and possible costs from ongoing litigation.
The State Controller projected that, in a "worst-case" scenario where all the
May Revision estimates were found to be too optimistic, the $1.8 billion cushion
of cash resources could disappear and a $500 million deficit would result,
forcing the "trigger" to be pulled on October 15.
The third step in the process occurred on October 15, 1995, when the State
Controller, in conjunction with the Legislative Analyst's Office, reviewed the
estimated cash condition of the General Fund for the
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1995-96 Fiscal Year. The State Controller estimates that the General Fund would
not have negative internal cash resources on June 30, 1996 (i.e., external
borrowing would be needed to pay all obligations due) (the "October Report"). If
a cash shortfall had been identified by the State Controller, the State
Legislature would have been required to enact legislation providing for
sufficient General Fund expenditure reductions, revenue increases, or both.
1995-96 Budget Act. On January 10, 1995, the Governor presented his
1995-96 Fiscal Year Budget Proposal (the "Proposed Budget"). Two of the
principal features of the Proposed Budget were a phased, 15% cut in personal
income and corporate taxes, and a further expansion of the "realignment" process
to transfer more responsibility and funding sources for certain health and
welfare programs to local governments. Neither of these proposals was approved
by the Legislature. As a result of the improving economy, with resulting
improved revenue and caseload estimates, the State entered the 1995-96 Budget
negotiations with the smallest nominal "budget gap" to be closed in many years.
The 1995-96 Budget Act was signed by the Governor on August 3, 1995. The
Budget Act projects General Fund revenues and transfers of $44.1 billion, a 3.5
percent increase from the prior year. Expenditures are budgeted at $43.4
billion, a 4 percent increase. The Department of Finance projects that, after
repaying the last of the carryover budget deficit, there will be a positive
balance of $28 million in the budget reserve, the SFEU at June 30, 1996. The
Budget Act also projects Special Fund revenues of $12.7 billion and appropriates
Special Fund expenditures of $13.4 billion.
Subsequent Developments. Reports from the Department of Finance indicate
that State General Fund revenues through the first four months of the 1995-96
fiscal year were about $676 million, or 5.4%, above Budget Act projections. For
the four months, personal income tax (primarily estimated tax payments) were
$261 million (4.6%) above projection; sales and use taxes were $151 million
(3.5%) above projection, and bank and corporation taxes (also primarily
estimated tax payments) were $182 million (12.7%) above projection.
The State Controller's October Report, while finding no need to impose
automatic budget cuts, noted a number of areas where there was likely to be a
divergence from the original budget estimates. On the positive side, the State
Controller noted that improving economic conditions were leading to improved
cash receipts. On the negative side, the October Report estimated that federal
actions to allow health and welfare cuts and to reimburse the State for illegal
immigrant costs were not likely to provide as much money as had been planned,
and that Proposition 98 expenditures for K-14 schools had been underestimated.
In addition, the State Controller reported that an annual review of internal
borrowable resources resulted in a $705 million increase of estimated available
internal borrowable resources. In total, therefore, the State Controller
estimated that the State's cash position on June 30, 1996 would be about $500
million worse than the estimate of $1.9 billion of available internal cash
resources included in the original budget, but still large enough to avoid the
Budget Adjustment Law cuts.
Orange County Bankruptcy. On December 6, 1994, Orange County, California
(the "County"), together with its pooled investment funds (the "Funds") filed
for protection under Chapter 9 of the federal Bankruptcy Code, after reports
that the Funds had suffered significant market losses in their investments,
causing a liquidity crisis for the Funds and the County. More than 180 other
public entities, most of which, but not all, are located in the County, were
also depositors in the Funds. The County has reported the Funds' loss at about
$1.54 billion, or about 23% of their initial deposits of approximately $7.5
billion. Many of the entities
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which deposited moneys in the Funds, including the County, faced interim and/or
extended cash flow difficulties because of the bankruptcy filing and may be
required to reduce programs or capital projects.
On May 2, 1995, the United States Bankruptcy Court approved a settlement
agreement covering claims of the other participating entities against the County
and the Funds. Most participants have received in cash 80% (90% for school
districts) of their Funds' investment; the balance is to be paid in the future.
The County succeeded in deferring, by consent of the holders thereof, until June
30, 1996, the repayment of $800 million of short-term obligations due in July
and August, 1995; these notes are, however, considered to be in default by
Moody's and Standard & Poor's. On June 27, 1995, County voters turned down a
proposal for a temporary 0.5% increase in the local sales tax to replace
revenues lost after the Funds' investment losses. It is anticipated that a
recovery plan (the "Plan") including, among others, the County and participants
in the Funds will be arrived at in the near future. The Plan has been approved
by the State Legislature and the Governor.
The State has no existing obligation with respect to any outstanding
obligations or securities of the County or any of the other participating
entities. However, in the event the County is unable to maintain County
administered State programs because of insufficient resources, it may be
necessary for the State to intervene, although no prediction can be made what,
if any, action may occur.
LOCAL GOVERNMENTS
The primary units of local government in California are the counties,
ranging in population from 1,300 (Alpine) to over 9,000,000 (Los Angeles).
Counties are responsible for the provision of many basic services, including
indigent healthcare, welfare, courts, jails and public safety in unincorporated
areas. There are also about 480 incorporated cities, and thousands of other
special districts formed for education, utility and other services. The fiscal
condition of local governments has been constrained since the enactment of
"Proposition 13" in 1978, which reduced and limited the future growth of
property taxes, and limited the ability of local governments to impose other
taxes. Counties, in particular, have had fewer options to raise revenues than
many other local government entities, and have been required to maintain many
services.
In the aftermath of Proposition 13, the State provided aid from the General
Fund to make up some of the loss of property tax moneys, including taking over
the principal responsibility for funding local K-12 schools and community
colleges. Under the pressure of the recent recession, the Legislature has
eliminated the remnants of this post-Proposition 13 aid to entities other than
K-14 education districts, although it has also provided additional funding
sources (such as sales taxes) and reduced mandates for local services. Many
counties continue to be under severe fiscal stress. While such stress has in
recent years most often been experienced by smaller, rural counties, larger
urban counties, such as Los Angeles, have also been affected.
CONSTITUTIONAL AND STATUTORY LIMITATIONS; RECENT INITIATIVES; PENDING LITIGATION
Article XIIIA of the California Constitution (which resulted from the
voter-approved Proposition 13 in 1978) limits the taxing powers of California
public agencies. Article XIIIA provides that the maximum ad valorem tax on real
property cannot exceed 1% of the "full cash value" of the property, and
effectively prohibits the levying of any other ad valorem property tax for
general purposes. However, on May 3, 1986, Proposition 46, an amendment to
Article XIIIA, was approved by the voters of the State of California, creating a
new exemption under Article XIIIA permitting an increase in ad valorem taxes on
real property in excess of 1% for bonded indebtedness approved by two-thirds of
the voters voting on the proposed indebtedness. "Full cash value" is defined as
"the County Assessor's valuation of real property as shown on the 1975-76 tax
bill under "full cash value" or, thereafter, the appraised value of real
property when purchased,
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newly constructed, or a change in ownership has occurred after the 1975
assessment." The "full cash value" is subject to annual adjustment to reflect
increases (not to exceed 2%) or decreases in the consumer price index or
comparable local data, or to reflect reductions in property value caused by
damage, destruction or other factors.
Article XIIIB of the California Constitution limits the amount of
appropriations of the State and of local governments to the amount of
appropriations of the entity for the prior year, adjusted for changes in the
cost of living, population and the services that the local government has
financial responsibility for providing. To the extent the revenues of the State
and/or local government exceed its appropriations, the excess revenues must be
rebated to the public either directly or through a tax decrease. Expenditures
for voter-approved debt services are not included in the appropriations limit.
In 1986, California voters approved an initiative statute known as
Proposition 62. This initiative (i) required that any tax for general
governmental purposes imposed by local governments be approved by a majority of
the electorate of the government entity, (ii) required that any special tax
(defined as taxes levied for other than general government purposes) imposed by
a local government entity be approved by a two-thirds vote of the voters within
that jurisdiction, (iii) restricted the use of revenues from a special tax to
the purposes or for the service for which the special tax is imposed, (iv)
prohibited the imposition of ad valorem taxes on real property by local
governmental entities except as permitted by Article XIIIA, (v) prohibited the
imposition of transaction taxes and sales taxes on the sale of real property by
local governments, (vi) required that any tax imposed by a local government on
or after August 1, 1985 be ratified by a majority vote of the electorate within
two years of the adoption of the initiative or be terminated by November 15,
1988, (vii) required that, in the event a local government fails to comply with
the provisions of this measure, a reduction in the amount of property tax
revenues allocated to such local government occurs in an amount equal to the
revenues received by such entity attributable to the tax levied in violation of
the initiative, and (viii) permitted those provisions to be amended exclusively
by the voters of the State of California.
On September 28, 1995 the California Supreme Court upheld the
constitutionality of the provision requiring a two-thirds vote in order for a
local government to impose a "special tax." Although the Supreme Court has yet
to rule on the provision requiring a majority vote for a "general tax," it
appears the Supreme Court is favorably disposed to uphold that portion of
Proposition 62 as well. In that event, a number of taxes currently being
collected (especially by counties and general law cities) would be invalidated.
Prior collection of such taxes may also be subject to claims for refund unless
the Supreme Court chooses to apply its ruling prospectively. The California
Supreme Court has yet to consider the validity of Proposition 62 to charter
cities.
At the November 9, 1988 general election, California voters approved an
initiative known as Proposition 98. This initiative amends Article XIIIB to
require that (i) the California Legislature establish a prudent state reserve
fund in an amount as it shall deem reasonable and necessary and (ii) revenues in
excess of amounts permitted to be spend and which would otherwise be returned
pursuant to Article XIIIB by revision of tax rates or fee schedules be
transferred and allocated (up to a maximum of 40%) to the State School Fund and
be expended solely for purposes of instructional improvement and accountability.
Proposition 98 also amends Article XVI to require that the State of California
provide a minimum level of funding for public schools and community colleges.
Commencing with the 1988-89 fiscal year, money to be applied by the State for
the support of school districts and community college districts shall not be
less than the greater of: (i) the amount which, as a percentage of the State
general fund revenues which may be appropriated pursuant to Article XIIIB,
equals the percentage of such State general fund revenues appropriated for
school districts and community college districts, respectively, in fiscal year
1986-87 or (ii) the
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amount required to ensure that the total allocations to school districts and
community college districts from the State general fund proceeds of taxes
appropriated pursuant to Article XIIIB and allocated local proceeds of taxes
shall not be less than the total amount from these sources in the prior year,
adjusted for increases in enrollment and adjusted for changes in the costs of
living pursuant to the provisions of Article XIIIB. The initiative permits the
enactment of legislation, by a two-thirds vote, to suspend the minimum funding
requirement for one year. As a result of Proposition 98, funds that the State
might otherwise make available to its political subdivisions may be allocated
instead to satisfy such minimum funding level.
On November 3, 1992, voters approved an initiative statute, Proposition
163, which exempts certain food products, including candy and other snack foods,
from California's sales tax. The sales tax had been broadened to include those
items as part of the 1991-92 budget legislation. The State Legislative Analyst
estimates a revenue reduction of $300 million per year ($200 million in
1992-93).
Article XIIIA, Article XIIIB and a number of propositions were adopted
pursuant to California's constitutional initiative process. From time to time,
other initiative measures could be adopted by California voters. The adoption of
any such initiatives may cause California issuers to receive reduced revenues,
or to increase expenditures, or both.
RECENT INITIATIVES
Proposition 187. On November 8, 1994 the voters approved Proposition 187,
an initiative statute ("Proposition 187"). Proposition 187 specifically
prohibits public funding of social services, health care services and public
school education for the benefit of any person not verified as either a United
States citizen or a person legally admitted to the United States. Among the
provisions in Proposition 187 the measure requires, commencing January 1, 1995,
that every school district in the state verify the legal status of every child
enrolling in the district for the first time. By January 1, 1996, each school
district must also verify the legal status of children already enrolled in the
district and of all parents or guardians of all students. If the district
"reasonably suspects" that a student, parent or guardian is not legally in the
United States, that district must report the student to the United States
Immigration and Naturalization Service and certain other parties. The
Legislative Analyst estimates that verification costs could be in the tens of
millions of dollars on a statewide level (including verification costs incurred
by other local governments) with first-year costs potentially in excess of $100
million.
The reporting requirements may violate the Family Educational Rights and
Privacy Act ("FERPA"), which generally prohibits schools that receive federal
funds from disclosing information in student records without parental consent.
Compliance with FERPA is a condition of receiving federal education funds, which
total $2.3 billion annually to California school districts. The Secretary of the
United States Department of Education has indicated that the reporting
requirement in Proposition 187 could jeopardize the ability of school districts
to receive these funds.
Opponents of Proposition 187 have filed at least eight lawsuits challenging
the constitutionality and validity of the measure. A United States District
Court judge overseeing four of the lawsuits has granted an injunction enjoining
the implementation of most of the provisions of Proposition 187, pending a trial
on the merits.
Pending Litigation. The State is a party to numerous legal proceedings,
many of which normally occur in governmental operations. Some of the
more-significant lawsuits pending against the State are described herein.
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The State is a defendant in 12 lawsuits involving the exclusion of small
business stock gains from preference tax and in some cases, also from taxation.
The lead cases are Mervin Morris v. Franchise Tax Board and James Lennane v.
Franchise Tax Board. The majority of the remaining cases had been deferred
pending the outcome of the Morris and Lennane cases. The Supreme Court has ruled
against the State in Lennane but has not yet ruled in Morris. The State will
lose at least $80 million as a result of the Lennane decision.
The State has lost several tax cases relating to the State's method of
determining the tax on gross health insurance premiums. The loss to the State
will be approximately $200 million.
In Parr v. State of California, a complaint was filed in federal court
claiming that payment of wages in registered warrants violated the Fair Labor
Standards Act ("FLSA"). The federal court held that the issuance of registered
warrants does violate the FLSA but subsequently withdrew its order. Further
proceedings are uncertain at this time. If the State loses, the maximum amount
of damages could be approximately $500 million.
The State is involved in a lawsuit seeking reimbursement for alleged
state-mandated costs. In Thomas Hayes v. Commission on State Mandates, the State
Director of Finance is appealing a 1984 decision by the State Board of Control.
The Board of Control decided in favor of local school districts' claims for
reimbursement for special education programs for handicapped students; however,
funds have not been appropriated. The amount of potential liability to the
State, if all potentially eligible school districts pursue timely claims, has
been estimated by the Department of Finance at over $1 billion.
In another case, the State is a defendant in Long Beach Unified School
District v. State of California. In this case, the school district seeks
reimbursement for voluntary desegregation costs incurred in the implementation
of California Department of Education guidelines. The years of reimbursement are
from fiscal year 1977-78 and each fiscal year thereafter to the present. The
district prevailed in a superior court, and the case has been decided by a State
appellate court against the State. A petition for review was denied and the
superior court judgment has become final, but the court retains jurisdiction to
oversee payment. The State anticipates that the unfavorable outcome will affect
pending claims by other school districts, and the total loss could be in excess
of $300 million.
A federal Court of Appeals in the case of Deanna Beno et al. v. Donna
Shalala, et al., reversing a trial court ruling in favor of the State, recently
determined that the Secretary of the United States Department of Health and
Human Services violated the federal Administrative Procedure Act when she
approved California's Assistance Payment Demonstration Project, which, in part,
granted California a waiver from complying with requirements for state
participation in the federal program for medical assistance (Medicaid). The
waiver had allowed California to reduce payments under the Aid to Families with
Dependent Children program (AFDC) below 1988 payment levels without violating
Medicaid requirements relating to maintenance of AFDC payment levels. California
had relied, in part, on the waiver to reduce state AFDC payments in 1992, 1993
and 1994. The Court of Appeals remanded the case to the trial court with
instructions to remand the demonstration project to the Secretary for additional
consideration of objections raised by the plaintiffs. The effect of the court's
decision on California is uncertain at this time.
One of the features of the 1994-95 Budget Act is a 2.3 percent reduction in
AFDC payments. In Welch v. Anderson, on August 19, 1994, the San Francisco
Superior Court issued a preliminary injunction against the California Director
of Social Services to prevent the 2.3 percent AFDC cuts from becoming effective
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September 1, 1994. While September cuts were already in process and could not be
halted, the court ordered the cuts to be restored. The preliminary injunction
has been appealed and the case on the merits remains pending.
The State is involved in two lawsuits related to contamination at the
Stringfellow toxic waste site. In one suit, the State is one of approximately
130 defendants in Penny Newman v. J. B. Stringfellow, et. al. in which 3,800
plaintiffs are claiming damages of $850 million arising from contamination at
the Stringfellow toxic waste site. The State is a defendant because it chose the
site and approved the deposit of toxic wastes. Seventeen of the 3,800 plaintiffs
have litigated their claims; in half of these cases plaintiffs' verdicts in the
total amount of $159,000 were received and in the remaining cases verdicts were
entered for the State. The other cases have been settled for $13.5 million. In
the separate suit described in United States, People of the State of California
v. J. B. Stringfellow, Jr., et al., the State has been found liable by the
District Court on the counterclaim. The amount of liability is still being
litigated, although allocation of liability has been determined by the trial
court, including an allocation of liability to the State.
The State is a defendant in a coordinated action involving 3,000 plaintiffs
seeking recovery for damages caused by the Yuba River flood of February 1986.
The trial court has found liability in inverse condemnation and awarded damages
of $500,000 to 12 sample plaintiffs. Potential lability to the remaining 300
plaintiffs, from claims filed, ranges form $800 million to $1.5 billion. An
appeal has been filed.
In 1992, a lawsuit was filed, called California Teachers' Association v.
Gould, which challenged the validity of these off-budget loans. As part of the
negotiations leading to the 1995-96 Budget Act, an oral agreement was reached to
settle this case. It is expected that a formal settlement reflecting these
conditions will be entered into in the near future.
The oral agreement provides that both the State and K-14 schools share in
the repayment of prior years' emergency loans to schools. Of the total $1.76
billion in loans, the State will repay $935 million, while schools will repay
$825 million. The State share of the repayment will be reflected as expenditures
above the current Proposition 98 base calculation. The schools' share of the
repayment will count as appropriations that count toward satisfying the
Proposition 98 guarantee, or from "below" the current base. Repayment are spread
over the eight-year period of 1994-95 through 2001-02 to mitigate any adverse
fiscal impact. Once a court settlement is reached, and the Director of Finance
certifies that such a settlement has occurred, $360 million in appropriations to
schools will be disbursed in August 1996.
The State is involved in a case concerning the default by Triad Healthcare
on a $167 million loan guaranteed by the Cal-Mortgage Loan Insurance Division of
the Office of Statewide Health Planning and Development (Cal-Mortgage). Monies
for the loan were raised through the sale of Certificates of Participation and
Cal-Mortgage insured the debt service payments. Since July 1993, Triad has
failed to make its monthly debt service payments; therefore, the reserve account
of the bonds has been used to make the payments. Once the reserve account is
exhausted, additional debt service payments would be made from the Health
Facility Construction Loan Insurance Fund as they become due. However, if there
is any shortfall in this fund, the State's General Fund would be used to make up
the difference.
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In Jernigan & Burleson v. State, filed in federal district court, the
prison inmate plaintiffs claim they are entitled to minimum wages while working
for the Prison Industry Authority. The inmates claims the State has violated the
Fair Labor Standards Act (the "FLSA"). Plaintiffs are seeking back pay for the
period from August 1990 onward, and liquidated damages, for a total of
approximately $350 million. In June 1995, the district court ruled that the
inmates are not employees under the FLSA. The decision has been appealed to the
Ninth Circuit Court of Appeals.
Additional lawsuits, challenge the transfer of moneys from special fund
accounts within the State Treasury to the State's General Fund pursuant to the
Budget Acts of 1991, 1992, 1993 and 1994. Plaintiffs in the two cases titled
Abramovitz, et al. v. Wilson, et al., filed in State and federal court, seek to
have the transfers reversed and the moneys, allegedly totaling approximately
$400 million, returned to the special funds. Plaintiffs in the case of Kurt
Hathaway, et. al. v. Wilson, filed in State court, seek to reverse transfers of
money from special fund accounts to the State's General Fund authorized in the
1994 and 1995 Budget Acts, allegedly totaling approximately $370 million. The
State disputes both liability and the amount claimed. In the case of
Professional Engineers in California Government ("PECG") v. Wilson, several
State employees' unions have challenged transfers made from special funds to the
general fund pursuant to the Budget Acts of 1993, 1994 and 1995 and seek
reimbursement of over $400 million to these special funds.
In the case of Board of Administration, California Public Employees'
Retirement System, et al. v. Pete Wilson, Governor, et al., plaintiffs
challenged the constitutionality of legislation which deferred payment of the
State's employer contribution to the Public Employees' Retirement System
beginning in Fiscal Year 1992-93. On January 11, 1995, the Sacramento County
Superior Court entered a judgment finding that the legislation
unconstitutionally impaired the vested contract rights of PERS members. The
judgment provides for issuance of a writ of mandate directing State defendants
to disregard the provisions of the legislation, to implement the statute
governing employer contributions that existed before the changes in the
legislation found to be constitutional, and to transfer to PERS the 1993-94 and
1994-95 contributions that are unpaid to date. The State defendants have
appealed.
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APPENDIX II
RATINGS OF MUNICIPAL BONDS
DESCRIPTION OF MUNICIPAL BOND RATINGS OF MOODY'S INVESTORS SERVICE, INC.
("MOODY'S")
<TABLE>
<S> <C>
Aaa Bonds which are 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".
Interest payments are protected by a large or by an exceptionally stable margin and
principal is secure. While the various protective elements are likely to change, such
changes as can be visualized are most unlikely to impair the fundamentally strong
position of such issues.
Aa Bonds which are rated Aa are judged to be of high quality by all standards. Together
with the Aaa group they comprise what are generally known as high grade bonds. They
are rated lower than the best bonds because margins of protection may not be as large
as in Aaa securities or fluctuation of protective elements may be of greater amplitude
or there may be other elements present which make the long-term risks appear somewhat
larger than in Aaa securities.
A Bonds which are rated A possess many favorable investment attributes and are to be
considered as upper medium grade obligations. Factors giving security to principal and
interest are considered adequate, but elements may be present which suggest a
susceptibility to impairment sometime in the future.
Baa Bonds which are rated Baa are considered as medium grade obligations, i.e., they are
neither highly protected nor poorly secured. Interest payment 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 which are rated Ba are judged to have speculative elements; their future 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 characterizes bonds in this class.
B Bonds which are rated B generally lack characteristics of the 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 which are 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 which are rated Ca represent obligations which are speculative in a high degree.
Such issues are often in default or have other marked shortcomings.
C Bonds which are rated C are the lowest rated class of bonds, and issues so rated can
be regarded as having extremely poor prospects of ever attaining any real investment
standing.
</TABLE>
Note: Those bonds in the Aa, A, Baa, Ba and B groups which Moody's
believes possess the strongest investment attributes are designated by the
symbols Aa1, A1, Baa1, Ba1 and B1.
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Short-term Notes: The four ratings of Moody's for short-term notes are MIG
1/VMIG1, MIG 2 /VMIG2, MIG 3/VMIG3 and MIG 4/VMIG4; MIG 1/VMIG1 denotes "best
quality . . . strong protection by established cash flows"; MIG 2/VMIG2 denotes
"high quality" with ample margins of protection; MIG 3 /VMIG3 notes are of
"favorable quality . . . but . . . lacking the undeniable strength of the
preceding grades"; MIG 4/VMIG4 notes are of "adequate quality . . . [p]rotection
commonly regarded as required of an investment security is present . . . there
is specific risk."
DESCRIPTION OF MOODY'S CORPORATE BOND RATINGS
Excerpts from Moody's description of its corporate bond ratings:
Aaa--judged to be the best quality, carry the smallest degree of investment
risk; Aa--judged to be of high quality by all standards; A--possess many
favorable investment attributes and are to be considered as upper medium grade
obligations; Baa considered as medium grade obligations, i.e., they are neither
highly protected nor poorly secured.
DESCRIPTION OF MOODY'S COMMERCIAL PAPER RATINGS
Moody's Commercial Paper ratings are opinions of the ability of issuers to
repay punctually promissory obligations not having an original maturity in
excess of nine months. Moody's employs the following three designations, all
judged to be investment grade, to indicate the relative repayment capacity of
rated issuers:
Issuers rated Prime-1 (or related supporting institutions) have a superior
capacity for repayment of short-term promissory obligations. Prime-1 repayment
capacity will normally be evidenced by the following characteristics: leading
market positions in well established industries; high rates of return on funds
employed; conservative capitalization structures with moderate reliance on debt
and ample asset protection; broad margins in earning coverage of fixed financial
charges and high internal cash generation; and well established access to a
range of financial markets and assured sources of alternate liquidity.
Issuers rated Prime-2 (or related supporting institutions) have a strong
capacity for repayment of short-term promissory obligations. This will normally
be evidenced by many of the characteristics cited above but to a lesser degree.
Earnings trends and coverage ratios, while sound, will be more subject to
variation. Capitalization characteristics, while still appropriate, may be more
affected by external conditions. Ample alternate liquidity is maintained.
Issuers rated Prime-3 (or related supporting institutions) have an
acceptable capacity for repayment of short-term promissory obligations. The
effects of industry characteristics and market composition may be more
pronounced. Variability in earnings and profitability may result in changes in
the level of debt protection measurements and the requirement for relatively
high financial leverage. Adequate alternate liquidity is maintained.
Issuers rated Not Prime do not fall within any of the Prime rating
categories.
DESCRIPTION OF MUNICIPAL DEBT RATINGS OF STANDARD & POOR'S RATINGS GROUP
("STANDARD & POOR'S")
A Standard & Poor's municipal debt rating is a current assessment of the
creditworthiness of an obligor with respect to a specific obligation. This
assessment may take into consideration obligors such as guarantors, insurers, or
lessees.
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The debt rating is not a recommendation to purchase, sell or hold a
security, inasmuch as it does not comment as to market price or suitability for
a particular investor.
The ratings are based on current information furnished by the issuer or
obtained by Standard & Poor's from other sources Standard & Poor's considers
reliable. Standard & Poor's does not perform an audit in connection with any
rating and may, on occasion, rely on unaudited financial information. The
ratings may be changed, suspended or withdrawn as a result of changes in, or
unavailability of, such information, or for other reasons.
The ratings are based, in varying degrees, on the following considerations:
<TABLE>
<S> <C>
I. Likelihood of default--capacity and willingness of the obligor as to the timely
payment of interest and repayment of principal in accordance with the terms of the
obligation;
II. Nature of and provisions of the obligation;
III. Protection afforded by, and relative position of, the obligation in the event of
bankruptcy, reorganization or other arrangement under the laws of bankruptcy and
other laws affecting creditors' rights.
AAA Debt rated "AAA" has the highest rating assigned by Standard & Poor's. Capacity
to pay interest and repay principal is extremely strong.
AA Debt rated "AA" has a very strong capacity to pay interest and repay principal
and differs from the higher rated issues only in small degree.
A Debt rated "A" has a strong capacity to pay interest and repay principal
although it is somewhat more susceptible to the adverse effects of changes in
circumstances and economic conditions than debt in higher-rated categories.
BBB Debt rated "BBB" is regarded as having an adequate capacity to pay interest and
repay principal. Whereas it normally exhibits adequate protection parameters,
adverse economic conditions or changing circumstances are more likely to lead
to a weakened capacity to pay interest and repay principal for debt in this
category than for debt in higher rated categories.
BB Debt rated "BB", "B", "CCC", "CC" and "C" is regarded, on balance, as
B predominately speculative with respect to capacity to pay interest and repay
CCC principal in accordance with the terms of the obligations. "BB" indicates the
CC lowest degree of speculation and "C" the highest degree of speculation. While
C such debt will likely have some quality and protective characteristics, these
are outweighed by large uncertainties or major exposures to adverse conditions.
CI The rating "CI" is reserved for income bonds on which no interest is being
paid.
D Debt rated "D" is in payment default. The "D" rating category is used when
interest payments of principal payments are not made on the date due even if
the applicable grace period has not expired, unless Standard & Poor's believes
that such payments will be made during such grace period. The "D" rating also
will be used upon the filing of a bankruptcy petition if debt service payments
are jeopardized.
</TABLE>
Plus (+) or Minus (-): The ratings from "AA" to "CCC" may be modified by the
addition of a plus or minus sign to show relative standing within the major
rating categories.
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<PAGE> 120
DESCRIPTION OF STANDARD & POOR'S CORPORATE BOND RATINGS
A Standard & Poor's corporate debt rating is a current assessment of the
creditworthiness of an obligor with respect to a specific obligation. Debt rated
"AAA" has the highest rating assigned by Standard & Poor's. Capacity to pay
interest and repay principal is extremely strong. Debt rated "AA" has a very
strong capacity to pay interest and to repay principal and differs from the
highest rated issues only in small degree. Debt rated "A" has a strong capacity
to pay interest and repay principal although it is somewhat more susceptible to
the adverse effects of changes in circumstances and economic conditions than
debt of a higher rated category. Debt rated "BBB" is regarded as having an
adequate capacity to pay interest and repay principal. Whereas it normally
exhibits adequate protection parameters, adverse economic conditions or changing
circumstances are more likely to lead to a weakened capacity to pay interest and
repay principal for debt in this category than in higher rated categories.
The ratings from "AA" to "BBB" may be modified by the addition of a plus or
minus sign to show relative standing within the major rating categories.
DESCRIPTION OF STANDARD & POOR'S COMMERCIAL PAPER RATINGS
A Standard & Poor's Commercial Paper Rating is a current assessment of the
likelihood of timely payment of debt having an original maturity of no more than
365 days. Ratings are graded into several categories, ranging from "A-1" for the
highest quality obligations to "D" for the lowest. These categories are as
follows:
<TABLE>
<S> <C>
A-1 This highest category indicates that the degree of safety regarding timely
payment is strong. Those issues determined to possess extremely strong safety
characteristics are denoted with a plus sign (+) designation.
A-2 Capacity for timely payment on issues with this designation is satisfactory.
However, the relative degree of safety is not as high as for issues designated
"A-1".
A-3 Issues carrying this designation have adequate capacity for timely payment. They
are, however, somewhat more vulnerable to the adverse effects of changes in
circumstances than obligations carrying the higher designations.
B Issues rated "B" are regarded as having only speculative capacity for timely
payment.
C This rating is assigned to short-term debt obligations with a doubtful capacity
for payment.
D Debt rated "D" is in payment default. The "D" rating category is used when
interest payments or principal payments are not made on the date due, even if the
applicable grace period has not expired, unless S&P believes that such payments
will be made during such grace period.
</TABLE>
A Commercial Paper Rating is not a recommendation to purchase or sell a
security. The ratings are based on current information furnished to Standard &
Poor's by the issuer or obtained by Standard & Poor's from other sources it
considers reliable. The ratings may be changed, suspended, or withdrawn as a
result of changes in, or unavailability of, such information.
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<PAGE> 121
A Standard & Poor's note rating reflects the liquidity concerns and market
access risks unique to notes. Notes due in 3 years or less will likely receive a
note rating. Notes maturing beyond 3 years will most likely receive a long-term
debt rating. The following criteria will be used in making that assessment.
-- Amortization schedule (the larger the final maturity relative to other
maturities, the more likely it will be treated as a note).
-- Source of payment (the more dependent the issue is on the market for its
refinancing, the more likely it will be treated as a note).
Note rating symbols are as follows:
SP-1 A very strong, or strong, capacity to pay principal and interest.
Issues that possess overwhelming safety characteristics will be given
a "+" designation.
SP-2 A satisfactory capacity to pay principal and interest.
SP-3 A speculative capacity to pay principal and interest.
Standard & Poor's may continue to rate note issues with a maturity greater
than three years in accordance with the same rating scale currently employed for
municipal bond ratings.
Unrated: Where no rating has been assigned or where a rating has been
suspended or withdrawn, it may be for reasons unrelated to the quality of the
issue.
Should no rating be assigned, the reason may be one of the following:
1. An application for rating was not received or accepted.
2. The issue or issuers belongs to a group of securities that are not
rated as a matter of policy.
3. There is a lack of essential data pertaining to the issue or issuer.
4. The issue was privately placed, in which case the rating is not
published in Standard & Poor's publications.
Suspension or withdrawal may occur if new and material circumstances arise, the
effects of which preclude satisfactory analysis; if there is no longer available
reasonable up-to-date information to permit a judgment to be formed; if a bond
is called for redemption; or for other reasons.
DESCRIPTION OF INVESTMENT GRADE BOND RATINGS OF FITCH INVESTORS SERVICE, INC.
("FITCH")
Fitch investment grade bond ratings provide a guide to investors in
determining the credit risk associated with a particular security. The ratings
represent Fitch's assessment of the issuer's ability to meet the obligations of
a specific debt issue or class of debt in a timely manner.
The rating takes into consideration special features of the issue, its
relationship to other obligations of the issuer, the current and prospective
financial condition and operating performance of the issuer and of any
guarantor, as well as the economic and political environment that might affect
the issuer's future financial strength and credit quality.
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<PAGE> 122
Fitch ratings do not reflect any credit enhancement that may be provided by
insurance policies or financial guaranties unless otherwise indicated.
Bonds that have the same rating are of similar but not necessarily
identical credit quality since the rating categories do not fully reflect small
differences in the degrees of credit risk.
Fitch ratings are not recommendations to buy, sell, or hold any security.
Ratings do not comment on the adequacy of market price, the suitability of any
security for a particular investor, or the tax-exempt nature or taxability of
payments made in respect of any security.
Fitch ratings are based on information obtained from issuers, other
obligors, underwriters, their experts, and other sources Fitch believes to be
reliable. Fitch does not audit or verify the truth or accuracy of such
information. Ratings may be changed, suspended, or withdrawn as a result of
changes in, or the unavailability of, information or for other reasons.
<TABLE>
<S> <C>
AAA Bonds considered to be investment grade and of the highest credit quality. The
obligor has an exceptionally strong ability to pay interest and repay principal,
which is unlikely to be affected by reasonably foreseeable events.
AA Bonds considered to be investment grade and of very high credit quality. The
obligor's ability to pay interest and repay principal is very strong, although
not quite as strong as bonds rated "AAA". Because bonds rated in the "AAA" and
"AA" categories are not significantly vulnerable to foreseeable future
developments, short-term debt of these issuers is generally rated "F-1+".
A Bonds considered to be investment grade and of high credit quality. The obligor's
ability to pay interest and repay principal is considered to be strong, but may
be more vulnerable to adverse changes in economic conditions and circumstances
than bonds with higher ratings.
BBB Bonds considered to be investment grade and of satisfactory credit quality. The
obligor's ability to pay interest and repay principal is considered to be
adequate. Adverse changes in economic conditions and circumstances, however, are
more likely to have 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.
</TABLE>
Plus (+) or Minus (-): Plus and minus signs are used with a rating symbol to
indicate the relative position of a credit within the rating category. Plus and
minus signs, however, are not used in the "AAA" category.
Credit Trend Indicator: Credit trend indicators show whether credit fundamentals
are improving, stable, declining, or uncertain, as follows:
<TABLE>
<S> <C>
Improving Up Arrow
Stable Left Arrow Right Arrow
Declining Down Arrow
Uncertain Up-Down Arrow
</TABLE>
Credit trend indicators are not predictions that any rating change will occur,
and have a longer-term time frame than issues placed on FitchAlert.
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<PAGE> 123
NR indicates that Fitch does not rate the specific issue.
CONDITIONAL: A conditional rating is premised on the successful completion of a
project or the occurrence of a specific event.
SUSPENDED: A rating is suspended when Fitch deems the amount of information
available from the issuer to be inadequate for rating purposes.
WITHDRAWN: A rating will be withdrawn when an issue matures or is called or
refinanced and, at Fitch's discretion, when an issuer fails to furnish proper
and timely information.
FITCHALERT: Ratings are placed on FitchAlert to notify investors of an
occurrence that is likely to result in a rating change and the likely direction
of such change. These are designated as "Positive," indicating a potential
upgrade, "Negative," for potential downgrade, or "Evolving," where ratings may
be raised or lowered. FitchAlert is relatively short-term, and should be
resolved within 12 months.
DESCRIPTION OF FITCH SPECULATIVE GRADE BOND RATINGS
Fitch speculative grade bond ratings provide a guide to investors in
determining the credit risk associated with a particular security. The ratings
("BB" to "C") represent Fitch's assessment of the likelihood of timely payment
of principal and interest in accordance with the terms of obligation for bond
issues not in default. For defaulted bonds, the rating ("DDD" to "D") is an
assessment of the ultimate recovery value through reorganization or liquidation.
The rating takes into consideration special features of the issue, its
relationship to other obligations of the issuer, the current and prospective
financial condition and operating performance of the issuer and any guarantor,
as well as the economic and political environment that might affect the issuer's
future financial strength.
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<PAGE> 124
Bonds that have the same rating are of similar but not necessarily
identical credit quality since rating categories cannot fully reflect the
differences in degrees of credit risk.
<TABLE>
<S> <C>
BB Bonds are considered speculative. The obligor's ability to pay interest and
repay principal may be affected over time by adverse economic changes.
However, business and financial alternatives can be identified which could
assist the obligor in satisfying its debt service requirements.
B Bonds are considered highly speculative. While bonds in this class are
currently meeting debt service requirements, the probability of continued
timely payment of principal and interest reflects the obligor's limited
margin of safety and the need for reasonable business and economic activity
throughout the life of the issue.
CCC Bonds have certain identifiable characteristics which, if not remedied, may
lead to default. The ability to meet obligations requires an advantageous
business and economic environment.
CC Bonds are minimally protected. Default in payment of interest and/or
principal seems probable over time.
C Bonds are in imminent default in payment of interest or principal.
DDD, DD and D Bonds are in default on interest and/or principal payments. Such bonds are
extremely speculative and should be valued on the basis of their ultimate
recovery value in liquidation or reorganization of the obligor. "DDD"
represents the highest potential for recovery on these bonds, and "D"
represents the lowest potential for recovery.
</TABLE>
Plus (+) or Minus (-): Plus and minus signs are used with a rating symbol to
indicate the relative position of a credit within the rating category. Plus and
minus signs, however, are not used in the "DDD", "DD", or "D" categories.
DESCRIPTION OF FITCH INVESTMENT GRADE SHORT-TERM RATINGS
Fitch's short-term ratings apply to debt obligations that are payable on
demand or have original maturities of generally up to three years, including
commercial paper, certificates of deposit, medium-term notes, and municipal and
investment notes.
The short-term rating places greater emphasis than a long-term rating on
the existence of liquidity necessary to meet the issuer's obligations in a
timely manner.
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<PAGE> 125
Fitch short-term ratings are as follows:
<TABLE>
<S> <C>
F-1+ Exceptionally Strong Credit Quality. Issues assigned this rating are regarded as
having the strongest degree of assurance for timely payment.
F-1 Very Strong Credit Quality. Issues assigned this rating reflect an assurance of
timely payment only slightly less in degree than issues rated "F-1+".
F-2 Good Credit Quality. Issues assigned this rating have a satisfactory degree of
assurance for timely payment, but the margin of safety is not as great as for
issues assigned "F-1+" and "F-1" ratings.
F-3 Fair Credit Quality. Issues assigned this rating have characteristics suggesting
that the degree of assurance for timely payment is adequate, however, near-term
adverse changes could cause these securities to be rated below investment grade.
F-S Weak Credit Quality. Issues assigned this rating have characteristics suggesting
a minimal degree of assurance for timely payment and are vulnerable to near-term
adverse changes in financial and economic conditions.
D Default. Issues assigned this rating are in actual or imminent payment default.
LOC The symbol "LOC" indicates that the rating is based on a letter of credit issued
by a commercial bank.
INS The symbol "INS" indicates that the rating is based on an insurance policy or
financial guaranty issued by an insurance company.
</TABLE>
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<PAGE> 126
INDEPENDENT AUDITORS' REPORT
The Board of Trustees and Shareholders,
MERRILL LYNCH CALIFORNIA MUNICIPAL BOND FUND OF
MERRILL LYNCH CALIFORNIA MUNICIPAL SERIES TRUST:
We have audited the accompanying statement of assets and liabilities, including
the schedule of investments, of Merrill Lynch California Municipal Bond Fund of
Merrill Lynch California Municipal Series Trust as of August 31, 1995, the
related statements of operations for the year then ended and changes in net
assets for each of the years in the two-year period then ended, and the
financial highlights for each of the years in the five-year period then ended.
These financial statements and the financial highlights are the responsibility
of the Fund's management. Our responsibility is to express an opinion on these
financial statements and the financial highlights based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and the financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned at August
31, 1995 by correspondence with the custodian and brokers. An audit also
includes assessing the accounting principles used and significant estimates made
by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, such financial statements and financial highlights present
fairly, in all material respects, the financial position of Merrill Lynch
California Municipal Bond Fund of Merrill Lynch California Municipal Series
Trust as of August 31, 1995, the results of its operations, the changes in its
net assets, and the financial highlights for the respective stated periods in
conformity with generally accepted accounting principles.
DELOITTE & TOUCHE LLP
Princeton, New Jersey
September 29, 1995
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<PAGE> 127
<TABLE>
SCHEDULE OF INVESTMENTS (in Thousands)
<CAPTION>
S&P Moody's Face Value
Ratings Ratings Amount Issue (Note 1a)
California--98.5%
<S> <S> <C> <S> <C>
AAA Aaa $ 3,000 Anaheim, California, Public Financing Authority, Tax Allocation Revenue
Bonds, RITES, 8.745% due 12/28/2018 (c)(j) $ 3,244
Antioch, California, Improvement Bonds (1915 Assessment District No. 27--
Lone Tree):
NR* NR* 630 Series D, 6.20% due 9/02/2002 641
NR* NR* 670 Series D, 6.40% due 9/02/2003 686
NR* NR* 4,975 Series D, 7.30% due 9/02/2013 5,129
NR* NR* 4,000 Series E, 7.125% due 9/02/2016 4,086
AAA Aaa 3,140 Brea, California, Public Financing Authority, Tax Allocation Revenue Bonds
(Redevelopment Project), Series A, 6.75% due 8/01/2022 (c) 3,309
AAA Aaa 2,025 Brentwood, California, Unified School District Revenue Bonds, 6.85%
due 8/01/2016 (d) 2,173
A1+ VMIG1++ 700 California Health Facilities Financing Authority Revenue Bonds (Catholic
Health Care), VRDN, Series C, 3.40% due 7/01/2020 (b)(c) 700
California Health Facilities Financing Authority Revenue Bonds, Series A:
AA Aa3 16,770 (Kaiser Permanente), 7% due 10/01/2018 17,851
AAA Aaa 4,350 (Kaiser Permanente), 7% due 10/01/2018 (c) 4,738
BB Ba 5,150 Refunding (Good Samaritan Health System), 7.50% due 5/01/2015 5,183
AAA Aaa 4,085 Refunding (San Diego Hospital Association), 6.20% due 8/01/2020 (c) 4,126
AAA Aaa 4,000 (Scripps Memorial Hospital), 6.25% due 10/01/2013 (c) 4,060
NR* A 5,780 (Scripps Research Institute), 6.625% due 7/01/2014 5,962
California HFA, Home Mortgage Revenue Bonds:
AA- Aa 5,080 AMT, Series A, 7.70% due 8/01/2030 5,381
AA- Aa 535 AMT, Series B, 8% due 8/01/2029 570
AA- Aa 10,200 AMT, Series F-1, 7% due 8/01/2026 10,639
AA- Aa 855 AMT, Series G, 8.15% due 8/01/2019 914
AA- Aa 2,205 Series A, 8.125% due 8/01/2019 2,373
AA- Aa 3,085 Series D, 7.25% due 8/01/2017 3,287
California HFA, Revenue Bonds, AMT:
AA- Aa 4,250 RIB, 8.777% due 8/01/2023 (j) 4,303
AAA Aaa 980 Series A, 7.20% due 2/01/2026 (c) 1,032
California Pollution Control Financing Authority, Solid Waste Disposal
Revenue Bonds (Shell Oil Co.--Martinez Project), VRDN, AMT (b):
A1+ VMIG1++ 700 Series A, 3.60% due 10/01/2024 700
A1+ VMIG1++ 300 Series B, 3.60% due 12/01/2024 300
</TABLE>
PORTFOLIO ABBREVIATIONS
To simplify the listings of Merrill Lynch California Municipal Bond
Fund's portfolio holdings in the Schedule of Investments, we have
abbreviated the names of many of the securities according to the
list below and at right.
ACES SM Adjustable Convertible Extendable Securities
AMT Alternative Minimum Tax (subject to)
COP Certificates of Participation
GO General Obligation Bonds
HFA Housing Finance Agency
IDR Industrial Development Revenue Bonds
INFLOS Inverse Floating Rate Municipal Bonds
M/F Multi-Family
RIB Residual Interest Bonds
RITES Residual Interest Tax-Exempt Securities
RITR Residual Interest Trust Receipts
S/F Single-Family
TRAN Tax Revenue Anticipation Notes
UT Unlimited Tax
VRDN Variable Rate Demand Notes
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<PAGE> 128
<TABLE>
SCHEDULE OF INVESTMENTS (continued) (in Thousands)
<CAPTION>
S&P Moody's Face Value
Ratings Ratings Amount Issue (Note 1a)
California (continued)
<S> <S> <C> <S> <C>
AA Aa $10,000 California State Department of Water Resources, Central Valley Project
Revenue Bonds (Water Systems), Series M, 5% due 12/01/2019 $ 8,707
A A1 2,000 California State, GO, UT, 10% due 2/01/2010 2,875
A A1 3,500 California State, GO, Various Purpose Bonds, UT, 5.90% due 4/01/2023 3,384
A+ A1 16,300 California State, GO, Veterans' Revenue Bonds, AMT, UT, Series AW, 7.70%
due 4/01/2009 17,698
California State Public Works Board, Lease Revenue Bonds:
A- A 10,675 (Department of Corrections--Monterey County), Series A, 7% due
11/01/2019 11,421
A- A 3,555 High Technology Facilities (San Jose Facilities), Series A, 7.75%
due 8/01/2006 4,100
A- A 7,000 (Various Community College Projects), 7% due 3/01/2019 7,469
AAA Aaa 10,625 (Various University of California Projects), Series A, 6.40% due
12/01/2016 (d) 10,998
A- A1 1,475 (Various University of California Projects), Series B, 6.625% due
12/01/2019 1,533
California Statewide Community Development Authority Revenue Bonds, COP:
AAA Aaa 5,360 (Good Samaritan Health System), 6.50% due 5/01/2024 (k) 5,547
AA Aa 4,750 (Saint Joseph Health System Group), 6.625% due 7/01/2021 4,972
A1 VMIG1++ 1,700 (Sutter Health Obligation Group), VRDN, 3.30% due 7/01/2015 (b)(d) 1,700
AAA Aaa 5,000 Central Coast, California, Water Authority Revenue Bonds
(State Water Project Regional Facilities), 6.60% due 10/01/2022 (d) 5,250
BBB NR* 1,000 Contra Costa County, California, Public Financing Authority,
Tax Allocation Revenue Refunding Bonds, Series A, 7.10% due 8/01/2022 1,033
Corona, California, COP, Corona Community:
AAA Aaa 1,915 8% due 3/01/2009 (a) 2,418
AAA Aaa 2,065 8% due 3/01/2010 (a) 2,606
AAA Aaa 2,230 8% due 3/01/2011 (a) 2,828
AAA Aaa 2,410 8% due 3/01/2012 (a) 3,067
AAA Aaa 2,605 8% due 3/01/2013 (a) 3,324
AAA Aaa 2,810 8% due 3/01/2014 (a) 3,592
AAA Aaa 3,035 8% due 3/01/2015 (i) 3,918
NR* Aaa 4,635 Cypress, California, S/F Residential Mortgage Revenue Refunding Bonds,
Series A, 7.10% due 1/01/2011(i) 4,944
A1+ VMIG1++ 600 Eastern Municipal Water District, California, Water and Sewer Revenue
Refunding Bonds, VRDN, COP, Series B, 3.35% due 7/01/2020 (b)(e) 600
AAA Aaa 5,000 El Cajon, California, Redevelopment Agency, Tax Allocation
(El Cajon Redevelopment Project), 6.60% due 10/01/2022 (d) 5,252
BBB+ NR* 3,600 Fontana, California, Redevelopment Agency, Tax Allocation Refunding
Bonds (Jurupa Hills Redevelopment Project), Series A, 7.20% due 10/01/2024 3,773
AAA Aaa 2,230 Irvine, California, Unified School District, Special Tax Community
Facilities Bonds (District No. 86-1), Series A, 8.10% due 11/15/2013 (c) 2,536
Long Beach, California, Improvement Bonds (1915 Assessment District 90-2):
NR* NR* 465 7% due 9/02/2001 479
NR* NR* 495 7.05% due 9/02/2002 510
NR* NR* 530 7.10% due 9/02/2003 546
NR* NR* 570 7.15% due 9/02/2004 587
NR* NR* 610 7.20% due 9/02/2005 628
NR* NR* 655 7.25% due 9/02/2006 675
NR* NR* 4,065 7.50% due 9/02/2011 4,202
</TABLE>
76
<PAGE> 129
<TABLE>
SCHEDULE OF INVESTMENTS (continued) (in Thousands)
<CAPTION>
S&P Moody's Face Value
Ratings Ratings Amount Issue (Note 1a)
California (continued)
<S> <S> <C> <S> <C>
NR* NR* $ 5,695 Long Beach, California, M/F Redevelopment Agency Revenue Bonds
(Housing--Pacific Court Apartments), Issue B, AMT, 6.95% due 9/01/2023 $ 5,100
NR* NR* 4,545 Long Beach, California, Special Tax Community Facilities, District No.3--
Pine Avenue, 6.375% due 9/01/2023 4,235
AAA Aaa 5,225 Los Angeles, California, Community Redevelopment Agency,
Housing Revenue Refunding Bonds, Series A, 6.45% due 7/01/2017 (d) 5,393
AAA Aaa 5,150 Los Angeles, California, Community Redevelopment Agency,
Tax Allocation Refunding Bonds (Bunker Hill), Series H, 6.50% due 12/01/2016 (f) 5,344
AAA Aaa 17,050 Los Angeles, California, Convention and Exhibition Center Authority,
COP, 9% due 12/01/2005 (a) 22,693
AA- Aa 10,000 Los Angeles, California, Department of Water and Power, Electric Plant
Revenue Bonds, Registered RITR, 8.522% due 2/01/2020 (j) 10,375
AAA Aaa 5,000 Los Angeles, California, Department of Water and Power, Waterworks Revenue
Bonds, 6.30% due 7/01/2024 (c) 5,122
Los Angeles, California, Harbor Department Revenue Bonds:
AAA NR* 14,000 7.60% due 10/01/2018 (i) 15,772
AA Aa 1,965 Series B, AMT, 6.60% due 8/01/2014 2,045
Los Angeles, California, Wastewater System Revenue Bonds (c):
AAA Aaa 2,000 Refunding, Series A, 5.70% due 6/01/2020 1,918
AAA Aaa 7,890 Series D, 6.625% due 12/01/2012 8,346
AAA Aaa 13,500 Los Angeles County, California, COP (Correctional Facilities Project), 6.50%
due 9/01/2013 (c) 13,975
NR* NR* 8,000 Los Angeles County, California, COP (Marina Del Rey), Series A, 6.50% due
7/01/2008 7,999
AAA Aaa 10,000 Los Angeles County, California, Metropolitan Transportation Authority,
Sales Tax Revenue Bonds (Proposition C--Second Senior), Series A, 5.50% due
7/01/2017 (d) 9,360
AA- Aaa 18,105 Los Angeles County, California, Transportation Commission, Sales Tax Revenue
Bonds, Series A, 6.90% due 7/01/2001 (a) 20,641
AAA Aaa 4,750 Marysville, California, Hospital Revenue Bonds (Fremont--Rideout Health Group),
Series A, 6.30% due 1/01/2022 (d) 4,837
Metropolitan Water District, Southern California, Waterworks Revenue Bonds:
AA Aa 3,000 6.625% due 7/01/2012 3,187
AA+ Aa 4,880 Refunding, 6.75% due 6/01/2022 5,036
AAA Aaa 2,000 Modesto, California, Health Facilities Revenue Bonds (Memorial Hospital
Association), Series A, 6.875% due 6/01/2021 (c) 2,125
AAA Aaa 5,635 Ontario, California, Redevelopment Financing Authority Revenue Bonds
(Cimarron Project No.1), 6.375% due 8/01/2020 (c) 5,776
AAA Aaa 20,300 Orange County, California, Local Transportation Authority,
Sales Tax Revenue Bonds, Second Series, 6.10% due 2/14/2011 (e) 20,665
A NR* 5,000 Palmdale, California, Civic Authority, Revenue Refunding Bonds
(Merged Redevelopment Project), Series A, 6.60% due 9/01/2034 5,262
A+ A1 8,000 Pasadena, California, COP, Refunding Bonds (Old Pasadena Parking Facility
Project), 6.25% due 1/01/2018 8,253
AAA Aaa 11,620 Pittsburg, California, Redevelopment Agency, Residential Mortgage Revenue Bonds,
9.60% due 6/01/2016 (i) 17,223
</TABLE>
77
<PAGE> 130
<TABLE>
SCHEDULE OF INVESTMENTS (continued) (in Thousands)
<CAPTION>
S&P Moody's Face Value
Ratings Ratings Amount Issue (Note 1a)
California (continued)
<S> <S> <C> <S> <C>
NR* NR* $ 4,890 Pleasanton, California, Joint Powers Financing Authority, Revenue Reassessment
Bonds, Sub-Series B, 6.75% due 9/02/2017 $ 4,925
AAA Aaa 1,000 Port Oakland, California, Port Revenue Bonds, AMT, Series E, 6.50% due
11/01/2016 (c) 1,030
Poway, California, Redevelopment Agency, Tax Allocation Revenue Refunding Bonds
(Paraguay Redevelopment Project) (e):
AAA Aaa 7,000 5.50% due 12/15/2023 6,499
AAA Aaa 3,800 5.75% due 12/15/2026 3,651
AAA Aaa 3,450 Rancho, California, Water District Financing Authority Revenue Bonds,
RITES, 9.199% due 9/11/2001 (a)(d)(j) 4,261
AAA Aaa 1,500 Redding, California, Electric System Revenue Bonds, COP, RIB, 8.65% due
7/01/2022(c)(j) 1,644
Redwood City, California, Public Financing Authority, Local Agency Revenue Bonds:
AAA Aaa 1,500 Refunding, Series A, 6.50% due 7/15/2011 (d) 1,592
A- NR* 2,500 Series B, 7.25% due 7/15/2011 2,696
A1+ VMIG1++ 2,600 Riverside County, California, COP (Riverside County Public Facilities),
ACES, Series A, 3.45% due 12/01/2015 (b) 2,600
Riverside County, California, Redevelopment Agency Bonds (Tax Allocation
Redevelopment Project), Series A:
BBB NR* 2,430 7.50% due 10/01/2026 2,590
AAA Aaa 3,000 Refunding, 5.625% due 8/01/2023 (c) 2,852
AAA Aaa 3,000 Rohnert Park, California, Community Development Agency, Tax Allocation
Refunding Bonds (Rohnert Park Redevelopment Project), 6.50% due 8/01/2020 (d) 3,094
AAA Aaa 5,335 Sacramento, California, City Financing Authority Revenue Bonds, 6.70% due
11/01/2001 (a) 6,060
Sacramento, California, Municipal Utilities District, Electric
Revenue Bonds:
AAA Aaa 5,000 INFLOS, 8.565% due 8/15/2018 (e)(j) 5,131
AAA Aaa 5,000 Series B, 6.375% due 8/15/2022 (c) 5,132
AA Aa 2,500 San Bernardino, California, Health Care System Revenue Bonds (Sisters of Charity),
Series A, 7% due 7/01/2021 2,689
SP1+ NR* 5,000 San Diego, California, Area Local Government Bonds, COP, TRAN, 4.75% due 10/18/1996 5,030
AAA Aaa 7,250 San Diego, California, IDR, Refunding (San Diego Gas & Electric),
Series C, 5.90% due 9/01/2018 (d) 7,107
San Francisco, California, City and County Airport Commission,
International Airport Revenue Bonds, Second Series (d):
AAA Aaa 3,240 AMT, Issue 6, 6.50% due 5/01/2018 3,371
AAA Aaa 8,000 AMT, Issue 6, 6.60% due 5/01/2020 8,412
AAA Aaa 8,500 Refunding, Issue 1, 6.30% due 5/01/2011 8,821
NR* NR* 1,280 San Francisco, California, City and County Redevelopment Agency,
Community Facilities District, Special Tax No. 1 Revenue Bonds (South Beach),
8.20% due 8/01/2013 1,390
AAA Aaa 6,195 San Francisco, California, City and County Sewer Revenue Refunding Bonds,
5.375% due 10/01/2016 (e) 5,784
AAA Aaa 4,150 Santa Clara County, California, Electric Revenue Bonds, Series A, 6.50% due
7/01/2021 (c) 4,293
AAA Aaa 10,000 Santa Clara County, California, Financing Authority, Lease Revenue Bonds
(VMC Facility Replacement Project), Series A, 6.75% due 11/15/2020 (d) 10,705
</TABLE>
78
<PAGE> 131
<TABLE>
SCHEDULE OF INVESTMENTS (concluded) (in Thousands)
<CAPTION>
S&P Moody's Face Value
Ratings Ratings Amount Issue (Note 1a)
California (concluded)
<S> <S> <C> <S> <C>
AA A1 $ 1,000 Santa Clara County, California, Transportation District, Sales Tax Revenue Bonds,
Series A, 6.75% due 6/01/2011 $ 1,059
AAA Aaa 2,000 Santa Fe Springs, California, Redevelopment Agency, Tax Allocation
(Consolidated Redevelopment Project), Series A, 6.40% due 9/01/2022 (c) 2,065
Southern California Home Financing Authority, S/F Mortgage Revenue Bonds, AMT (h):
AAA NR* 4,175 Series A, 7.625% due 10/01/2023 4,445
AAA NR* 2,450 Series A, 7.35% due 9/01/2024 (g) 2,597
AAA NR* 1,040 Series B, 7.75% due 3/01/2024 (g) 1,101
AAA Aaa 5,000 Southern California Public Power Authority, Power Project Revenue Bonds (San
Juan Unit 3), Series A, 5% due 1/01/2020 (c) 4,352
AA+ VMIG1++ 4,100 Southern California Public Power Authority, Transmission Project, Revenue
Refunding Bonds (Southern Transmission Project), VRDN, 3.15% due 7/01/2019 (b)(d) 4,100
BBB+ NR* 21,930 Stanislaus, California, Waste-to-Energy Financing Agency, Solid Waste Facility
Revenue Refunding Bonds (Ogden Martin System, Inc. Project), 7.625% due 1/01/2010 23,401
AAA Aaa 4,000 Stockton, California, Revenue Bonds (Wastewater Treatment Plant Expansion),
COP, Series A, 6.80% due 9/01/2024 (e) 4,258
AAA Aaa 4,000 Tri-City, California, Hospital District Revenue Bonds (Tri-City Hospital), 7.50%
due 2/01/2017 (c) 4,526
University of California Revenue Bonds (Multiple Purpose Projects):
A- NR* 14,700 Refunding, Series A, 6.875% due 9/01/2002 (a) 16,858
AAA Aaa 8,000 Series D, 6.25% due 9/01/2012 (c) 8,238
AAA Aaa 6,000 Series D, 6.375% due 9/01/2019 (c) 6,159
AAA Aaa 11,845 Series D, 6.375% due 9/01/2024 (c) 12,126
West Covina, California, COP (Queen of the Valley Hospital):
A A 2,810 6.50% due 8/15/2019 2,803
A A 6,000 6.95% due 8/15/2023 6,310
AAA Aaa 6,000 West Sacramento, California, Redevelopment Agency, Tax Allocation Revenue Bonds
(West Sacramento Redevelopment Project), 6.25% due 9/01/2010 (c) 6,206
Puerto Rico--2.4%
A Baa1 5,000 Puerto Rico Commonwealth, GO, UT, 6.45% due 7/01/2017 5,169
A Baa1 10,465 Puerto Rico Commonwealth, Highway and Transportation Authority,
Highway Revenue Bonds, Series T, 6.625% due 7/01/2018 10,915
Total Investments (Cost--$638,499 )--100.9% 673,288
Liabilities in Excess of Other Assets--(0.9%) (5,884)
--------
Net Assets--100.0% $667,404
========
<FN>
(a)Prerefunded.
(b)The interest rate is subject to change periodically based upon
prevailing market rates. The interest rate shown is the rate in
effect at August 31, 1995.
(c)MBIA Insured.
(d)AMBAC Insured.
(e)FGIC Insured.
(f)FSA Insured.
(g)FNMA Collateralized.
(h)GNMA Collateralized.
(i)Escrowed to Maturity.
(j)The interest rate is subject to change periodically and inversely
based upon prevailing market rates. The interest rate shown is the
rate in effect at August 31, 1995.
(k)CAPMAC Insured.
*Not Rated.
++Highest short-term rating by Moody's Investors Service, Inc.
Ratings of issues shown have not been audited by Deloitte & Touche
LLP.
See Notes to Financial Statements.
</TABLE>
79
<PAGE> 132
FINANCIAL INFORMATION
<TABLE>
Statement of Assets and Liabilities as of August 31, 1995
<S> <S> <C> <C>
Assets: Investments, at value (identified cost--$638,499,362)(Note 1a) $673,287,854
Cash 99,976
Receivables:
Securities sold $ 20,724,278
Interest 12,184,525
Beneficial interest sold 229,241 33,138,044
------------
Prepaid registration fees and other assets (Note 1e) 128,247
------------
Total assets 706,654,121
------------
Liabilities: Payables:
Securities purchased 36,423,400
Beneficial interest redeemed 1,146,312
Dividends to shareholders (Note 1f) 949,895
Investment adviser (Note 2) 307,096
Distributor (Note 2) 262,489 39,089,192
------------
Accrued expenses and other liabilities 160,746
------------
Total liabilities 39,249,938
------------
Net Assets: Net assets $667,404,183
============
Net Assets Class A Shares of beneficial interest, $.10 par value,
Consist of: unlimited number of shares authorized $ 388,100
Class B Shares of beneficial interest, $.10 par value,
unlimited number of shares authorized 5,405,555
Class C Shares of beneficial interest, $.10 par value,
unlimited number of shares authorized 27,471
Class D Shares of beneficial interest, $.10 par value,
unlimited number of shares authorized 33,747
Paid-in capital in excess of par 650,305,824
Accumulated realized capital losses on investments--net (Note 5) (16,973,155)
Accumulated distributions in excess of realized capital gains--net (6,571,851)
Unrealized appreciation on investments--net 34,788,492
------------
Net assets $667,404,183
============
Net Asset Value: Class A--Based on net assets of $44,228,256 and 3,880,999
shares of beneficial interest outstanding $ 11.40
============
Class B--Based on net assets of $616,198,905 and 54,055,554
shares of beneficial interest outstanding $ 11.40
============
Class C--Based on net assets of $3,130,524 and 274,709 shares of
beneficial interest outstanding $ 11.40
============
Class D--Based on net assets of $3,846,498 and 337,469 shares of
beneficial interest outstanding $ 11.40
============
See Notes to Financial Statements.
</TABLE>
80
<PAGE> 133
FINANCIAL INFORMATION (continued)
<TABLE>
Statement of Operations
<CAPTION>
For the Year Ended
August 31, 1995
<S> <S> <C>
Investment Income Interest and amortization of premium and discount earned $ 45,693,141
(Note 1d):
Expenses: Investment advisory fees (Note 2) 3,828,093
Account maintenance and distribution fees--Class B (Note 2) 3,249,016
Transfer agent fees--Class B (Note 2) 292,378
Printing and shareholder reports 125,242
Professional fees 83,636
Registration fees (Note 1e) 78,769
Custodian fees 66,614
Accounting services (Note 2) 64,518
Trustees' fees and expenses 40,349
Transfer agent fees--Class A (Note 2) 19,780
Pricing fees 17,934
Account maintenance and distribution fees--Class C (Note 2) 8,263
Account maintenance fees--Class D (Note 2) 2,131
Transfer agent fees--Class D (Note 2) 847
Transfer agent fees--Class C (Note 2) 727
Other 14,609
------------
Total expenses 7,892,906
------------
Investment income--net 37,800,235
------------
Realized & Realized loss on investments--net (16,973,155)
Unrealized Gain Change in unrealized appreciation on investments--net 17,518,587
(Loss) on ------------
Investments Net Increase in Net Assets Resulting from Operations $ 38,345,667
- --Net (Notes 1b, ============
1d & 3):
See Notes to Financial Statements.
</TABLE>
81
<PAGE> 134
FINANCIAL INFORMATION (continued)
<TABLE>
Statements of Changes in Net Assets
<CAPTION>
For the Year Ended August 31,
Increase (Decrease) in Net Assets: 1995 1994
<S> <S> <C> <C>
Operations: Investment income--net $ 37,800,235 $ 43,908,000
Realized gain (loss) on investments--net (16,973,155) 4,109,882
Change in unrealized appreciation on investments--net 17,518,587 (61,534,369)
------------ ------------
Net increase (decrease) in net assets resulting from operations 38,345,667 (13,516,487)
------------ ------------
Dividends & Investment income--net:
Distributions to Class A (3,035,857) (3,624,918)
Shareholders Class B (34,575,842) (40,283,082)
(Note 1f): Class C (69,364) --
Class D (119,172) --
Realized gain on investments--net:
Class A -- (1,039,120)
Class B -- (12,643,710)
In excess of realized gain on investments--net:
Class A -- (499,088)
Class B -- (6,072,763)
------------ ------------
Net decrease in net assets resulting from dividends and
distributions to shareholders (37,800,235) (64,162,681)
------------ ------------
Beneficial Net decrease in net assets derived from beneficial interest
Interest transactions (120,046,349) (21,161,878)
Transactions ------------ ------------
(Note 4):
Net Assets: Total decrease in net assets (119,500,917) (98,841,046)
Beginning of year 786,905,100 885,746,146
------------ ------------
End of year $667,404,183 $786,905,100
============ ============
See Notes to Financial Statements.
</TABLE>
82
<PAGE> 135
FINANCIAL INFORMATION (continued)
<TABLE>
Financial Highlights
<CAPTION>
Class A
The following per share data and ratios have been derived
from information provided in the financial statements.
For the Year Ended August 31,
Increase (Decrease) in Net Asset Value: 1995 1994 1993 1992 1991
<S> <S> <C> <C> <C> <C> <C>
Per Share Net asset value, beginning of year $ 11.32 $ 12.38 $ 11.80 $ 11.44 $ 11.03
Operating -------- -------- -------- -------- --------
Performance: Investment income--net .64 .68 .70 .72 .74
Realized and unrealized gain (loss) on
investments--net .08 (.78) .78 .41 .41
-------- -------- -------- -------- --------
Total from investment operations .72 (.10) 1.48 1.13 1.15
-------- -------- -------- -------- --------
Less dividends and distributions:
Investment income--net (.64) (.68) (.70) (.72) (.74)
Realized gain on investments--net -- (.19) (.20) (.05) --
In excess of realized gain on
investments--net -- (.09) -- -- --
-------- -------- -------- -------- --------
Total dividends and distributions (.64) (.96) (.90) (.77) (.74)
-------- -------- -------- -------- --------
Net asset value, end of year $ 11.40 $ 11.32 $ 12.38 $ 11.80 $ 11.44
======== ======== ======== ======== ========
Total Based on net asset value per share 6.77% (.92%) 13.19% 10.23% 10.73%
Investment ======== ======== ======== ======== ========
Return:*
Ratios to Expenses .65% .62% .63% .63% .64%
Average ======== ======== ======== ======== ========
Net Assets: Investment income--net 5.83% 5.65% 5.87% 6.26% 6.57%
======== ======== ======== ======== ========
Supplemental Net assets, end of year (in thousands) $ 44,228 $ 60,017 $ 64,526 $ 46,556 $ 37,499
Data: ======== ======== ======== ======== ========
Portfolio turnover 53.40% 75.66% 61.24% 52.31% 116.09%
======== ======== ======== ======== ========
<FN>
*Total investment returns exclude the effect of sales loads.
See Notes to Financial Statements.
</TABLE>
83
<PAGE> 136
FINANCIAL INFORMATION (concluded)
<TABLE>
Financial Highlights (concluded)
<CAPTION>
Class B
The following per share data and ratios have been derived
from information provided in the financial statements.
For the Year Ended August 31,
Increase (Decrease) in Net Asset Value: 1995 1994 1993 1992 1991
<S> <S> <C> <C> <C> <C> <C>
Per Share Net asset value, beginning of year $ 11.32 $ 12.38 $ 11.80 $ 11.44 $ 11.03
Operating -------- -------- -------- -------- --------
Performance: Investment income--net .59 .61 .64 .67 .68
Realized and unrealized gain (loss) on
investments--net .08 (.78) .78 .41 .41
-------- -------- -------- -------- --------
Total from investment operations .67 (.17) 1.42 1.08 1.09
-------- -------- -------- -------- --------
Less dividends and distributions:
Investment income--net (.59) (.61) (.64) (.67) (.68)
Realized gain on investments--net -- (.19) (.20) (.05) --
In excess of realized gain on
investments--net -- (.09) -- -- --
-------- -------- -------- -------- --------
Total dividends and distributions (.59) (.89) (.84) (.72) (.68)
-------- -------- -------- -------- --------
Net asset value, end of year $ 11.40 $ 11.32 $ 12.38 $ 11.80 $ 11.44
======== ======== ======== ======== ========
Total Investment Based on net asset value per share 6.28% (1.50%) 12.62% 9.68% 10.18%
Return:** ======== ======== ======== ======== ========
Ratios to Average Expenses, excluding account maintenance
Net Assets: and distribution fees .66% .63% .63% .63% .65%
======== ======== ======== ======== ========
Expenses 1.16% 1.13% 1.13% 1.13% 1.15%
======== ======== ======== ======== ========
Investment income--net 5.32% 5.15% 5.38% 5.76% 6.07%
======== ======== ======== ======== ========
Supplemental Net assets, end of year (in thousands) $616,199 $726,888 $821,220 $729,569 $690,885
Data: ======== ======== ======== ======== ========
Portfolio turnover 53.40% 75.66% 61.24% 52.31% 116.09%
======== ======== ======== ======== ========
<CAPTION>
The following per share data and ratios have been derived
from information provided in the financial statements. For the Period Oct. 21, 1994++
to Aug. 31, 1995
Increase (Decrease) in Net Asset Value: Class C Class D
<S> <S> <C> <C>
Per Share Net asset value, beginning of period $ 10.94 $ 10.94
Operating ------------ ------------
Performance: Investment income--net .49 .54
Realized and unrealized gain on investments--net .46 .46
------------ ------------
Total from investment operations .95 1.00
------------ ------------
Less dividends from investment income--net (.49) (.54)
------------ ------------
Net asset value, end of period $ 11.40 $ 11.40
============ ============
Total Investment Based on net asset value per share 8.96%+++ 9.42%+++
Return:** ============ ============
Ratios to Expenses, excluding account maintenance and distribution fees .67%* .66%*
Average ============ ============
Net Assets: Expenses 1.27%* .76%*
============ ============
Investment income--net 5.04%* 5.59%*
============ ============
Supplemental Net assets, end of period (in thousands) $ 3,131 $ 3,846
Data: ============ ============
Portfolio turnover 53.40% 53.40%
============ ============
<FN>
*Annualized.
**Total investment returns exclude the effect of sales loads.
++Commencement of Operations.
+++Aggregate total investment return.
See Notes to Financial Statements.
</TABLE>
84
<PAGE> 137
NOTES TO FINANCIAL STATEMENTS
1. Significant Accounting Policies:
Merrill Lynch California Municipal Bond Fund (the "Fund") is part of
Merrill Lynch California Municipal Series Trust (the "Trust"). The
Fund is registered under the Investment Company Act of 1940 as a
diversified, open-end management investment company. The Fund offers
four classes of shares under the Merrill Lynch Select Pricing SM
System. Shares of Class A and Class D are sold with a front-end
sales charge. Shares of Class B and Class C may be subject to a
contingent deferred sales charge. All classes of shares have
identical voting, dividend, liquidation and other rights and the
same terms and conditions, except that Class B, Class C and Class D
Shares bear certain expenses related to the account maintenance of
such shares, and Class B and Class C Shares also bear certain
expenses related to the distribution of such shares. Each class has
exclusive voting rights with respect to matters relating to its
account maintenance and distribution expenditures. The following is
a summary of significant accounting policies followed by the Fund.
(a) Valuation of investments--Municipal bonds and other portfolio
securities in which the Fund invests are traded primarily in the
over-the-counter municipal bond and money markets and are valued at
the last available bid price in the over-the-counter market or on
the basis of yield equivalents as obtained from one or more dealers
that make markets in the securities. Financial futures contracts and
options thereon, which are traded on exchanges, are valued at their
settlement prices as of the close of such exchanges. Short-term
investments with remaining maturities of sixty days or less are
valued at amortized cost, which approximates market value.
Securities and assets for which market quotations are not readily
available are valued at fair value as determined in good faith by or
under the direction of the Board of Trustees of the Trust, including
valuations furnished by a pricing service retained by the Trust,
which may utilize a matrix system for valuations. The procedures of
the pricing service and its valuations are reviewed by the officers
of the Trust under the general supervision of the Trustees.
(b) Derivative financial instruments--The Fund may engage in various
portfolio strategies to seek to increase its return by hedging its
portfolio against adverse movements in the debt markets. Losses may
arise due to changes in the value of the contract or if the
counterparty does not perform under the contract.
* Financial futures contracts--The Fund may purchase or sell interest
rate futures contracts and options on such futures contracts for the
purpose of hedging the market risk on existing securities or the
intended purchase of securities. Futures contracts are contracts for
delayed delivery of securities at a specific future date and at a
specific price or yield. Upon entering into a contract, the Fund
deposits and maintains as collateral such initial margin as required
by the exchange on which the transaction is effected. Pursuant to
the contract, the Fund agrees to receive from or pay to the broker
an amount of cash equal to the daily fluctuation in value of the
contract. Such receipts or payments are known as variation margin
and are recorded by the Fund as unrealized gains or losses. When the
contract is closed, the Fund records a realized gain or loss equal
to the difference between the value of the contract at the time it
was opened and the value at the time it was closed.
(c) Income taxes--It is the Fund's policy to comply with the
requirements of the Internal Revenue Code applicable to regulated
investment companies and to distribute substantially all of its
taxable income to its shareholders. Therefore, no Federal income tax
provision is required.
(d) Security transactions and investment income--Security
transactions are recorded on the dates the transactions are entered
into (the trade dates). Interest income is recognized on the accrual
basis. Discounts and market premiums are amortized into interest
income. Realized gains and losses on security transactions are
determined on the identified cost basis.
(e) Prepaid registration fees--Prepaid registration fees are charged
to expense as the related shares are issued.
(f) Dividends and distributions--Dividends from net investment
income are declared daily and paid monthly. Distributions of capital
gains are recorded on the ex-dividend dates. Distributions in excess
of realized capital gains are due primarily to differing tax
treatments for futures transactions and post-October losses.
85
<PAGE> 138
2. Investment Advisory Agreement and
Transactions with Affiliates:
The Fund has entered into an Investment Advisory Agreement with Fund
Asset Management, L.P. ("FAM"). The general partner of FAM is
Princeton Services, Inc. ("PSI"), an indirect wholly-owned
subsidiary of Merrill Lynch & Co., Inc. ("ML & Co."), which is the
limited partner. The Fund has also entered into a Distribution
Agreement and Distribution Plans with Merrill Lynch Funds
Distributor, Inc. ("MLFD" or "Distributor"), a wholly-owned
subsidiary of Merrill Lynch Group, Inc.
FAM is responsible for the management of the Fund's portfolio and
provides the necessary personnel, facilities, equipment and certain
other services necessary to the operations of the Fund. For such
services, the Fund pays a monthly fee based upon the average daily
value of the Fund's net assets at the following annual rates: 0.55%
of the Fund's average daily net assets not exceeding $500 million;
0.525% of average daily net assets in excess of $500 million but not
exceeding $1 billion; and 0.50% of average daily net assets in
excess of $1 billion. The Investment Advisory Agreement obligates
FAM to reimburse the Fund to the extent the Fund's expenses
(excluding interest, taxes, distribution fees, brokerage fees and
commissions, and extraordinary items) exceed 2.5% of the Fund's
first $30 million of average daily net assets, 2.0% of the next $70
million of average daily net assets, and 1.5% of the remaining
average net assets. FAM's obligation to reimburse the Fund is
limited to the amount of the management fee. No fee payment will be
made during any fiscal year which will cause such expenses to exceed
expense limitations at the time of such payment.
Pursuant to the distribution plans ("the Distribution Plans")
adopted by the Fund in accordance with Rule 12b-1 under the
Investment Company Act of 1940, the Fund pays the Distributor
ongoing account maintenance and distribution fees. The fees are
accrued daily and paid monthly at annual rates based upon the
average daily net assets of the shares as follows:
Account Distribution
Maintenance Fee Fee
Class B 0.25% 0.25%
Class C 0.25% 0.35%
Class D 0.10% --
Pursuant to a sub-agreement with the Distributor, Merrill Lynch,
Pierce, Fenner & Smith Inc. ("MLPF&S"), a subsidiary of ML & Co.,
also provides account maintenance and distribution services to the
Fund. The ongoing account maintenance fee compensates the
Distributor and MLPF&S for providing account maintenance services to
Class B, Class C and Class D shareholders. The ongoing distribution
fee compensates the Distributor and MLPF&S for providing shareholder
and distribution-related services to Class B and Class C
shareholders.
For the year ended August 31, 1995, MLFD earned underwriting
discounts and MLPF&S earned dealer concessions on sales of the
Fund's Class A and Class D Shares as follows:
MLFD MLPF&S
Class A $2,220 $28,775
Class D $1,704 $20,537
For the year ended August 31, 1995, MLPF&S received contingent
deferred sales charges of $866,830 and $3,844 relating to
transactions in Class B and Class C Shares, respectively.
Merrill Lynch Financial Data Services, Inc. ("MLFDS"), a wholly-
owned subsidiary of ML & Co., is the Fund's transfer agent.
Accounting services are provided to the Fund by FAM at cost.
Certain officers and/or trustees of the Fund are officers and/or
directors of FAM, PSI, MLPF&S, MLFDS, MLFD, and/or ML & Co.
3. Investments:
Purchases and sales of investments, excluding short-term securities,
for the year ended August 31, 1995 were $360,260,804 and
$455,808,554, respectively.
Net realized and unrealized gains (losses) as of August 31, 1995
were as follows:
Realized Unrealized
Losses Gains
Long-term investments $(12,697,427) $ 34,788,492
Short-term investments (1,146,290) --
Financial futures
contracts (3,129,438) --
------------ -------------
Total $(16,973,155) $ 34,788,492
============ =============
86
<PAGE> 139
NOTES TO FINANCIAL STATEMENTS (concluded)
As of August 31, 1995, net unrealized appreciation for Federal
income tax purposes aggregated $34,788,492 of which $35,965,265
related to appreciated securities and $1,176,773 related to depre-
ciated securities. The aggregate cost of investments at August 31,
1995 for Federal income tax purposes was $638,499,362.
4. Beneficial Interest Transactions:
Net decrease in net assets derived from beneficial interest
transactions was $(120,046,349) and $(21,161,878) for the years
ended August 31, 1995 and August 31, 1994, respectively.
Transactions in shares of beneficial interest for each class were as
follows:
Class A Shares for the Year Dollar
Ended August 31, 1995 Shares Amount
Shares sold 356,036 $ 3,948,528
Shares issued to share-
holders in reinvestment of
dividends 110,995 1,224,562
----------- -------------
Total issued 467,031 5,173,090
Shares redeemed (1,889,907) (20,801,528)
----------- -------------
Net decrease (1,422,876) $ (15,628,438)
=========== =============
Class A Shares for the Year Dollar
Ended August 31, 1994 Shares Amount
Shares sold 1,162,525 $ 13,965,656
Shares issued to share-
holders in reinvestment of
dividends & distributions 216,094 2,566,392
----------- -------------
Total issued 1,378,619 16,532,048
Shares redeemed (1,287,071) (15,074,976)
----------- -------------
Net increase 91,548 $ 1,457,072
=========== =============
Class B Shares for the Year Dollar
Ended August 31, 1995 Shares Amount
Shares sold 4,055,625 $ 44,759,130
Shares issued to share-
holders in reinvestment
of dividends 1,364,078 15,067,056
----------- -------------
Total issued 5,419,703 59,826,186
Shares redeemed (15,559,912) (170,703,755)
Automatic conversion
of shares (22,131) (248,360)
----------- -------------
Net decrease (10,162,340) $(111,125,929)
=========== =============
Class B Shares for the Year Dollar
Ended August 31, 1994 Shares Amount
Shares sold 7,118,622 $ 84,446,664
Shares issued to shareholders
in reinvestment of dividends
& distributions 2,212,118 26,273,099
----------- -------------
Total issued 9,330,740 110,719,763
Shares redeemed (11,430,290) (133,338,713)
----------- -------------
Net decrease (2,099,550) $ (22,618,950)
=========== =============
Class C Shares for the Period
October 21, 1994++ to Dollar
August 31, 1995 Shares Amount
Shares sold 343,686 $ 3,830,307
Shares issued to share-
holders in reinvestment
of dividends 3,078 34,747
----------- -------------
Total issued 346,764 3,865,054
Shares redeemed (72,055) (813,364)
----------- -------------
Net increase 274,709 $ 3,051,690
=========== =============
++Commencement of Operations.
Class D Shares for the Period
October 21, 1994++ to Dollar
August 31, 1995 Shares Amount
Shares sold 383,812 $ 4,170,592
Automatic conversion
of shares 22,131 248,360
Shares issued to share-
holders in reinvestment of
dividends 7,710 86,300
----------- -------------
Total issued 413,653 4,505,252
Shares redeemed (76,184) (848,924)
----------- -------------
Net increase 337,469 $ 3,656,328
=========== =============
++Commencement of Operations.
5. Capital Loss Carryforward:
At August 31, 1995, the Fund had a net capital loss carryforward of
approximately $9,806,000, all of which expires in 2003. This amount
will be available to offset like amounts of any future taxable
gains.
87
<PAGE> 140
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TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Investment Objective and Policies....... 2
Description of Municipal Bonds and
Temporary Investments................. 5
Description of Municipal Bonds........ 5
Description of Temporary
Investments......................... 7
Repurchase Agreements................. 8
Financial Futures Transactions and
Options............................. 9
Investment Restrictions................. 14
Management of the Trust................. 16
Trustees and Officers................. 16
Compensation of Trustees.............. 18
Management and Advisory
Arrangements........................ 18
Purchase of Shares...................... 20
Alternative Sales Arrangements........ 20
Initial Sales Charge
Alternative--Class A and Class D
Shares.............................. 21
Reduced Initial Sales Charges......... 21
Distribution Plans.................... 24
Limitations on the Payment of Deferred
Sales Charges....................... 25
Redemption of Shares.................... 26
Deferred Sales Charges--Class B and
Class C Shares...................... 26
Portfolio Transactions.................. 27
Determination of Net Asset Value........ 28
Shareholder Services.................... 29
Investment Account.................... 29
Automatic Investment Plans............ 30
Automatic Reinvestment of Dividends
and Capital Gains Distributions..... 30
Systematic Withdrawal Plans--Class A
and Class D Shares.................. 31
Exchange Privilege.................... 32
Distributions and Taxes................. 45
Environmental Tax..................... 48
Tax Treatment of Futures and Options
Transactions........................ 49
Performance Data........................ 49
General Information..................... 52
Description of Series and Shares...... 52
Computation of Offering Price Per
Share............................... 53
Independent Auditors.................. 53
Custodian............................. 53
Transfer Agent........................ 54
Legal Counsel......................... 54
Reports to Shareholders............... 54
Additional Information................ 54
Appendix I
Economic and Other Conditions in
California.......................... 55
Appendix II
Ratings of Municipal Bonds............ 65
Independent Auditors' Report............ 74
Financial Statements.................... 75
</TABLE>
Code #10328-1295
[MERRILL LYNCH LOGO]
Merrill Lynch
California Municipal
Bond Fund
Merrill Lynch California
Municipal Series Trust
STATEMENT OF
ADDITIONAL
INFORMATION
December 29, 1995
Distributor:
Merrill Lynch
Funds Distributor, Inc.
<PAGE> 141
APPENDIX FOR GRAPHIC AND IMAGE MATERIAL
Pursuant to Rule 304 of Regulation S-T, the following table presents
fair and accurate narrative descriptions of graphic and image material omitted
from this EDGAR Submission File due to ASCII-incompatibility and
cross-references this material to the location of each occurrence in the text.
<TABLE>
<CAPTION>
DESCRIPTION OF OMITTED LOCATION OF GRAPHIC
GRAPHIC OR IMAGE OR IMAGE IN TEXT
- ---------------------- -------------------
<S> <C>
Compass plate, circular Back cover of Prospectus and
graph paper and Merrill Lynch back cover of Statement of
logo including stylized market Additional Information
bull
</TABLE>
