<PAGE> 1
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON DECEMBER 20, 1996
SECURITIES ACT FILE NO. 2-96581
INVESTMENT COMPANY ACT FILE NO. 811-4264
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM N-1A
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 [X]
PRE-EFFECTIVE AMENDMENT NO. [ ]
POST-EFFECTIVE AMENDMENT NO. 12 [X]
AND/OR
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940 [X]
AMENDMENT NO. 19 [X]
(CHECK APPROPRIATE BOX OR BOXES)
------------------------
MERRILL LYNCH CALIFORNIA MUNICIPAL BOND FUND
OF MERRILL LYNCH CALIFORNIA MUNICIPAL SERIES TRUST
(EXACT NAME OF REGISTRANT AS SPECIFIED IN CHARTER)
<TABLE>
<S> <C>
800 SCUDDERS MILL ROAD
PLAINSBORO, NEW JERSEY 08536
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
</TABLE>
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE (609) 282-2800
ARTHUR ZEIKEL
MERRILL LYNCH CALIFORNIA MUNICIPAL SERIES TRUST
800 SCUDDERS MILL ROAD, PLAINSBORO, NEW JERSEY
MAILING ADDRESS: P.O. BOX 9011, PRINCETON, NEW JERSEY 08543-9011
(NAME AND ADDRESS OF AGENT FOR SERVICE)
------------------------
COPIES TO:
<TABLE>
<S> <C>
COUNSEL FOR THE TRUST:
BROWN & WOOD LLP PHILIP L. KIRSTEIN, ESQ.
ONE WORLD TRADE CENTER FUND ASSET MANAGEMENT
NEW YORK, NEW YORK 10048-0557 P.O. BOX 9011
ATTENTION: THOMAS R. SMITH, JR. PRINCETON, NEW JERSEY 08543-9011
</TABLE>
------------------------
IT IS PROPOSED THAT THIS FILING WILL BECOME EFFECTIVE (CHECK APPROPRIATE BOX)
[X] immediately upon filing pursuant to paragraph (b)
[ ] on (date) pursuant to paragraph (b)
[ ] 60 days after filing pursuant to paragraph (a)(1)
[ ] on (date) pursuant to paragraph (a)(1)
[ ] 75 days after filing pursuant to paragraph (a)(2)
[ ] on (date) pursuant to paragraph (a)(2) of Rule 485.
IF APPROPRIATE, CHECK THE FOLLOWING BOX:
[ ] this post-effective amendment designates a new effective date for
a
previously filed post-effective amendment.
------------------------
THE REGISTRANT HAS REGISTERED AN INDEFINITE NUMBER OF ITS SHARES OF
BENEFICIAL INTEREST UNDER THE SECURITIES ACT OF 1933 PURSUANT TO RULE 24F-2
UNDER THE INVESTMENT COMPANY ACT OF 1940. THE NOTICE REQUIRED BY SUCH RULE FOR
THE REGISTRANT'S MOST RECENT FISCAL YEAR WAS FILED ON OCTOBER 22, 1996.
CALCULATION OF REGISTRATION FEE UNDER THE SECURITIES ACT OF 1933
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C> <C> <C>
- --------------------------------------------------------------------------------
AMOUNT OF PROPOSED MAXIMUM PROPOSED MAXIMUM
TITLE OF SECURITIES SHARES BEING OFFERING PRICE AGGREGATE AMOUNT OF
BEING REGISTERED REGISTERED PER UNIT OFFERING PRICE* REGISTRATION FEE
- ----------------------------------
Shares of Beneficial Interest (par
value $.10 per share)........... 9,097,278 $12.10 $329,991 $100
- ------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
*(1) The calculation of the maximum aggregate offering price is made pursuant to
Rule 24e-2 under the Investment Company Act of 1940.
(2) The total amount of securities redeemed or repurchased during Registrant's
previous year was 9,070,006 Shares of Beneficial Interest.
(3) None of the Shares described in (2) above have been used for reduction
pursuant to Rule 24e-2(a) or Rule 24f-2(c) under the Investment Company Act
of 1940 in previous filings during Registrant's current fiscal year.
(4) All of the Shares redeemed during Registrant's previous fiscal year are
being used for the reduction of the registration fee in this amendment to
the Registration Statement.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE> 2
MERRILL LYNCH CALIFORNIA MUNICIPAL BOND FUND
MERRILL LYNCH CALIFORNIA MUNICIPAL SERIES TRUST
REGISTRATION STATEMENT ON FORM N-1A
CROSS REFERENCE SHEET
<TABLE>
<CAPTION>
N-1A ITEM NO. LOCATION
- ------------- ---------------------------------------
<S> <C> <C>
PART A
Item 1. Cover Page............................... Cover Page
Item 2. Synopsis................................. Fee Table
Item 3. Condensed Financial Information.......... Financial Highlights; Performance Data
Item 4. General Description of Registrant........ Investment Objective and Policies;
Additional Information
Item 5. Management of the Fund................... Fee Table; Management of the Trust;
Portfolio Transactions; Inside Back
Cover Page
Item 5A. Management's Discussion of Fund
Performance............................ Not Applicable
Item 6. Capital Stock and Other Securities....... Cover Page; Merrill Lynch Select
Pricing(SM) System; Additional
Information
Item 7. Purchase of Securities Being Offered..... Cover Page; Merrill Lynch Select
Pricing(SM) System; Fee Table; Purchase
of Shares; Shareholder Services;
Additional Information; Inside Back
Cover Page
Item 8. Redemption or Repurchase................. Merrill Lynch Select Pricing(SM) System;
Fee Table; Purchase of Shares;
Redemption of Shares
Item 9. Pending Legal Proceedings................ Not Applicable
PART B
Item 10. Cover Page............................... Cover Page
Item 11. Table of Contents........................ Back Cover Page
Item 12. General Information and History.......... Additional Information
Item 13. Investment Objectives and Policies....... Investment Objective and Policies
Item 14. Management of the Fund................... Management of the Trust
Item 15. Control Persons and Principal Holders of
Securities............................. Management of the Trust; General
Information--Additional Information
Item 16. Investment Advisory and Other Services... Management of the Trust; Purchase of
Shares; General Information
Item 17. Brokerage Allocation and Other
Practices.............................. Portfolio Transactions
Item 18. Capital Stock and Other Securities....... General Information--Description of
Shares
Item 19. Purchase, Redemption and Pricing of
Securities Being Offered............... Purchase of Shares; Redemption of
Shares; Determination of Net Asset
Value; Shareholder Services
Item 20. Tax Status............................... Distributions and Taxes
Item 21. Underwriters............................. Purchase of Shares
Item 22. Calculation of Performance Data.......... Performance Data
Item 23. Financial Statements..................... Financial Statements
PART C
</TABLE>
Information required to be included in Part C is set forth under the
appropriate Item, so numbered, in Part C to this Registration Statement.
<PAGE> 3
PROSPECTUS
DECEMBER 20, 1996
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 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 California Municipal Bonds. The Fund may invest in certain tax-exempt
securities classified as "private activity bonds" that may subject certain
investors in the Fund to an alternative minimum tax. At times, the Fund may seek
to hedge its portfolio through the use of futures transactions and options.
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,
please 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 NOR HAS THE SECURITIES AND EXCHANGE 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 20, 1996 (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> 4
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(f)
annually to 0.0% after
the fourth year(e)
Exchange Fee................................. None None None None
ANNUAL FUND OPERATING EXPENSES (AS A PERCENTAGE
OF AVERAGE NET ASSETS):
Management Fees(g)........................... 0.55% 0.55% 0.55% 0.55%
Rule 12b-1 Fees(h):
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(i)........... 0.03% 0.04% 0.04% 0.03%
Miscellaneous............................ 0.06% 0.06% 0.06% 0.06%
-------- ----- ----- ------
Total Other Expenses................. 0.10% 0.11% 0.11% 0.10%
-------- ----- ----- ------
TOTAL FUND OPERATING EXPENSES................ 0.65% 1.16% 1.26% 0.75%
-------- ----- ----- ------
-------- ----- ----- ------
</TABLE>
- ---------------
(a) Class A shares are sold to a limited group of investors including existing
Class A shareholders and certain participants in fee-based programs. See
"Purchase of Shares--Initial Sales Charge Alternatives--Class A and Class D
Shares"--page 24 and "Shareholder Services--Fee-Based Programs"--page 35.
(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 26.
(c) Reduced for purchases of $25,000 and over and waived for purchases of Class
A shares in connection with certain fee-based programs. 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 24.
(d) Class A and Class D shares are not subject to a contingent deferred sales
charge ("CDSC"), except that certain purchases of $1,000,000 or more which
are not subject to an initial sales charge may instead be subject to a CDSC
of 1.0% of amounts redeemed within the first year after purchase. Such CDSC
may be waived in connection with redemptions to fund participation in
certain fee-based programs. See "Shareholder Services--Fee-Based
Programs"--page 35.
(e) The CDSC may be modified in connection with redemptions to fund
participation in certain fee-based programs. See "Shareholder
Services--Fee-Based Programs"--page 35.
(f) The CDSC may be waived in connection with redemptions to fund participation
in certain fee-based programs. See "Shareholder Services--Fee-Based
Programs"--page 35.
(Footnotes continue on following page)
2
<PAGE> 5
(Footnotes for preceding page)
- ---------------
(g) See "Management of the Trust--Management and Advisory Arrangements"--page
20.
(h) See "Purchase of Shares--Distribution Plans"--page 29.
(i) See "Management of the Trust--Transfer Agency Services"--page 22.
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 on page 2, (2) a 5% annual
return throughout the period 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 $69 $152
Class D........................................... $ 47 $63 $80 $129
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 $69 $152
Class D........................................... $ 47 $63 $80 $129
</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 Conduct
Rules 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 PRICINGSM SYSTEM
The Fund offers four classes of shares under the Merrill Lynch Select
PricingSM 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 PricingSM System is used by more
3
<PAGE> 6
than 50 registered investment companies advised by Merrill Lynch Asset
Management, L.P. ("MLAM") or Fund Asset Management, L.P. ("FAM" or the
"Manager"), an affiliate of MLAM. Funds advised by MLAM or FAM which utilize the
Merrill Lynch Select Pricing(SM) System are referred to herein as "MLAM-advised
mutual funds".
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
CDSCs, distribution fees 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, 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>
<S> <C> <C> <C> <C> <C> <C>
- ------------------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------------
ACCOUNT
MAINTENANCE DISTRIBUTION
CLASS SALES CHARGE(1) FEE FEE CONVERSION FEATURE
-------------------------------------------------------------------------------------------------------------
A Maximum 4.00% 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%(4) 0.25% 0.25% approximately ten years(5)
-------------------------------------------------------------------------------------------------------------
C 1.0% CDSC for one year(6) 0.25% 0.35% No
-------------------------------------------------------------------------------------------------------------
D Maximum 4.00% initial sales
charge(3) 0.10% No No
-------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
(Footnotes on following page)
4
<PAGE> 7
(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 and waived for purchases of Class A
shares in connection with certain fee-based programs. 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 a 1.0% CDSC if redeemed within one
year. Such CDSC may be waived in connection with redemptions to fund
participation in certain fee-based programs. See "Class A" and "Class D"
below.
(4) The CDSC may be modified in connection with redemptions to fund
participation in certain fee-based programs.
(5) 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.
(6) The CDSC may be waived in connection with redemptions to fund participation
in certain fee-based programs.
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 of the Fund in a
shareholder account are entitled to purchase additional Class A shares
of the Fund in that account. Other eligible investors include
participants in certain fee-based programs. In addition, Class A
shares will be offered at net asset value to 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 4.00%, which is reduced for purchases of
$25,000 and over and waived for purchases of Class A shares in
connection with certain fee-based programs. 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 1.0% CDSC if
the shares are redeemed within one year after purchase. Such CDSC may
be waived in connection with redemptions to fund participation in
certain fee-based programs. 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. Such CDSC may be modified in
connection with redemptions to fund participation in certain fee-based
programs. 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
5
<PAGE> 8
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".
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 of 1.0% if they are redeemed within one year of purchase.
Such CDSC may be waived in connection with redemptions to fund
participation in certain fee-based programs. Although Class C shares
are subject to a 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 account
maintenance fees and higher distribution 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 1.0% if the shares are
redeemed within one year after purchase. Such CDSC may be waived in
connection with redemptions to fund participation in certain fee-based
programs. The schedule of initial sales charges and reductions for
Class D shares is the same as the schedule for Class A shares, except
that there is no waiver for purchases of Class D shares in connection
with certain fee-based programs. 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
PricingSM 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 charge reductions are not available with
respect to the CDSCs 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
6
<PAGE> 9
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 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> 10
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, 1996 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. 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,
------------------------------------------------------------------------------------
1996 1995 1994 1993 1992 1991 1990 1989+
------- ------- ------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Increase (Decrease) in Net Asset Value:
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of year........ $ 11.40 $ 11.32 $ 12.38 $ 11.80 $ 11.44 $ 11.03 $ 11.22 $ 11.02
------- ------- ------- ------- ------- ------- ------- -------
Investment income--net.................... .64 .64 .68 .70 .72 .74 .77 .63
Realized and unrealized gain (loss) on
investments--net........................ .09 .08 (.78) .78 .41 .41 (.19) .20
------- ------- ------- ------- ------- ------- ------- -------
Total from investment operations.......... .73 .72 (.10) 1.48 1.13 1.15 .58 .83
------- ------- ------- ------- ------- ------- ------- -------
Less dividends and distributions:
Investment income--net.................... (.64) (.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) (.64) (.96) (.90) (.77) (.74) (.77) (.63)
------- ------- ------- ------- ------- ------- ------- -------
Net asset value, end of year.............. $ 11.49 $ 11.40 $ 11.32 $ 12.38 $ 11.80 $ 11.44 $ 11.03 $ 11.22
======= ======= ======= ======= ======= ======= ======= =======
TOTAL INVESTMENT RETURN:**
Based on net asset value per share........ 6.53% 6.75% (.92)% 13.19% 10.23% 10.73% 5.21% 7.96%#
======= ======= ======= ======= ======= ======= ======= =======
RATIOS TO AVERAGE NET ASSETS:
Expenses.................................. .65% .65% .62% .63% .63% .64% .65% .65%*
======= ======= ======= ======= ======= ======= ======= =======
Investment income--net.................... 5.51% 5.83% 5.65% 5.87% 6.26% 6.57% 6.77% 6.80%*
======= ======= ======= ======= ======= ======= ======= =======
SUPPLEMENTAL DATA:
Net assets, end of year (in thousands).... $42,668 $44,228 $60,017 $64,526 $46,556 $37,499 $29,558 $19,451
======= ======= ======= ======= ======= ======= ======= =======
Portfolio turnover........................ 53.79% 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> 11
FINANCIAL HIGHLIGHTS (CONTINUED)
<TABLE>
<CAPTION>
CLASS B
-------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
FOR THE YEAR ENDED AUGUST 31,
-------------------------------------------------------------
<CAPTION>
1996 1995 1994 1993 1992
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Increase (Decrease) in Net Asset
Value:
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of
year............................. $ 11.40 $ 11.32 $ 12.38 $ 11.80 $ 11.44
------- ------- ------- ------- -------
Investment income--net............. .58 .59 .61 .64 .67
Realized and unrealized gain (loss)
on investments--net.............. .09 .08 (.78) .78 .41
------- ------- ------- ------- -------
Total from investment operations... .67 .67 (.17) 1.42 1.08
------- ------- ------- ------- -------
Less dividends and distributions:
Investment income--net............. (.58) (.59) (.61) (.64) (.67)
Realized gain on
investments--net................. -- -- (.19) (.20) (.05)
In excess of realized gain on
investments--net................. -- -- (.09) -- --
------- ------- ------- ------- -------
Total dividends and
distributions.................... (.58) (.59) (.89) (.84) (.72)
------- ------- ------- ------- -------
Net asset value, end of year....... $ 11.49 $ 11.40 $ 11.32 $ 12.38 $ 11.80
======= ======= ======= ======= =======
TOTAL INVESTMENT RETURN:*
Based on net asset value per
share............................ 5.99% 6.25% (1.50)% 12.62% 9.68%
======= ======= ======= ======= =======
RATIOS TO AVERAGE NET ASSETS:
Expenses........................... 1.16% 1.16% 1.13% 1.13% 1.13%
======= ======= ======= ======= =======
Investment income--net............. 5.01% 5.32% 5.15% 5.38% 5.76%
======= ======= ======= ======= =======
SUPPLEMENTAL DATA:
Net assets, end of year (in
thousands)....................... $ 480,668 $ 616,199 $ 726,888 $ 821,220 $ 729,569
======= ======= ======= ======= =======
Portfolio turnover................. 53.79% 53.40% 75.66% 61.24% 52.31%
======= ======= ======= ======= =======
<CAPTION>
<S> <C> <C> <C> <C> <C>
1991 1990 1989 1988 1987
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Increase (Decrease) in Net Asset
Value:
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of
year............................. $ 11.03 $ 11.23 $ 10.77 $ 10.96 $ 11.55
------- ------- ------- ------- -------
Investment income--net............. .68 .71 .71 .71 .72
Realized and unrealized gain (loss)
on investments--net.............. .41 (.20) .46 (.19) (.54)
------- -------- ------- ------- ------
Total from investment operations... 1.09 .51 1.17 .52 .18
------- -------- ------- ------- ------
Less dividends and distributions:
Investment income--net............. (.68) (.71) (.71) (.71) (.72)
Realized gain on
investments--net................. -- -- -- -- (.05)
In excess of realized gain on
investments--net................. -- -- -- -- --
------- ------- ------- ------- -------
Total dividends and
distributions.................... (.68) (.71) (.71) (.71) (.77)
------- ------- ------- ------- ------
Net asset value, end of year....... $ 11.44 $ 11.03 $ 11.23 $ 10.77 $ 10.96
=======
TOTAL INVESTMENT RETURN:*
Based on net asset value per
share............................ 10.18% 4.58% 11.14% 5.05% 1.52%
======= ====== ====== ====== ======
RATIOS TO AVERAGE NET ASSETS:
Expenses........................... 1.15% 1.15% 1.16% 1.16% 1.15%
======= ====== ====== ====== ======
Investment income--net............. 6.07% 6.27% 6.42% 6.63% 6.34%
======= ====== ====== ====== ======
SUPPLEMENTAL DATA:
Net assets, end of year (in
thousands)....................... $ 690,885 $ 663,551 $ 665,566 $ 611,454 $ 661,755
======= ======== ======== ======== ========
Portfolio turnover................. 116.09% 119.66% 114.49% 77.99% 69.23%
======= ======== ======== ======== ========
</TABLE>
- ---------------
* Total investment returns exclude the effects of sales loads.
9
<PAGE> 12
FINANCIAL HIGHLIGHTS (CONCLUDED)
<TABLE>
<CAPTION>
CLASS C CLASS D
---------------------------------- ----------------------------------
FOR THE PERIOD FOR THE PERIOD
FOR THE OCTOBER 21, 1994+ FOR THE OCTOBER 21, 1994+
YEAR ENDED TO YEAR ENDED TO
AUGUST 31, AUGUST 31, AUGUST 31, AUGUST 31,
1996 1995 1996 1995
----------- ------------------- ----------- -------------------
<S> <C> <C> <C> <C>
Increase (Decrease) in Net Asset Value:
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period.................. $ 11.40 $ 10.94 $ 11.40 $ 10.94
------- ------- -------- -------
Investment income--net................................ .57 .49 .63 .54
Realized and unrealized gain on investments--net...... .09 .46 .09 .46
------- ------- -------- -------
Total from investment operations...................... .66 .95 .72 1.00
------- ------- -------- -------
Less dividends from investment income--net............ (.57) (.49) (.63) (.54)
------- ------- -------- -------
Net asset value, end of period........................ $ 11.49 $ 11.40 $ 11.49 $ 11.40
======= ======= ======== =======
TOTAL INVESTMENT RETURN:**
Based on net asset value per share.................... 5.88% 8.91%# 6.43% 9.39%#
======= ======= ======== =======
RATIOS TO AVERAGE NET ASSETS:
Expenses.............................................. 1.26% 1.27%* .75% .76%*
======= ======= ======== =======
Investment income--net................................ 4.91% 5.04%* 5.42% 5.59%*
======= ======= ======== =======
SUPPLEMENTAL DATA:
Net assets, end of period (in thousands).............. $ 8,112 $ 3,131 $ 111,817 $ 3,846
======= ======= ======== =======
Portfolio turnover.................................... 53.79% 53.40% 53.79% 53.40%
======= ======= ======== =======
</TABLE>
- ---------------
+ Commencement of operations.
* Annualized.
** Total investment returns exclude the effects of sales loads.
# Aggregate total investment return.
10
<PAGE> 13
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, 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 herein as "California Municipal
Bonds". Unless otherwise indicated, references to Municipal Bonds shall be
deemed to include California Municipal Bonds. The Fund at all times, except
during temporary defensive periods, will maintain at least 65% of its total
assets invested in California Municipal Bonds. The investment objective of the
Fund as set forth in the first sentence of this paragraph is a fundamental
policy and may not be changed without shareholder approval. At times, the Fund
may 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 Fund may also
invest in variable rate demand obligations ("VRDOs"). 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 Services ("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
11
<PAGE> 14
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 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 include both 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 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 be ultimately responsible for such
determinations.
The Fund ordinarily does not intend to realize investment income not exempt
from Federal and California income taxes. 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, income taxes. 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 also 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
12
<PAGE> 15
(the "1940 Act"). Other Non-Municipal Tax-Exempt Securities could include trust
certificates or other derivative instruments evidencing interests in one or more
long-term municipal securities.
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. 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 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 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
outstanding shares of the Fund. 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".
13
<PAGE> 16
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 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 local facilities for water
supply, gas, electricity, sewage or solid waste disposal. For purposes of this
Prospectus, such obligations are Municipal Bonds if the interest paid thereon is
excluded from gross income for purposes of Federal income taxation and
California Municipal Bonds, if the interest thereon is exempt from Federal and
California income tax, even though such bonds may be industrial development
bonds ("IDBs") or "private activity bonds" as discussed below.
The two principal classifications of Municipal Bonds are "general
obligation" bonds and "revenue" bonds which latter category includes 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 its state constitution 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 viability of such facility
or such revenue source.
14
<PAGE> 17
The Fund may purchase IDBs or private activity bonds. IDBs or private
activity bonds are, in most cases, 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. IDBs and private activity bonds are generally not secured by a pledge
of the taxing power of the issuer of such bonds. Therefore, 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 entity's
dependence on revenues for 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. 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
15
<PAGE> 18
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% 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.
The value of bonds and other fixed-income obligations may fall when
interest rates rise and rise when interest rates fall. In general, bonds and
other fixed-income obligations with longer maturities will be subject to greater
volatility resulting from interest rate fluctuations than will similar
obligations with shorter maturities. Under normal conditions, it is generally
anticipated that the Fund's average weighted maturity would be in excess of ten
years.
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 may not invest in such illiquid
obligations if such investments, together with other illiquid investments, would
exceed 15% of the Fund's total assets.
16
<PAGE> 19
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 liquid securities 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. 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 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.
17
<PAGE> 20
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 ("CFTC"), 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 liquid 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 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.
18
<PAGE> 21
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% 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 which means the lesser
of (i) 67% of the shares represented at a meeting at which more than 50% of the
outstanding shares are represented or (ii) more than 50% of the outstanding
shares. Among its fundamental policies, the Fund may not 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.) Investment restrictions and policies that are
non-fundamental policies may be changed by the Board of Trustees without
shareholder approval. As a non-fundamental policy, the Fund may not 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
19
<PAGE> 22
extraordinary or emergency purposes. In addition the Fund will not purchase
securities while borrowings are outstanding.
As a non-fundamental policy, the Fund will not 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 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.
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 classified as "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.
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 its affiliate, MLAM; President
and Director of Princeton Services, Inc. ("Princeton Services"); Executive Vice
President of ML & Co.; and Director of the Distributor.
JAMES H. BODURTHA--Director and Executive Vice President, The China
Business Group, Inc.
HERBERT I. LONDON--John M. Olin Professor of Humanities, New York
University.
ROBERT R. MARTIN--Former Chairman, Kinnard Investments, 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.
20
<PAGE> 23
MANAGEMENT AND ADVISORY ARRANGEMENTS
The Manager, 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, 1996, the Manager and MLAM had a total of
approximately $223.7 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. 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 Fund.
Walter O'Connor became the Portfolio Manager of the Fund in 1995 and is
responsible for the day-to-day management of the Fund's investment portfolio. 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.
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 fiscal year ended August 31, 1996, the total fee paid by
the Fund to the Manager was $3,611,875 (based on average net assets of
approximately $660.4 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 fiscal year ended August 31,
1996, the Fund reimbursed the Manager $118,709 for accounting services. For the
fiscal year ended August 31, 1996, the ratio of total expenses to average net
assets was .65% for Class A shares, 1.16% for Class B shares, 1.26% for Class C
shares and .75% 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.
21
<PAGE> 24
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. (the "Transfer Agent"), which
is a wholly-owned subsidiary of ML & Co., acts as the Trust'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 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 fiscal year
ended August 31, 1996, the Fund paid the Transfer Agent a total fee of $256,742
pursuant to the Transfer Agency Agreement for providing transfer agency
services. At November 30, 1996, the Fund had 935 Class A shareholder accounts,
10,043 Class B shareholder accounts, 309 Class C shareholder accounts and 3,857
Class D shareholder accounts. At this level of accounts, the annual fee payable
to the Transfer Agent would aggregate approximately $198,000 plus out-of-pocket
expenses.
PURCHASE OF SHARES
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 PricingSM
System, 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 (the
"NYSE") (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 NYSE 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 NYSE, on that day. If the purchase orders are not
22
<PAGE> 25
received by the Distributor prior to 30 minutes after the close of business on
the NYSE, 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 fees and higher
account maintenance fees. 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
CDSCs, distribution fees 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.
23
<PAGE> 26
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> <C>
-----------------------------------------------------------------------------------------------
A Maximum 4.00% initial sales No
charge(2)(3) 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%(4) 0.25% 0.25% shares
automatically after
approximately ten years(5)
-----------------------------------------------------------------------------------------------
C 1.0% CDSC for one year(6) 0.25% 0.35% No
-----------------------------------------------------------------------------------------------
D Maximum 4.00% initial sales No
charge(3) 0.10% No
-----------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------
</TABLE>
(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 "Initial Sales Charge
Alternatives--Class A and Class D Shares--Eligible Class A Investors".
(3) Reduced for purchases of $25,000 or more and waived for purchases of Class A
shares in connection with certain fee-based programs. 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 a 1.0% CDSC if redeemed within one
year. Such CDSC may be waived in connection with redemptions to fund
participation in certain fee-based programs.
(4) The CDSC may be modified in connection with redemptions to fund
participation in certain fee-based programs.
(5) The conversion period for dividend reinvestment shares and certain fee-based
programs may be 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.
(6) The CDSC may be waived in connection with redemptions to fund participation
in certain fee-based programs.
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 and on Class A purchases in connection with certain
fee-based programs. If the sales charge is waived in connection with a
purchase of $1,000,000 or more, such purchases may be subject to a CDSC of
1.0% if the shares are redeemed within one year after purchase. Such CDSC may
be waived in connection with redemptions to fund participation in certain
fee-based programs. The charge will be assessed on an amount equal to the
lesser of the proceeds of the redemption or the cost of the shares being
redeemed.
24
<PAGE> 27
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. For the
fiscal year ended August 31, 1996, the Fund sold 343,484 Class A shares for
aggregate net proceeds of $3,993,921. The gross sales charges for the sale of
Class A shares of the Fund for that year were $20,961, of which $2,185 and
$18,776 were received by the Distributor and Merrill Lynch, respectively. For
the fiscal year ended August 31, 1996, the Distributor received no CDSCs with
respect to redemption within one year after purchase of Class A shares purchased
subject to a front-end sales charge waiver. For the fiscal year ended August 31,
1996, the Fund sold 623,197 Class D shares for aggregate net proceeds of
$7,211,474. The gross sales charges for the sale of Class D shares of the Fund
for the year were $31,208, of which $2,960 and $28,248 were received by the
Distributor and Merrill Lynch, respectively. For the fiscal year ended August
31, 1996, the Distributor received no CDSCs with respect to 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, collective
investment trusts for which Merrill Lynch Trust Company serves as trustee and
purchases made in connection with certain fee-based programs. In addition, Class
A shares are offered at net asset value to ML & Co. and its subsidiaries and
their directors and employees, and to members of the Boards of MLAM-advised
registered investment companies, including the Trust. Certain persons who
acquired shares of certain MLAM-advised closed-end funds in their initial
offerings 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. In addition, 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. and, if certain
conditions set forth in the Statement of Additional Information are met, to
shareholders of Merrill Lynch Municipal Strategy Fund, Inc. and Merrill Lynch
High Income Municipal Bond Fund, Inc. who wish to reinvest the net proceeds from
a sale of certain of their shares of common stock pursuant to a tender offer
conducted by such funds in shares of the Fund and certain other MLAM-advised
mutual 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". See "Shareholder
Services -- Fee-Based Programs". Class A and Class D shares are offered at net
asset value to Employee Access Accounts(SM) available through qualified
employers which provide employer-sponsored retirement and savings plans that are
eligible to purchase such shares at net asset value. Class A shares are offered
at net asset value to shareholders of Merrill Lynch Senior Floating Rate Fund,
Inc. and, subject to certain conditions, Class A and Class D shares are offered
at net asset value to
25
<PAGE> 28
shareholders of Merrill Lynch Municipal Strategy Fund, Inc. and Merrill Lynch
High Income Municipal Bond Fund, Inc., who wish to reinvest the net proceeds
from a sale of certain of their shares of common stock in shares of the Fund,
pursuant to tender offers conducted by those funds.
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.
Additional information concerning these reduced initial sales charges is
set forth in the Statement of Additional Information.
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 is 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 ongoing
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."
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 the dealer's 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.
26
<PAGE> 29
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. 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
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, 1996, the Distributor received CDSCs of
$427,650 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 purchased 100 Class B 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 upon 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).
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. The terms of the CDSC may be modified in connection with
27
<PAGE> 30
redemptions to fund participation in certain fee-based programs. See
"Shareholder Services -- Fee-Based Programs".
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 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 fiscal year ended August 31,
1996, the Distributor received CDSCs of $4,398 with respect to redemptions of
Class C shares, all of which were paid to Merrill Lynch. No Class C CDSC will be
assessed in connection with redemptions to fund participation in certain
fee-based programs. See "Shareholder Services -- Fee-Based Programs".
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
28
<PAGE> 31
exchange will apply, and the holding period for the shares exchanged will be
tacked onto the holding period for the shares acquired.
The Conversion Period may be modified for certain fee-based programs. See
"Shareholder Services -- Fee-Based Programs".
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 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 fiscal year ended August 31, 1996, the Fund paid the Distributor
$2,723,756 pursuant to the Class B Distribution Plan (based on average net
assets subject to such Class B Distribution Plan of approximately $541.8
million), all of which was paid to Merrill Lynch for providing account
maintenance and distribution-related activities and services in connection with
Class B shares. For the fiscal year ended August 31, 1996, the Fund paid the
Distributor $35,107 pursuant to the Class C Distribution Plan (based on average
net assets subject to such Class C Distribution Plan of approximately $5.8
million), all of which was paid to Merrill Lynch for providing account
maintenance and distribution-related activities and services in connection with
Class C shares. For the fiscal year ended August 31, 1996, the Fund paid the
Distributor $68,985 pursuant to the Class D Distribution Plan (based on average
net assets subject to such Class D Distribution Plan of approximately $68.6
million), all of which was paid to Merrill Lynch for providing account
maintenance activities in connection with Class D shares. At November 30, 1996,
the net assets of the Fund subject to the Class B Distribution Plan aggregated
approximately $460.4 million. At this asset level, the
29
<PAGE> 32
annual fee payable pursuant to such Class B Distribution Plan would aggregate
approximately $2.3 million. At November 30, 1996, the net assets of the Fund
subject to the Class C Distribution Plan aggregated $9.4 million. At this asset
level, the annual fee payable pursuant to such Class C Distribution Plan would
aggregate approximately $56,000. At November 30, 1996, the net assets of the
Fund subject to the Class D Distribution Plan aggregated approximately $138.8
million. At this asset level, the annual fee payable pursuant to such Class D
Distribution Plan would aggregate approximately $139,000.
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
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 CDSCs 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. As of December 31, 1995, the fully
allocated accrual expenses incurred by the Distributor and Merrill Lynch for the
period since the commencement of operations of Class B shares exceeded fully
allocated accrual revenues by $5,694,000 (0.99% of Class B net assets at that
date). As of August 31, 1996, direct cash revenues for the period since the
commencement of operations of Class B shares exceeded direct cash expenses by
$21,546,289 (4.48% of Class B net assets at that date). Similar fully allocated
accrual data for Class C shares is not presented because such revenues and
expenses for the period from October 21, 1994 (commencement of operations) to
December 31, 1995 are de minimis. As of August 31, 1996, direct cash revenues
for the period since the commencement of operations of Class C shares exceeded
direct cash expenses by $14,011 (0.17% of Class C net assets at that date).
LIMITATIONS ON THE PAYMENT OF DEFERRED SALES CHARGES
The maximum sales charge rule in the Conduct Rules 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 will be paid
to the
30
<PAGE> 33
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 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 fees, the
distribution fees 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".
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 Trust.
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.
31
<PAGE> 34
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 will
not exceed 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 repurchase is received by the dealer prior to the regular close of
business on the NYSE (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 NYSE 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 NYSE in order to obtain that
day's closing price.
The foregoing 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. Repurchases 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.
Redemption payments will be made within seven days of the proper tender of
the certificates, if any, and stock power or letter requesting redemption, in
each instance with signatures guaranteed as noted above.
REINSTATEMENT PRIVILEGE--CLASS A AND CLASS D SHARES
Shareholders who have redeemed their Class A or Class D shares have a
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. Alternatively, the
reinstatement privilege may be exercised through the investor's Merrill Lynch
Financial Consultant 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.
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, copies of the various plans described below and instructions
as to how to participate in the various services or plans, or to change options
with respect thereto
32
<PAGE> 35
can be obtained from the Trust by calling the telephone number on the cover page
hereof or from the Distributor or Merrill Lynch.
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. The statements will also 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
will be 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
U.S. 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(SM) 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
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<PAGE> 36
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 for 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 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 of the exchanged
shares and a purchase of the acquired shares for Federal income tax purposes.
For further information, see "Shareholder Services-- Exchange Privilege" in the
Statement of Additional Information.
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 written
notification or by telephone (1-800-MER-FUND) to the Transfer Agent, 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 monthly.
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) or CBA(R) Systematic Redemption Program, subject to
certain conditions.
34
<PAGE> 37
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. 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) or CBA(R) Automated Investment Program.
FEE-BASED PROGRAMS
Certain Merrill Lynch fee-based programs, including pricing alternatives
for securities transactions (each referred to in this paragraph as a "Program"),
may permit the purchase of Class A shares at net asset value. Under specified
circumstances, participants in certain Programs may deposit other classes of
shares which will be exchanged for Class A shares. Initial or deferred sales
charges otherwise due in connection with such exchanges may be waived or
modified, as may the Conversion Period applicable to the deposited shares.
Termination of participation in a Program may result in the redemption of shares
held therein or the automatic exchange thereof to another class at net asset
value, which may be shares of a money market fund. In addition, upon termination
of participation in a Program, shares that have been held for less than
specified periods within such Program may be subject to a fee based upon the
current value of such shares. These Programs also generally prohibit such shares
from being transferred to another account at Merrill Lynch, to another
broker-dealer or to the Transfer Agent. Except in limited circumstances (which
may also involve an exchange as described above), such shares must be redeemed
and another class of shares purchased (which may involve the imposition of
initial or deferred sales charges and distribution and account maintenance fees)
in order for the investment not to be subject to Program fees. Additional
information regarding a specific Program (including charges and limitations on
transferability applicable to shares that may be held in such Program) is
available in such Program's client agreement and from Merrill Lynch Investor
Services at (800) MER-FUND (637-3863).
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 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), 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
35
<PAGE> 38
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 permitting it
to, among other things, (i) purchase investment grade tax-exempt securities from
Merrill Lynch when Merrill Lynch is a member of an underwriting syndicate and
(ii) purchase tax-exempt securities from and sell tax-exempt securities to
Merrill Lynch in secondary market transactions. An affiliated person 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. 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
Fund will, however, monitor its trading so as to comply with the Federal income
tax requirement 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.
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 NYSE (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 reinvested automatically in shares unless the shareholder
elects to receive such distributions in cash.
36
<PAGE> 39
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 Code. If it
so qualifies, 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.
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 Fund intends to invest at least 50%
of its 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 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 advisors before purchasing Fund shares.
Exempt-interest dividends paid to a corporate shareholder subject to
California state franchise tax will not be exempt from California taxation.
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 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.
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<PAGE> 40
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 disallowed to the extent of any exempt-interest dividends
received by the shareholder. In addition, any such loss that is not disallowed
under the rule stated above will be treated as long-term capital loss to the
extent of any capital gain 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 certain "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 certain
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 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 Code provisions, 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").
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<PAGE> 41
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
and corporate franchise 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 advisors 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.
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
39
<PAGE> 42
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,
1996 was 4.94% for Class A shares, 4.63% for Class B shares, 4.53% for Class C
shares and 4.84% for Class D shares and the tax-equivalent yield for the same
period (based on a Federal income tax rate of 28%) was 6.86% for Class A shares,
6.43% for Class B shares, 6.29% for Class C shares and 6.72% 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 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 NYSE
(generally, 4:00 P.M., New York time), on each day during which the NYSE 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
40
<PAGE> 43
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
fees, higher account maintenance fees 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 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 Trustees of the Trust may classify and
reclassify the shares of any Series into additional classes at a future date.
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
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<PAGE> 44
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.
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" only shall be liable.
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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.)
1. .............................. 4. ..............................
2. .............................. 5. ..............................
3. .............................. 6. ..............................
(Please Print)
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> <C> <C> <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.
43
<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)
</TABLE>
- --------------------------------------------------------------------------------
4. LETTER OF INTENTION--CLASS A AND D SHARES ONLY (SEE TERMS AND CONDITIONS IN
THE STATEMENT OF ADDITIONAL INFORMATION)
<TABLE>
<S> <C>
......................, 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 or sales made under a Letter of
Intention, Automatic Investment Plan 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.
44
<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
(Please Print)
<TABLE>
<S> <C> <C> <C> <C> <C> <C> <C>
------------------------------------
Name of Owner.......................................................................
------------------------------------
Social Security No.
or Taxpayer Identification Number
Name of Co-Owner (if any)...........................................................
Address.............................................................................
.................................................................................... Account Number...........................
(zip code) (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 [ ] 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.
45
<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 California Municipal Bond 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 personally 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.
46
<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 LLP
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 PricingSM 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 Transactions and Options... 17
Repurchase Agreements........................ 19
Investment Restrictions...................... 19
Management of the Trust........................ 20
Trustees..................................... 20
Management and Advisory Arrangements......... 21
Code of Ethics............................... 21
Transfer Agency Services..................... 22
Purchase of Shares............................. 22
Initial Sales Charge Alternatives--
Class A and Class D Shares................. 24
Deferred Sales Charge Alternatives--
Class B and Class C Shares................. 26
Distribution Plans........................... 29
Limitations on the Payment of Deferred Sales
Charges.................................... 30
Redemption of Shares........................... 31
Redemption................................... 31
Repurchase................................... 32
Reinstatement Privilege--
Class A and Class D Shares................. 32
Shareholder Services........................... 32
Investment Account........................... 33
Exchange Privilege........................... 33
Automatic Reinvestment of Dividends and
Capital Gains Distributions................ 34
Systematic Withdrawal Plans.................. 34
Automatic Investment Plans................... 35
Fee-Based Programs........................... 35
Portfolio Transactions......................... 35
Distributions and Taxes........................ 36
Distributions................................ 36
Taxes........................................ 37
Performance Data............................... 39
Additional Information......................... 40
Determination of Net Asset Value............. 40
Organization of the Trust.................... 41
Shareholder Reports.......................... 42
Shareholder Inquiries........................ 42
Authorization Form............................. 43
</TABLE>
Code #10327-1296
[MERRILL LYNCH LOGO]
Merrill Lynch
California Municipal
Bond Fund
Merrill Lynch California
Municipal Series Trust
[mlynch compass]
PROSPECTUS
December 20, 1996
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 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 20, 1996 (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 20, 1996.
<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. The Fund anticipates that at all times,
except during temporary defensive periods, it will maintain at least 65% of its
total assets 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 ("IDBs") 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 Services ("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 not exempt
from Federal and California income taxes. 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 income taxes. 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. Other Non-Municipal Tax-Exempt Securities also
could include trust certificates or other derivative instruments evidencing
interests in one or more long-term municipal securities.
Except when acceptable securities are unavailable as determined by the
Manager, the Fund will, under normal circumstances, invest at least 65% of its
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 Investments, together
2
<PAGE> 55
with such other instruments as are not exempt from California taxation, shall
not exceed 20% of the Fund's total assets. The Fund at all times will have at
least 80% of its total assets invested in securities 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 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 objectives 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 obligations 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% 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% 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 or obligors 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 or
obligors 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.
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 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 or private activity bonds are
issued by or on behalf of public authorities to finance various privately owned
or operated 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 and California 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 industrial development bonds or private
activity bonds, the proceeds of which are used for the construction, equipment
or improvement of privately operated industrial or 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, tax increment (or tax allocation) and
assessment bonds, the payment of the special tax, tax increment and assessments
may be secured solely by remedies
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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 IDBs and,
for bonds issued after August 15, 1986, private activity 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. 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% 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 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
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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 Public Securities
Association Index 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 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
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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 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 other illiquid investments, would exceed
15% of the Fund's total assets.
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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.
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. 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 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 purchaser 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
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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 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
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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 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 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 futures contract or underlying
debt securities. Like the purchase of a futures contract, the Fund will purchase
a call option on a futures contract to hedge against a market advance when the
Fund is not fully invested.
The writing of a call option on a futures contract constitutes a partial
hedge against declining prices of the securities which are deliverable upon
exercise of the 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 Futures Contracts. The purchase of a put option on a
futures contract is analogous to the purchase of a protective put option on
portfolio securities. The Fund will purchase put options on futures contracts to
hedge the Fund's portfolio against the risk of rising interest rates.
The writing of a put option on a futures contract constitutes a partial
hedge against increasing prices of the securities which are deliverable upon
exercise of the 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 futures contract is required to deposit
initial and variation margin pursuant to requirements similar to those
applicable to futures contracts. Premiums received from the writing of an option
will be included in initial margin. The writing of an option on a futures
contract involves risks similar to those relating to futures contracts.
The Trust has received an order from 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 futures contracts. Section 17(f) relates to the custody of securities and
other assets of an investment company and may be 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
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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 futures contracts or a call option with respect
thereto or writes a put option on a futures contract, an amount of cash, cash
equivalents or liquid 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 futures
contracts involves the risk of imperfect correlation between movements in the
price of the 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 futures contract moves more than the price of the hedged security,
the Fund will experience either a loss or gain on the 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 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 futures contracts. Conversely, the Fund may purchase or sell fewer
futures contracts if the volatility of the price of the hedged securities is
historically less than that of the 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 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 futures contracts and the prices of the
Municipal Bonds held by the Fund may be greater.
The Fund expects to liquidate a majority of the 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 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 futures position only if, in the judgment of the Manager, there
appears to be an actively traded secondary market for such 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.
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To the extent interest rates remain stable during the period in which a 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
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 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 futures contracts were approved for trading in 1986.
Trading in such financial futures contracts may tend to be less liquid than that
in other futures contracts. The trading of 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.
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
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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 Information, as they may
be amended from time to time, and without registering as a 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.
d. 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.
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
14
<PAGE> 67
(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 tax requirements.
Because of the affiliation of Merrill Lynch, Pierce, Fenner & Smith
Incorporated ("Merrill Lynch") with the Trust, the Fund is prohibited from
engaging in certain transactions involving such firm or its affiliates except
for brokerage transactions permitted under the 1940 Act involving only usual and
customary commissions or transactions pursuant to an exemptive order under the
1940 Act. Included among such restricted transactions will be 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 (64) --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. ("MLFD" or the
"Distributor") since 1977.
JAMES H. BODURTHA (52) --Trustee(2)--36 Popponesset Road, Cotuit,
Massachusetts 02635. Director and Executive Vice President, The China Business
Group, Inc. since 1996; Chairman and Chief Executive Officer, China Enterprise
Management Corporation from 1993 to 1996; Chairman, Berkshire Corporation since
1980; Partner, Squire, Sanders & Dempsey from 1980 to 1993.
HERBERT I. LONDON (57) --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 1980; Dean, Gallatin Division of New York
University from 1978 to 1993; Distinguished Fellow, Herman Kahn Chair, Hudson
Institute from 1984 to 1985; Trustee, Hudson Institute since 1980; Director,
Damon Corporation since 1991; Overseer, Center for Naval Analyses from 1983 to
1993; Limited Partner, Hypertech L.P. since 1996.
15
<PAGE> 68
ROBERT R. MARTIN (69) --Trustee (2)--513 Grand Hill, St. Paul, Minnesota
55102. 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; Chairman of the Board, WTC Industries,
Inc. in 1994; Trustee, Northland College since 1992.
JOSEPH L. MAY (67) --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 (44) --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.
TERRY K. GLENN (56) --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; President of Princeton Administrators,
L.P. since 1988.
VINCENT R. GIORDANO (52) --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 (45) --Vice President (1)(2)--Vice President of the
Manager and MLAM since 1984.
WALTER O'CONNOR (35) --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 (36) --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 (47) --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 MLFD since 1984 and
Vice President thereof since 1981.
JERRY WEISS (38) --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, 1996, the Trustees and officers of the Trust as a group (12
persons) owned an aggregate of less than 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.
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<PAGE> 69
COMPENSATION OF TRUSTEES
The Trust pays each Trustee not affiliated with the Manager (each a
"non-affiliated Trustee") a fee of $5,000 per year plus $500 per meeting
attended. The Trust also compensates members of its Audit and Nominating
Committee (the "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, 1996, fees and expenses paid to
non-affiliated Trustees which were allocated to the Fund aggregated $40,129.
The following table sets forth for the fiscal year ended August 31, 1996,
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
registered investment companies (including the Trust) 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............................ $7,956 None $ 157,500*
Herbert I. London............................ $7,956 None $ 157,500
Robert R. Martin............................. $7,956 None $ 157,500
Joseph L. May................................ $7,956 None $ 157,500
Andre F. Perold.............................. $7,956 None $ 157,500
</TABLE>
- ---------------
(1) The Trustees serve on the boards of FAM/MLAM Advised Funds as follows: Mr.
Bodurtha (22 registered investment companies consisting of 46 portfolios);
Mr. London (22 registered investment companies consisting of 46 portfolios);
Mr. Martin (22 registered investment companies consisting of 46 portfolios);
Mr. May (22 registered investment companies consisting of 46 portfolios);
and Mr. Perold (22 registered investment companies consisting of 46
portfolios).
* $157,500 represents the amount Mr. Bodurtha would have received if he had
been a Trustee for the entire calendar year ended December 31, 1995. Mr.
Bodurtha was elected to the Trust's Board of Trustees effective June 23,
1995.
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 Fund.
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 its
affiliates. 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 its
17
<PAGE> 70
affiliates 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.
Pursuant to a management agreement between the Trust on behalf of the Fund
and the Manager (the "Management Agreement"), 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, 1994, 1995 and 1996, the total advisory
fees paid by the Fund to the Manager aggregated $4,567,938, $3,828,093 and
$3,611,875, respectively.
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 a
portion of the Trust's general administrative expenses will be allocated on the
basis of the asset size of the respective series of the Trust ("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 (including the Fund) 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 fiscal years
ended August 31, 1994, 1995 and 1996, the Fund reimbursed the Manager $101,105,
$64,518 and $118,709, respectively 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 the Fund. Certain
expenses in connection with the account maintenance and distribution of Class B
and Class C shares will be financed by the Fund 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 Plans".
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
18
<PAGE> 71
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.
The Fund issues four classes of shares under the Merrill Lynch Select
Pricing(SM) 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
registered investment companies advised by MLAM or its affiliate, the Manager.
Funds advised by MLAM or the Manager which utilize the Merrill Lynch Select
Pricing(SM) System 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 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 ALTERNATIVES--CLASS A AND CLASS D SHARES
The gross sales charges for the sale of Class A shares for the fiscal 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 fiscal 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
19
<PAGE> 72
A shares for the fiscal year ended August 31, 1996 were $20,961, of which the
Distributor received $2,185 and Merrill Lynch received $18,776. 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 gross sales
charges for the sale of Class D shares for the fiscal year ended August 31, 1996
were $31,208, of which the Distributor received $2,960 and Merrill Lynch
received $28,284. For the fiscal years ended August 31, 1994, 1995 and 1996 the
Distributor received no CDSCs with respect to redemptions within one year after
purchase of Class A shares purchased subject to a front-end sales charge waiver.
For the period October 21, 1994 (commencement of operations) to August 31, 1995
and for the fiscal year ended August 31, 1996, the Distributor received no CDSCs
with respect to redemptions within one year after purchase of Class D shares
purchased subject to a front-end sales charge waiver.
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.
Closed-End Investment Option. Class A shares of the Fund and other
MLAM-advised mutual funds ("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 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 either have 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.
Shareholders of certain MLAM-advised continuously offered closed-end funds
may reinvest at net asset value the net proceeds from a sale of certain shares
of common stock of such funds in shares of the Fund. Upon exercise of this
investment option, shareholders of Merrill Lynch Senior Floating Rate Fund, Inc.
will receive Class A shares of the Fund and shareholders of Merrill Lynch
Municipal Strategy Fund, Inc. and Merrill Lynch High Income Municipal Bond Fund,
Inc. will receive Class D shares of the Fund, except that
20
<PAGE> 73
shareholders already owning Class A shares will be eligible to purchase
additional Class A shares pursuant to this option, if such additional Class A
shares will be held in the same account as the existing Class A shares and the
other requirements pertaining to the reinvestment privilege are met. In order to
exercise this investment option, a shareholder of one of the above-referenced
continuously offered closed-end funds (an "eligible fund") must sell his or her
shares of common stock of the eligible fund (the "eligible shares") back to the
eligible fund in connection with a tender offer conducted by the eligible fund
and reinvest the proceeds immediately in the designated class of shares of the
Fund. This investment option is available only with respect to eligible shares
as to which no Early Withdrawal Charge or CDSC (each as defined in the eligible
fund's prospectus) is applicable. Purchase orders from eligible fund
shareholders wishing to exercise this investment option will be accepted only on
the day that the related tender offer terminates and will be effected at the net
asset value of the designated class of the Fund on such day.
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 13-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 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 13-month period (while remaining registered in the name of the
purchaser)
21
<PAGE> 74
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 a purchase during the
term of such Letter would otherwise be subject to a further reduced sales charge
based on the right of accumulation, the purchaser will be entitled on that
purchase and subsequent purchases to that further reduced percentage sales
charge 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 AccountsSM available through qualified 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.
Purchase Privilege of Certain Persons. Trustees of the Trust, members of
the Boards of other MLAM-advised investment companies, 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 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 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 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 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
22
<PAGE> 75
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.
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 of 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 sales 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 Trustees"), 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 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
such
23
<PAGE> 76
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 Conduct Rules of the National
Association of Securities Dealers, Inc. (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 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,
1996 with respect to the Class B and Class C shares of the Fund indicating the
maximum allowable payments that can be made under the NASD maximum sales charge
rule and, with respect to Class B shares, the Distributor's voluntary maximum.
<TABLE>
<CAPTION>
DATA CALCULATED AS OF AUGUST 31, 1996
-----------------------------------------------------------------------------------------
(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 SHARES FOR THE PERIOD
SEPTEMBER 30, 1985 (COMMENCEMENT OF
OPERATIONS) TO AUGUST 31, 1996:
Under NASD Rule as Adopted............ $1,426,378 $89,149 $ 75,812 $164,961 $ 30,649 $134,312 $ 1,202
Under Distributor's Voluntary
Waiver.............................. $1,426,378 $89,149 $ 7,132 $96,281 $ 30,649 $ 65,632 $ 1,202
<CAPTION>
CLASS C SHARES FOR THE PERIOD OCTOBER
21, 1994 (COMMENCEMENT OF OPERATIONS)
TO AUGUST 31, 1996:
<S> <C> <C> <C> <C> <C> <C> <C>
Under NASD Rule as Adopted............ $ 8,560 $ 535 $ 43 $ 578 $ 33 $ 545 $ 28
</TABLE>
- ------------------
(1) Purchase price of all eligible Class B or Class C shares sold during the
periods indicated 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.
24
<PAGE> 77
(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 ("NYSE") is restricted as determined by the Commission or
the NYSE 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 CHARGES--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 fiscal years ended
August 31, 1994, 1995 and 1996 the Distributor received CDSCs of $704,845,
$866,830 and $427,650, respectively, with respect to redemptions of Class B
shares, all of which were paid to Merrill Lynch. For the period October 21, 1994
(commencement of operations) to August 31, 1995, and for the fiscal year ended
August 31, 1996 the Distributor received CDSCs of $8,242 and $4,398,
respectively, with respect to redemptions of Class C shares, all of which were
paid to Merrill Lynch.
PORTFOLIO TRANSACTIONS
Reference is made to "Investment Objective and Policies--Other Investment
Policies and Practices" in the 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 Trust, including Merrill Lynch, may not serve as dealer in
connection with transactions with the Fund. 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 fiscal year ended August 31, 1994, the Fund engaged in no
transactions pursuant to such order. During the fiscal year ended August 31,
1995, the Fund engaged in sixty transactions pursuant to such order for an
aggregate market value of approximately $138.3 million. For the fiscal year
ended August 31, 1996, the Fund engaged in six transactions pursuant to such
order for an aggregate market value of approximately $9.9 million. The Trust has
25
<PAGE> 78
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.
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
transactions.
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 Conduct Rules of the NASD 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. 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 fiscal years
ended August 31, 1995 and 1996 were 53.40% and 53.79%, 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
26
<PAGE> 79
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 NYSE (generally, 4:00 P.M. New York time), on each day
during which the NYSE is open for trading. The NYSE 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 Class B, Class C and Class D shares
generally will be lower than the per share net asset value of Class A shares,
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. In addition, the per share net asset value of
Class B and Class C shares generally will be lower than the per share net asset
value of Class D shares, reflecting the daily expense accruals of the
distribution fees, higher account maintenance fees and higher transfer agency
fees applicable with respect to 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.
27
<PAGE> 80
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 gain 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
reinvestment of ordinary income dividends, and long-term capital gain
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. 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) or 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
automatically reinvested 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
28
<PAGE> 81
their income dividends or capital gains distributions, or both, in cash, in
which event payment will be mailed on or about the payment date.
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 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 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 NYSE (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 NYSE 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, 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) or
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 three 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 Systematic Redemption
29
<PAGE> 82
Program is not available if Fund shares are being purchased within the account
pursuant to the Automatic Investment Program. For more information on the CMA(R)
or CBA(R) Systematic Redemption Program, eligible shareholders should contact
their Merrill Lynch Financial Consultant.
EXCHANGE PRIVILEGE
Shareholders of each class of shares of the Fund have an exchange privilege
with certain other MLAM-advised mutual funds. Under the Merrill Lynch SelectSM
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 for 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 as follows: Class A shares may
be exchanged for shares of Merrill Lynch Ready Assets Trust, Merrill Lynch
Retirement Reserves Money Fund (available only for exchanges within certain
retirement plans), Merrill Lynch U.S.A. Government Reserves and Merrill Lynch
U.S. Treasury Money Fund; Class B, Class C and Class D shares may be exchanged
for shares of Merrill Lynch Government Fund, Merrill Lynch Institutional Fund,
Merrill Lynch Institutional Tax-Exempt Fund and Merrill Lynch Treasury Fund.
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. It is contemplated that the exchange privilege
may be applicable to other new mutual funds whose shares may be distributed by
the Distributor.
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 shall be deemed
to have been sold with a sales charge equal to the sales charge previously paid
on the Class A or Class D shares on which the dividend was paid. Based on this
formula, Class A and Class D shares generally may be exchanged into the Class A
or Class D shares of the other funds or into shares of certain money market
funds without a sales charge.
30
<PAGE> 83
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, of other
MLAM-advised mutual funds ("new Class B or Class C shares") 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 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 or Class C shares. For example, an investor
may exchange Class B shares of the Fund for those of Merrill Lynch Special Value
Fund, Inc. ("Special Value Fund") 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 Special Value Fund and receive cash. There will be
no CDSC 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 Special Value Fund Class B shares, the investor will be deemed to have held
the new Special Value Fund Class B shares for more than five years.
Shareholders also may exchange shares of the Fund into shares of certain
money market funds 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 newly-acquired 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 ("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 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 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 would not incur a CDSC.
Before effecting an exchange, shareholders should obtain a currently
effective prospectus of the fund into which the exchange is to be made.
To exercise the exchange privilege, a shareholder should contact his or her
Merrill Lynch Financial Consultant, who will advise the Fund of the exchange.
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
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<PAGE> 84
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, 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.
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 Commission rule permitting the issuance and sale
of multiple classes of shares) 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
32
<PAGE> 85
paying exempt-interest dividends, such as the Fund, will not be deductible by
the investor for Federal or California 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 its total assets consists of California
Municipal Bonds. The Fund intends to invest at least 50% of its assets in
California Municipal Bonds at all times. 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. Accordingly, investors
in the Fund including, in particular, corporate investors which may be subject
to the California corporate 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. 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 disallowed to the extent of any exempt-interest dividends
received by the shareholder. In addition, any such loss that is not disallowed
under the rule stated above will be treated as long-term capital loss to the
extent of any capital gain 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
33
<PAGE> 86
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 certain 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 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.
The Fund may invest in high yield securities as previously described.
Furthermore, the Fund may also invest in instruments the return on which
includes nontraditional features such as indexed principal or interest payments
("nontraditional instruments"). These instruments may be subject to special tax
rules under which the Fund may be required to accrue and distribute income
before amounts due under the obligations are paid. In addition, it is possible
that all or a portion of the interest payments on such high yield securities
and/or nontraditional instruments could be recharacterized as taxable ordinary
income.
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 any sales charge
paid to the Fund on the exchanged shares 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.
34
<PAGE> 87
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 previously imposed a deductible tax (the "Environmental Tax") on a
corporation's modified 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 has
expired for tax years beginning after December 31, 1995, but may be reinstated
in the future. The Environmental Tax was imposed even if the corporation was not
required to pay an alternative minimum tax because the corporation's regular
income tax liability exceeded its minimum tax liability. The Code provides,
however, that a RIC such as the Fund would not be 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) could 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 sales of securities and 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 sales of
securities and 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,
35
<PAGE> 88
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 advisors 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 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.
36
<PAGE> 89
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, 1996..... 2.27% $1,022.70 1.99% $1,019.90
Five Years Ended August 31, 1996... 6.18% $1,349.60 6.50% $1,370.20
Ten Years Ended August 31, 1996.... 6.47% $1,871.30
Inception (October 25, 1988) to
August 31, 1996................... 6.97% $1,697.50
Inception (October 21, 1994) to
August 31, 1996...................
ANNUAL TOTAL RETURN
(excluding maximum applicable sales charges)
Year Ended August 31,
1996.............................. 6.53% $1,065.30 5.99% $1,059.90
1995.............................. 6.75% $1,067.50 6.25% $1,062.50
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...................
AGGREGATE TOTAL RETURN
(including maximum applicable sales charges)
Inception (September 30, 1985) to
August 31, 1996.................. 130.53% $2,305.30
Inception (October 25, 1988) to
August 31, 1996................... 69.75% $1,697.50
Inception (October 21, 1994) to
August 31, 1996...................
YIELD
30 days ended on August 31, 1996... 4.94% 4.63%
TAX-EQUIVALENT YIELD*
30 days ended on August 31, 1996... 6.86% 6.43%
</TABLE>
<TABLE>
<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
------------ ------------ ------------ ------------
AVERAGE ANNUAL TOTAL RETURN
(including maximum applicable sales charges)
<S> <C> <C> <C> <C>
One Year Ended August 31, 1996..... 4.88% $1,048.80 2.17% $1,021.70
Five Years Ended August 31, 1996...
Ten Years Ended August 31, 1996....
Inception (October 25, 1988) to
August 31, 1996...................
Inception (October 21, 1994) to
August 31, 1996................... 7.95% $1,153.20 6.15% $1,117.60
ANNUAL TOTAL RETURN
(excluding maximum applicable sales charges)
Year Ended August 31,
1996.............................. 5.88% $1,058.80 6.43% $1,064.30
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................... 8.91% $1,089.10 9.39% $1,093.90
AGGREGATE TOTAL RETURN
(including maximum applicable sales charges)
Inception (September 30, 1985) to
August 31, 1996..................
Inception (October 25, 1988) to
August 31, 1996...................
Inception (October 21, 1994) to
August 31, 1996................... 15.32% $1,153.20 11.76% $1,117.60
YIELD
30 days ended on August 31, 1996... 4.53% 4.84%
TAX-EQUIVALENT YIELD*
30 days ended on August 31, 1996... 6.29% 6.72%
</TABLE>
- ---------------
* Based on a Federal income tax rate of 28%.
37
<PAGE> 90
In order to reflect the reduced sales charges in the case of Class A or
Class D shares or the waiver of the CDSC 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.
GENERAL INFORMATION
DESCRIPTION OF SHARES
The Declaration of Trust provides that the Trust shall be comprised of
separate 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.
The Board of Trustees of the Trust may classify and reclassify the shares of any
Series into additional classes at a future date.
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
38
<PAGE> 91
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 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. 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, 1996, is set forth
below.
<TABLE>
<CAPTION>
AUGUST 31, 1996
------------------------------------------------------------
CLASS A CLASS B CLASS C CLASS D
----------- ------------ ---------- ------------
<S> <C> <C> <C> <C>
Net Assets........................... $42,668,594 $480,667,799 $8,111,647 $111,816,734
========== =========== ========= ===========
Number of Shares Outstanding......... 3,713,704 41,822,524 705,950 9,729,971
========== =========== ========= ===========
Net Asset Value Per Share (net assets
divided by number of shares
outstanding)....................... $ 11.49 $ 11.49 $ 11.49 $ 11.49
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....................... $ 11.97 $ 11.49 $ 11.49 $ 11.97
========== =========== ========= ===========
</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 and
"Redemption of Shares--Deferred Sales Charges--Class B and Class C Shares"
herein.
INDEPENDENT AUDITORS
Deloitte & Touche LLP, 117 Campus Drive, Princeton, New Jersey 08540-6400,
has been selected as the independent auditors of the Fund. The independent
auditors are responsible for auditing the annual financial statements of the
Fund.
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.
39
<PAGE> 92
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 LLP, 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 exhibits
relating thereto, which the Trust has filed with the Commission, Washington,
D.C., under the Securities Act and the 1940 Act 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, 1996.
40
<PAGE> 93
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 herein as the
"State") is the largest among the 50 states and one of the largest in the world.
This diversified economy has major components in agriculture, manufacturing,
high technology, trade, entertainment, tourism, construction and services. Total
State gross domestic product of about $890 billion in 1995 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, 1995, the 5-county Los Angeles area accounted for 49
percent, with 15.6 million residents. The 10-county San Francisco Bay Area
represented 21 percent, with a population of 6.6 million.
After suffering through a severe recession, California's economy has been
on a steady recovery since the start of 1994. Employment grew by over 500,000 in
1994 and 1995, and the pre-recession level of total employment is expected to be
matched in 1996. The strongest growth has been in export-related industries,
business services, electronics, entertainment and tourism, all of which have
offset the recession-related losses which were heaviest in aerospace and
defense-related industries (which accounted for two-thirds of the job losses),
finance and insurance. Residential housing construction, with new permits for
under 100,000 annual new units issued in 1994 and 1995, is weaker than in
previous recoveries, but has been growing slowly since 1993.
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 Program -- K-14
education, health, welfare and corrections -- was increasing faster than the
revenue base, driven by the State's
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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.
Prior Years. As a result of these factors and others, from the late 1980s
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 multi-billion 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 "borrower" 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 the fiscal year.
The 1994-95 Fiscal Year represented the fourth consecutive year that the
Governor and the 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
updated in May and June, 1994, recognized that the accumulated deficit could not
be repaid in one year and proposed a two-year solution.
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 would be invoked for the 1994-95 Fiscal Year.
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 1995-96 Fiscal Year, the State Controller estimated that
the General Fund would have internal cash resources on June 30, 1996 (i.e.,
external borrowing would not be needed to pay all obligations due). If a cash
shortfall had been identified by the State Controller,
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the State Legislature would have been required to enact legislation providing
for sufficient General Fund expenditure reductions, revenue increases, or both.
1995-96. 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 enclosed 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.
1996-1997. The following are principal features of the 1996-97 Budget Act:
1. Proposition 98 funding for schools and community college districts
increased by almost $1.6 billion (General Fund) and $1.65 billion total above
revised 1995-96 levels. Almost half of this money was budgeted to fund
class-size reductions in kindergarten and grades 1-3. Also, for the second year
in a row, the full cost of living allowance (3.2 percent) was funded. The
Proposition 98 increases have brought K-12 expenditures to almost $4,800 per
pupil (also called per ADA, or Average Daily Attendance), an almost 15% increase
over the level prevailing during the recession years. Community colleges will
receive an increase in funding of $157 million for 1996-97 out of this $1.6
billion total.
Because of the higher than projected revenues in 1995-96, an additional
$1.1 billion ($190 per K-12 ADA and $145 million for community colleges) was
appropriated and retroactively applied towards the 1995-96 Proposition 98
guarantee, bringing K-12 expenditures in that year to over $4,600 per ADA. These
new funds were appropriated for a variety of purposes, including block grants,
allocations for each school site, facilities for class size reduction, and a
reading initiative. Similar retroactive increases totaling $230 million, based
on final figures on revenues and State population growth, were made to the
1991-92 and the 1994-95 Proposition 98 guarantees, most of which was allocated
to each school site.
2. The Budget Act assumed savings of approximately $660 million in health
and welfare costs which required changes in federal law, including federal
welfare reform. The Budget Act further assumed federal law changes in August
1996 which would allow welfare cash grant levels to be reduced by October 1,
1996. These cuts totaled approximately $163 million of the anticipated $660
million savings.
3. A 4.9 percent increase in funding for the University of California ($130
million General Fund) and the California State University system ($101 million
General Fund), with no increases in student fees, maintaining the second year of
the Governor's four-year "Compact" with the State's higher education units.
4. The Budget Act assumed the federal government will provide approximately
$700 million in new aid for incarceration and health care costs of illegal
immigrants. These funds reduce appropriations in these categories that would
otherwise have to be paid from the General Fund. (For purposes of cash flow
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projections, the Department of Finance expects $540 million of this amount to be
received during the 1996-97 fiscal year.)
5. General Fund support for the Department of Corrections was increased by
about 7 percent over the prior year, reflecting estimates of increased prison
population.
6. With respect to aid to local governments, the principal new programs
included in the Budget Act are $100 million in grants to cities and counties for
law enforcement purposes, and budgeted $50 million for competitive grants to
local governments for programs to combat juvenile crime.
The Budget Act did not contain any tax increases. As noted, there was a
reduction in corporate taxes. In addition, the Legislature approved another
one-year suspension of the Renters Tax Credit, saving $520 million in
expenditures.
Federal Welfare Reform. Following enactment of the 1996-97 Budget Act,
Congress passed and the President signed (on August 22, 1996) the Personal
Responsibility and Work Opportunity Act of 1996 (P.L. 104-193, the "Law") making
a fundamental reform of the current welfare system. Among many provisions, the
Law includes: (i) conversion of Aid to Families with Dependent Children from an
entitlement program to a block grant titled Temporary Assistance for Needy
Families (TANF), with lifetime time limits on TANF recipients, work requirements
and other changes; (ii) provisions denying certain federal welfare and public
benefits to legal noncitizens, allowing states to elect to deny additional
benefits (including TANF) to legal noncitizens, and generally denying almost all
benefits to illegal immigrants; and (iii) changes in the Food Stamp program,
including reducing maximum benefits and imposing work requirements.
The Law requires states to implement the new TANF program not later than
July 1, 1997 and provides California approximately $3.7 billion in block grant
funds for FY 1996-97 for the provisions of the Law. States are allowed to
implement TANF as soon as possible and will receive a prorated block grant
effective the date of application. The California State Plan is to be submitted
in time to allow grant reductions to be implemented effective January 1, 1997
(allowing $92 million of the $163 million referred to in paragraph 2 above to be
saved) and to allow the State to capture approximately $267 million in
additional federal block grant funds over the currently budgeted level. None of
the other federal changes needed to achieve the balance of the $660 million cost
savings were enacted. Thus, in lieu of the $660 million savings initially
assumed to be saved, it is now projected that savings will total approximately
$360 million.
A preliminary analysis of the law by the Legislative Analyst's Office
indicates that an overall assessment of how these changes will affect the
State's General Fund will not be known for some time, and will depend on how the
State implements the Law. There are many choices including how quickly the State
implements the Law; the degree to which the State elects to make up for cuts in
federal aid, provide more aid to counties, or cut some of its own existing
programs for noncitizens; and the State's ability to avoid certain penalties
written into the Law.
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
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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
"special taxes" (those devoted to a specific purpose) without two-thirds voter
approval. A recent California Supreme Court decision has upheld the
constitutionality of an initiative statute, previously held invalid by lower
courts, which requires voter approval for "general" as well as "special" taxes
at the local level. Counties, in particular, have had fewer options to raise
revenues than 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 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. Orange County implemented
significant reductions in services and personnel, and continues to face fiscal
constraints in the aftermath of its bankruptcy.
CONSTITUTIONAL AND STATUTORY LIMITATIONS; RECENT INITIATIVES; PENDING
LEGISLATION
Constitutional and Statutory Limitations. 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 percent of the
"full cash value" of the property and effectively prohibits the levying of any
other ad valorem tax on real property 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
percent 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, 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 percent) 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 the 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 local government has financial
responsibility for providing. To the extent that 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 a local governmental entity be approved by a
majority of the electorate of the governmental entity, (ii) required that any
special tax (defined as taxes levied for other than general government purposes)
imposed by a local governmental entity be approved by a two-thirds vote of the
voters within that jurisdiction, (iii) restricted the use of revenues from a
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special tax to the purposes or for the services 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 that 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 collecting 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 with regard to
charter cities.
Recent Initiatives. 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 it shall deem reasonable and necessary and (ii)
revenues in excess of amounts permitted to be spent 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 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 cost 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 requirements 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.
During the recent recession, General Fund revenues for several years were
less than originally projected, so that the original Proposition 98
appropriations turned out to be higher than the minimum percentage provided in
the law. The Legislature responded to these developments by designating the
"extra" Proposition 98 payments in one year as a "loan" from future years'
Proposition 98 entitlements and also intended that the "extra" payments would
not be included in the Proposition 98 "base" for calculating future years'
entitlement.
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By implementing these actions, per-pupil funding from Proposition 98 sources
stayed almost constant at approximately $4,220 from Fiscal Year 1991-92 to
Fiscal Year 1993-94.
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. The settlement was approved by the court in July 1996.
The settlement provides, among other things, 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 by
forgiveness of the amount owed, 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. Repayments are spread over the eight-year period
of 1994-95 through 2001-02 to mitigate any adverse fiscal impact. The Director
of Finance has certified that a settlement has occurred, allowing approximately
$377 million in appropriations from the 1995-96 Fiscal Year to schools to be
disbursed.
On November 8, 1994, the voters approved Proposition 187, an initiative
statute ("Proposition 187"), Proposition 187 specifically prohibits funding by
the State 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 pertaining to public school education, 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 measure also prohibits a school district from providing
education to a student it does not verify as either a United States citizen or a
person legally admitted to the United States. The State 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
requirements 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. On November 2, 1995, a United
States District Court judge struck down the central provisions of Proposition
187 by ruling that parts of Proposition 187 conflict with Federal power over
immigration. The ruling concluded that states may not enact their own schemes to
"regulate immigration or devise immigration regulations which run parallel or
purport to supplement Federal immigration law". As a consequence of the ruling,
students may not be denied public education and may not be asked about their
immigration status when enrolling in public schools. Further, the ruling struck
down the requirements of
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Proposition 187 that teachers and district employees report information on the
immigrant status of students, parents and guardians. An appeal has been filed.
Article XIIIA, Article XIIIB and a number of other 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.
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.
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 has lost
at least $80 million as a result of the Lennane decision.
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. The parties
have agreed to a settlement which has to be approved by the trail court. Under
the terms of the judgment, a maximum of $1.3 million will be paid to eligible
separated State employees and approximately $1 million will be paid in statutory
attorney's fees and costs. In addition, eligible current State employees will
receive employee leave, in an amount presently not quantified.
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
Districts 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, reversing a trail 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
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has 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 trail court with
instructions to remand the Demonstration Project to the Secretary for additional
consideration of objections raised by the plaintiffs. The State submitted a
renewed waiver request to the Secretary, which was granted in early 1996.
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
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 upheld 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 courterclaim. 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 appellate court affirmed the trial court finding of liability in inverse
condemnation and awarded damages of $500,000 to 12 sample plaintiffs. Potential
liability to the remaining 300 plaintiffs, from claims filed, ranges from $800
million to $1.5 billion.
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.
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 claim that the State has violated
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 rules that the inmates are not employees under the
FLSA. The decision has been appealed to the Ninth Circuit Court of Appeals,
which affirmed the District Court decision holding that the inmates are not
employees under the FLSA. The inmates have filed a Petition for Rehearing and a
Petition for Hearing En Banc with the Ninth Circuit.
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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 courts, seek to
have the transfers reversed and the monies allegedly totalling 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 totalling approximately $370 million. The
State disputes both liability and the amount claimed. In the case of
Professional Engineers in California Government v. Wilson, several State
employees' unions have challenged transfers made from special funds to the
General Fund pursuant to the Budget Act 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
("PERS") 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 were found to be unconstitutional and to transfer to PERS the
1993-94 and 1994-95 contributions that are unpaid to date. The State defendants
have appealed.
50
<PAGE> 103
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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<PAGE> 104
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.
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 SERVICES
("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.
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.
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<PAGE> 105
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.
53
<PAGE> 106
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. Ratings are applicable to
both taxable and tax-exempt commercial paper. Issues assigned the highest rating
are regarded as having the greatest capacity for timely payment. Issues in this
category are further refined with the designation 1, 2, and 3 to indicate the
relative degrees of safety. Issues in the "A" category are as follows:
<TABLE>
<S> <C>
A-1 This designation indicates that the degree of safety regarding timely payment is
either overwhelming or very 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> 107
A Standard & Poor's note rating reflects the liquidity concerns and market
access risks unique to notes. Notes due in three years or less will likely
receive a note rating. Notes maturing beyond three 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 FITCH INVESTORS SERVICE, INC. ("FITCH") INVESTMENT GRADE BOND
RATINGS
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> 108
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 [arrow up]
Stable [arrow left and right]
Declining [arrow down]
Uncertain [arrow up and down]
</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.
56
<PAGE> 109
<TABLE>
<S> <C>
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.
</TABLE>
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.
57
<PAGE> 110
Bonds that have the same rating are of similar but not necessarily
identical credit quality since rating categories cannot fully reflect the
differences in degree 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.
58
<PAGE> 111
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> 112
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, 1996, 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, 1996 by correspondence with the custodian. 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, 1996, 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
October 1, 1996
60
<PAGE> 113
MERRILL LYNCH CALIFORNIA MUNICIPAL BOND FUND AUGUST 31, 1996
<TABLE>
SCHEDULE OF INVESTMENTS (in Thousands)
<CAPTION>
S&P Moody's Face Value
Ratings Ratings Amount Issue (Note 1a)
California--97.5%
<S> <C> <C> <C> <C>
NR* NR* $ 3,750 Alameda, California, Public Financing Authority, Local Agency Special Tax Revenue
Refunding Bonds (Community Facility #1), Series A, 7% due 8/01/2019 $ 3,804
AAA Aaa 3,000 Anaheim, California, Public Financing Authority, Tax Allocation Revenue Bonds,
Registered RITES, 9.03% due 12/28/2018 (c)(j) 3,352
Antioch, California, Improvement Bonds (1915 Assessment District No.27-Lone Tree):
NR* NR* 665 Series D, 6.40% due 9/02/2003 679
NR* NR* 4,955 Series D, 7.30% due 9/02/2013 5,123
NR* NR* 4,000 Series E, 7.125% due 9/02/2016 4,126
AAA Aaa 3,140 Brea, California, Public Financing Authority, Tax Allocation Revenue Bonds
(Redevelopment Project AB), Series A, 6.75% due 8/01/2022 (c) 3,407
AAA Aaa 2,025 Brentwood, California, GO, Unified School District, 6.85% due 8/01/2016 (d)(k) 2,151
California Health Facilities Financing Authority Revenue Bonds, Series A:
AAA Aaa 4,350 (Kaiser Permanente), 7% due 10/01/2018 (c) 4,677
BB Aaa 5,150 Refunding (Good Samaritan Health System), 7.50% due 5/01/2000 (a) 5,754
AAA Aaa 4,000 (Scripps Memorial Hospital), 6.25% due 10/01/2013 (c) 4,162
A1+ VMIG1++ 1,580 (Scripps Memorial Hospital), VRDN, 3.35% due 12/01/2005 (b)(c) 1,580
NR* A 5,780 (Scripps Research Institute), 6.625% due 7/01/2014 6,071
A1+ VMIG1++ 5,500 California Health Facilities Financing Authority, Revenue Refunding Bonds
(Catholic West), Series C, VRDN, 3.25% due 7/01/2011 (b)(c) 5,500
California HFA, Home Mortgage Revenue Bonds:
AA- Aa 3,620 AMT, Series A, 7.70% due 8/01/2030 3,795
AA- Aa 470 AMT, Series B, 8% due 8/01/2029 491
AA- Aa 10,115 AMT, Series F-1, 7% due 8/01/2026 10,626
AA- Aa 790 AMT, Series G, 8.15% due 8/01/2019 823
AA- Aa 2,110 Series A, 8.125% due 8/01/2019 2,220
AA- Aa 2,850 Series D, 7.25% due 8/01/2017 3,001
California HFA, Revenue Bonds, AMT:
AA- Aa 4,150 RIB, 8.856% due 8/01/2023 (j) 4,186
AAA Aaa 980 Series A, 7.20% due 2/01/2026 (c) 1,025
</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.
AMT Alternative Minimum Tax (subject to)
COP Certificates of Participation
GO General Obligation Bonds
HFA Housing Finance Agency
INFLOS Inverse Floating Rate Municipal Bonds
M/F Multi-Family
PCR Pollution Control Revenue Bonds
RIB Residual Interest Bonds
RITES Residual Interest Tax-Exempt Securities
RITR Residual Interest Trust Receipts
S/F Single Family
UT Unlimited Tax
VRDN Variable Rate Demand Notes
61
<PAGE> 114
MERRILL LYNCH CALIFORNIA MUNICIPAL BOND FUND AUGUST 31, 1996
<TABLE>
SCHEDULE OF INVESTMENTS (continued) (in Thousands)
<CAPTION>
S&P Moody's Face Value
Ratings Ratings Amount Issue (Note 1a)
California (continued)
<S> <C> <C> <C> <C>
California Pollution Control Financing Authority, PCR, Refunding, VRDN (b):
A1+ P1 $ 3,000 (Exxon Project), 3.50% due 12/01/2012 $ 3,000
A1 NR* 4,700 (Pacific Gas and Electric Co.), AMT, Series G, 3.45% due 2/01/2016 4,700
California Pollution Control Financing Authority, Resource Recovery Revenue Bonds,
VRDN, AMT (b):
NR* NR* 3,200 (Delano Project), 3.50% due 8/01/2019 3,200
NR* P1 2,800 (Delano Project), 3.50% due 8/01/2019 2,800
NR* P1 2,500 (Delano Project), Series 1991, 3.50% due 8/01/2029 2,500
NR* P1 2,400 Refunding (Ultra Power Malaga Project), Series A, 3.55% due 4/01/2017 2,400
NR* P1 3,600 Refunding (Ultra Power Rocklin Project), Series A, 3.55% due 6/01/2017 3,600
A1+ VMIG1++ 8,300 California Pollution Control Financing Authority, Solid Waste Disposal Revenue Bonds
(Shell Oil Co.-Martinez Project), VRDN, AMT, Series A, 3.50% due 10/01/2024 (b) 8,300
AA Aa 10,000 California State Department of Water Resources, Central Valley Project Revenue Bonds
(Water Systems), Series M, 5% due 12/01/2019 8,754
California State Public Works Board, Lease Revenue Bonds:
A A 10,675 (Department of Corrections-Monterey County Soledad II), Series A, 7% due 11/01/2019 11,735
A A 3,555 High Technology Facilities (San Jose Facilities), Series A, 7.75% due 8/01/2006 4,018
A A 7,000 (Various Community College Projects), Series B, 7% due 3/01/2019 7,682
AAA Aaa 10,775 (Various University of California Projects), Series A, 6.40% due 12/01/2016 (d) 11,410
A A1 1,475 (Various University of California Projects), Series B, 6.625% due 12/01/2019 1,567
California State, Veterans' Bonds, AMT, UT:
A+ A 16,300 Series AW, 7.70% due 4/01/2009 17,372
AAA Aaa 13,250 Series BD, BE, BF, 6.375% due 2/01/2027 (d) 13,401
AA Aa 4,750 California Statewide Communities Development Authority Revenue Bonds (Saint Joseph
Health System Group), COP, 6.625% due 7/01/2021 4,993
AAA Aaa 5,000 Central Coast, California, Water Authority Revenue Bonds (State Water Project
Regional Facilities), 6.60% due 10/01/2022 (d) 5,396
BBB NR* 1,000 Contra Costa County, California, Public Financing Authority, Tax Allocation Revenue
Refunding Bonds, Series A, 7.10% due 8/01/2022 1,055
Corona, California, COP, Corona Community:
AAA Aaa 1,915 8% due 3/01/2009 (a) 2,375
AAA Aaa 2,065 8% due 3/01/2010 (a) 2,573
AAA Aaa 2,230 8% due 3/01/2011 (a) 2,792
AAA Aaa 2,410 8% due 3/01/2012 (a) 3,030
AAA Aaa 2,605 8% due 3/01/2013 (a) 3,286
AAA Aaa 2,810 8% due 3/01/2014 (a) 3,553
AAA Aaa 3,035 8% due 3/01/2015 (i) 3,843
NR* Aaa 4,635 Cypress, California, S/F Residential Mortgage Revenue Refunding Bonds, Series A,
7.10% due 1/01/2011 (i) 5,270
AAA Aaa 5,000 El Cajon, California, Redevelopment Agency, Tax Allocation Bonds (El Cajon
Redevelopment Project), 6.60% due 10/01/2022 (d) 5,349
BBB+ NR* 4,600 Fontana, California, Redevelopment Agency, Tax Allocation Refunding Bonds
(Jurupa Hills Redevelopment Project), Series A, 7.20% due 10/01/2024 4,927
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) 2,436
</TABLE>
62
<PAGE> 115
MERRILL LYNCH CALIFORNIA MUNICIPAL BOND FUND AUGUST 31, 1996
<TABLE>
SCHEDULE OF INVESTMENTS (continued) (in Thousands)
<CAPTION>
S&P Moody's Face Value
Ratings Ratings Amount Issue (Note 1a)
California (continued)
<S> <C> <C> <C> <C>
Long Beach, California, Improvement Bonds (1915 Assessment District 90-2):
NR* NR* $ 465 7% due 9/02/2001 $ 481
NR* NR* 495 7.05% due 9/02/2002 512
NR* NR* 530 7.10% due 9/02/2003 548
NR* NR* 570 7.15% due 9/02/2004 589
NR* NR* 610 7.20% due 9/02/2005 629
NR* NR* 655 7.25% due 9/02/2006 676
NR* NR* 4,065 7.50% due 9/02/2011 4,219
NR* NR* 5,695 Long Beach, California, M/F Housing Redevelopment Agency Revenue Bonds
(Pacific Court Apartments), Issue B, AMT, 6.95% due 9/01/2023 4,516
NR* NR* 4,545 Long Beach, California, Special Tax Community Facilities Bonds (District No.3-Pine
Avenue), 6.375% due 9/01/2023 4,255
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) 5,523
AAA Aaa 17,050 Los Angeles, California, Convention and Exhibition Center Authority, COP,
9% due 12/01/2005 (a) 22,124
Los Angeles, California, Convention and Exhibition Center Authority, Lease Revenue
Refunding Bonds, Series A (c):
AAA Aaa 8,000 5.125% due 8/15/2013 7,447
AAA Aaa 12,000 5.125% due 8/15/2021 10,707
AA- Aa 10,000 Los Angeles, California, Department of Water and Power, Electric Plant Revenue
Bonds, Registered RITR, 8.327% due 2/01/2020 (j) 10,687
AAA Aaa 5,000 Los Angeles, California, Department of Water and Power, Waterworks Revenue Bonds,
6.30% due 7/01/2024 (c) 5,166
Los Angeles, California, Harbor Department Revenue Bonds:
AAA NR* 10,000 7.60% due 10/01/2018 (i) 12,056
AA Aa 1,000 AMT, Series B, 6.625% due 8/01/2025 1,043
AAA Aaa 7,890 Los Angeles, California, Wastewater System Revenue Bonds, Series D,
6.625% due 12/01/2012 (c) 8,519
AAA Aaa 10,000 Los Angeles County, California, COP (Correctional Facilities Project),
6.50% due 9/01/2000 (a)(c) 10,908
AAA Aaa 10,000 Los Angeles County, California, Metropolitan Transportation Authority, Sales Tax
Revenue Refunding Bonds (Proposition A), Series A, 5% due 7/01/2021 (e) 8,763
AAA Aaa 12,070 Los Angeles County, California, Public Works Financing Authority, Lease Revenue
Refunding Bonds, Series A, 6% due 9/01/2005 (c) 12,891
AAA Aaa 10,000 Los Angeles County, California, Sanitation Districts, Financing Authority Revenue
Bonds(Capital Projects), Series A, 5.25% due 10/01/2019 (c) 9,115
AAA Aaa 6,250 Marysville, California, Hospital Revenue Bonds (Fremont-Rideout Health Group),
Series A, 6.30% due 1/01/2022 (d) 6,420
AA Aa 11,650 Metropolitan Water District, Southern California, Waterworks Revenue Bonds, RIB,
7.811% due 8/05/2022 (j) 11,038
A- A 3,570 Northern California Power Agency, Public Power Revenue Bonds (Hydroelectric Project
#1), Series E, 7.15% due 7/01/2024 3,742
</TABLE>
63
<PAGE> 116
MERRILL LYNCH CALIFORNIA MUNICIPAL BOND FUND AUGUST 31, 1996
<TABLE>
SCHEDULE OF INVESTMENTS (continued) (in Thousands)
<CAPTION>
S&P Moody's Face Value
Ratings Ratings Amount Issue (Note 1a)
California (continued)
<S> <C> <C> <C> <C>
AAA Aaa $ 5,635 Ontario, California, Redevelopment Financing Authority Revenue Bonds (Cimarron
Project No. 1-Center City), 6.375% due 8/01/2020 (c) $ 5,879
AAA Aaa 20,300 Orange County, California, Local Transportation Authority, Sales Tax Revenue Bonds,
Second Series, 6.10% due 2/14/2011 (e) 20,778
A NR* 3,000 Palmdale, California, Civic Authority Revenue Refunding Bonds (Merged Redevelopment
Project), Series A, 6.60% due 9/01/2034 3,166
AAA Aaa 11,620 Pittsburg, California, Redevelopment Agency, Residential Mortgage Revenue Bonds,
9.60% due 6/01/2016 (i) 16,882
NR* NR* 8,680 Pleasanton, California, Joint Powers Financing Authority, Revenue Reassessment Bonds,
Sub-Series B, 6.75% due 9/02/2017 8,804
AAA Aaa 3,450 Rancho, California, Water District Financing Authority Revenue Bonds, RITES,
9.024% due 9/11/2001 (a)(d)(j) 4,088
Redwood City, California, Public Financing Authority, Local Agency Revenue Bonds:
AAA Aaa 1,500 Refunding, Series A, 6.50% due 7/15/2011 (d) 1,586
A- NR* 2,500 Series B, 7.25% due 7/15/2011 2,707
BBB NR* 2,430 Riverside County, California, Redevelopment Agency Bonds (Tax Allocation
Redevelopment Project No. 4), Series A, 7.50% due 10/01/2026 2,616
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) 3,180
Sacramento, California, Municipal Utility District, Electric Revenue Bonds:
AAA Aaa 7,000 INFLOS, 8.717% due 8/15/2018 (e)(j) 7,332
AAA Aaa 5,000 Series B, 6.375% due 8/15/2022 (c) 5,230
AA Aa 2,500 San Bernardino, California, Health Care System Revenue Bonds (Sisters of Charity),
Series A, 7% due 7/01/2001 (a) 2,789
AAA Aaa 5,000 San Diego, California, Public Facilities Financing Authority, Sewer Revenue Bonds,
5% due 5/15/2020 (e) 4,452
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 3,384
AAA Aaa 8,000 AMT, Issue 6, 6.60% due 5/01/2020 8,450
AAA Aaa 8,500 Refunding, Issue 1, 6.30% due 5/01/2011 8,925
NR* NR* 1,280 San Francisco, California, City and County Redevelopment Agency, Community Facilities
District Special Tax No. 1 Bonds (South Beach), 8.20% due 8/01/2013 1,372
AAA Aaa 4,150 Santa Clara, California, Electric Revenue Bonds, Series A, 6.50% due 7/01/2021 (c) 4,415
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) 10,937
AA A1 1,000 Santa Clara County, California, Transportation District, Sales Tax Revenue Bonds,
Series A, 6.75% due 6/01/2011 1,082
</TABLE>
64
<PAGE> 117
MERRILL LYNCH CALIFORNIA MUNICIPAL BOND FUND AUGUST 31, 1996
<TABLE>
SCHEDULE OF INVESTMENTS (concluded) (in Thousands)
<CAPTION>
S&P Moody's Face Value
Ratings Ratings Amount Issue (Note 1a)
California (concluded)
<S> <C> <C> <C> <C>
AAA Aaa $ 2,000 Santa Fe Springs, California, Redevelopment Agency, Tax Allocation Bonds
(Consolidated Redevelopment Project), Series A, 6.40% due 9/01/2022 (c) $ 2,102
Southern California Home Financing Authority, S/F Mortgage Revenue Bonds, AMT (h):
AAA NR* 3,905 (Mortgage Backed Security), Series A, 7.625% due 10/01/2023 4,105
AAA NR* 2,450 (Mortgage Backed Security), Series A, 7.35% due 9/01/2024 (g) 2,547
AAA NR* 1,040 Series B, 7.75% due 3/01/2024 (g) 1,098
BBB+ NR* 20,590 Stanislaus, California, Waste-to-Energy Financing Agency, Solid Waste Facility
Revenue Refunding Certificates (Ogden Martin System Inc. Project), 7.625%
due 1/01/2010 22,121
AAA Aaa 6,500 Stockton, California, Revenue Bonds (Wastewater Treatment Plant Expansion), COP,
Series A, 6.80% due 9/01/2024 (e) 7,121
AAA Aaa 4,000 Tri-City, California, Hospital District Revenue Bonds (Tri-City Hospital),
8.97% due 2/01/2002 (a)(c) 4,603
University of California Revenue Bonds (Multiple Purpose Projects):
A NR* 14,700 Refunding, Series A, 6.875% due 9/01/2002 (a) 16,578
AAA Aaa 3,000 Refunding, Series C, 5% due 9/01/2023 (d) 2,616
AAA Aaa 8,000 Series D, 6.25% due 9/01/2012 (c) 8,368
AAA Aaa 6,000 Series D, 6.375% due 9/01/2019 (c) 6,277
AAA Aaa 11,845 Series D, 6.375% due 9/01/2024 (c) 12,392
A A 6,000 West Covina, California, COP (Queen of the Valley Hospital), 6.95% due 8/15/2023 6,483
AAA Aaa 6,000 West Sacramento, California, Redevelopment Agency, Tax Allocation Bonds
(West Sacramento Redevelopment Project), 6.25% due 9/01/2010 (c) 6,294
Puerto Rico--1.2%
A Baa1 5,000 Puerto Rico Commonwealth, GO, UT, 6.45% due 7/01/2017 5,260
AAA Baa1 2,000 Puerto Rico Commonwealth, Highway and Transportation Authority, Highway Revenue
Bonds, Series T, 6.625% due 7/01/2002 (a) 2,222
Total Investments (Cost--$598,690)--98.7% 634,685
Other Assets Less Liabilities--1.3% 8,580
--------
Net Assets--100.0% $643,265
========
<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, 1996.
(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, 1996.
(k)Bank Qualified.
*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>
65
<PAGE> 118
MERRILL LYNCH CALIFORNIA MUNICIPAL BOND FUND AUGUST 31, 1996
FINANCIAL INFORMATION
<TABLE>
Statement of Assets and Liabilities as of August 31, 1996
<S> <C> <C> <C>
Assets: Investments, at value (identified cost--$598,689,871) (Note 1a) $634,685,255
Cash 82,858
Receivables:
Interest $ 10,813,406
Beneficial interest sold 408,759 11,222,165
------------
Prepaid registration fees and other assets (Note 1e) 117,848
------------
Total assets 646,108,126
------------
Liabilities: Payables:
Beneficial interest redeemed 1,430,109
Dividends to shareholders (Note 1f) 633,611
Investment adviser (Note 2) 319,670
Distributor (Note 2) 234,874 2,618,264
------------
Accrued expenses and other liabilities 225,088
------------
Total liabilities 2,843,352
------------
Net Assets: Net assets $643,264,774
============
Net Assets Class A Shares of beneficial interest, $.10 par value, unlimited
Consist of: number of shares authorized $ 371,370
Class B Shares of beneficial interest, $.10 par value, unlimited
number of shares authorized 4,182,252
Class C Shares of beneficial interest, $.10 par value, unlimited
number of shares authorized 70,595
Class D Shares of beneficial interest, $.10 par value, unlimited
number of shares authorized 972,997
Paid-in capital in excess of par 620,910,864
Accumulated realized capital losses on investments--net (Note 5) (16,973,057)
Accumulated distributions in excess of realized capital gains--net
(Note 1f) (2,265,631)
Unrealized appreciation on investments--net 35,995,384
------------
Net assets $643,264,774
============
Net Asset Value: Class A--Based on net assets of $42,668,594 and 3,713,704 shares
of beneficial interest outstanding $ 11.49
============
Class B--Based on net assets of $480,667,799 and 41,822,524 shares
of beneficial interest outstanding $ 11.49
============
Class C--Based on net assets of $8,111,647 and 705,950 shares
of beneficial interest outstanding $ 11.49
============
Class D--Based on net assets of $111,816,734 and 9,729,971 shares
of beneficial interest outstanding $ 11.49
============
See Notes to Financial Statements.
</TABLE>
66
<PAGE> 119
MERRILL LYNCH CALIFORNIA MUNICIPAL BOND FUND AUGUST 31, 1996
FINANCIAL INFORMATION (continued)
<TABLE>
Statement of Operations
<CAPTION>
For the Year Ended
August 31, 1996
<S> <C> <C> <C>
Investment Income Interest and amortization of premium and discount earned $ 41,044,550
(Note 1d):
Expenses: Investment advisory fees (Note 2) $ 3,611,875
Account maintenance and distribution fees--Class B (Note 2) 2,723,756
Transfer agent fees--Class B (Note 2) 216,676
Accounting services (Note 2) 118,709
Printing and shareholders reports 77,586
Professional fees 73,696
Account maintenance fees--Class D (Note 2) 68,985
Custodian fees 66,467
Registration fees (Note 1e) 66,297
Trustees' fees and expenses 40,129
Account maintenance and distribution fees--Class C (Note 2) 35,107
Transfer agent fees--Class D (Note 2) 22,807
Pricing fees 18,621
Transfer agent fees--Class A (Note 2) 14,677
Transfer agent fees--Class C (Note 2) 2,582
Other 43,874
------------
Total expenses 7,201,844
------------
Investment income--net 33,842,706
------------
Realized & Realized gain on investments--net 4,306,220
Unrealized Change in unrealized appreciation on investments--net 1,206,892
Gain on ------------
Investments--Net Net Increase in Net Assets Resulting from Operations $ 39,355,818
(Notes 1b, 1d & 3): ============
See Notes to Financial Statements.
</TABLE>
67
<PAGE> 120
MERRILL LYNCH CALIFORNIA MUNICIPAL BOND FUND AUGUST 31, 1996
FINANCIAL INFORMATION (continued)
<TABLE>
Statements of Changes in Net Assets
<CAPTION>
For the Year Ended August 31,
Increase (Decrease) in Net Assets: 1996 1995
<S> <C> <C> <C>
Operations: Investment income--net $ 33,842,706 $ 37,800,235
Realized gain (loss) on investments--net 4,306,220 (16,973,155)
Change in unrealized appreciation on investments--net 1,206,892 17,518,587
------------ ------------
Net increase in net assets resulting from operations 39,355,818 38,345,667
------------ ------------
Dividends to Investment income--net:
Shareholders Class A (2,457,264) (3,035,857)
(Note 1f): Class B (27,350,656) (34,575,842)
Class C (287,834) (69,364)
Class D (3,746,952) (119,172)
------------ ------------
Net decrease in net assets resulting from dividends to
shareholders (33,842,706) (37,800,235)
------------ ------------
Beneficial Net decrease in net assets derived from beneficial interest
Interest transactions (29,652,521) (120,046,349)
Transactions ------------ ------------
(Note 4):
Net Assets: Total decrease in net assets (24,139,409) (119,500,917)
Beginning of year 667,404,183 786,905,100
------------ ------------
End of year $643,264,774 $667,404,183
============ ============
</TABLE>
<TABLE>
Financial Highlights
<CAPTION>
The following per share data and ratios have been derived
from information provided in the financial statements. Class A
For the Year Ended August 31,
Increase (Decrease) in Net Asset Value: 1996 1995 1994 1993 1992
<S> <C> <C> <C> <C> <C> <C>
Per Share Net asset value, beginning of year $ 11.40 $ 11.32 $ 12.38 $ 11.80 $ 11.44
Operating -------- -------- -------- -------- --------
Performance: Investment income--net .64 .64 .68 .70 .72
Realized and unrealized gain (loss) on
investments--net .09 .08 (.78) .78 .41
-------- -------- -------- -------- --------
Total from investment operations .73 .72 (.10) 1.48 1.13
-------- -------- -------- -------- --------
Less dividends and distributions:
Investment income--net (.64) (.64) (.68) (.70) (.72)
Realized gain on investments--net -- -- (.19) (.20) (.05)
In excess of realized gain on
investments--net -- -- (.09) -- --
-------- -------- -------- -------- --------
Total dividends and distributions (.64) (.64) (.96) (.90) (.77)
-------- -------- -------- -------- --------
Net asset value, end of year $ 11.49 $ 11.40 $ 11.32 $ 12.38 $ 11.80
======== ======== ======== ======== ========
Total Investment Based on net asset value per share 6.53% 6.77% (.92%) 13.19% 10.23%
Return:* ======== ======== ======== ======== ========
Ratios to Expenses .65% .65% .62% .63% .63%
Average ======== ======== ======== ======== ========
Net Assets Investment income--net 5.51% 5.83% 5.65% 5.87% 6.26%
======== ======== ======== ======== ========
Supplemental Net assets, end of year (in thousands) $ 42,668 $ 44,228 $ 60,017 $ 64,526 $ 46,556
Data: ======== ======== ======== ======== ========
Portfolio turnover 53.79% 53.40% 75.66% 61.24% 52.31%
======== ======== ======== ======== ========
<FN>
*Total investment returns exclude the effects of
sales loads.
See Notes to Financial Statements.
</TABLE>
68
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MERRILL LYNCH CALIFORNIA MUNICIPAL BOND FUND AUGUST 31, 1996
FINANCIAL INFORMATION (concluded)
<TABLE>
Financial Highlights (concluded)
<CAPTION>
The following per share data and ratios have been derived
from information provided in the financial statements. Class B
For the Year Ended August 31,
Increase (Decrease) in Net Asset Value: 1996 1995 1994 1993 1992
<S> <C> <C> <C> <C> <C> <C>
Per Share Net asset value, beginning of year $ 11.40 $ 11.32 $ 12.38 $ 11.80 $ 11.44
Operating -------- -------- -------- -------- --------
Performance: Investment income--net .58 .59 .61 .64 .67
Realized and unrealized gain (loss) on
investments--net .09 .08 (.78) .78 .41
-------- -------- -------- -------- --------
Total from investment operations .67 .67 (.17) 1.42 1.08
-------- -------- -------- -------- --------
Less dividends and distributions:
Investment income--net (.58) (.59) (.61) (.64) (.67)
Realized gain on investments--net -- -- (.19) (.20) (.05)
In excess of realized gain on
investments--net -- -- (.09) -- --
-------- -------- -------- -------- --------
Total dividends and distributions (.58) (.59) (.89) (.84) (.72)
-------- -------- -------- -------- --------
Net asset value, end of year $ 11.49 $ 11.40 $ 11.32 $ 12.38 $ 11.80
======== ======== ======== ======== ========
Total Investment Based on net asset value per share 5.99% 6.28% (1.50%) 12.62% 9.68%
Return:** ======== ======== ======== ======== ========
Ratios to Expenses 1.16% 1.16% 1.13% 1.13% 1.13%
Average ======== ======== ======== ======== ========
Net Assets: Investment income--net 5.01% 5.32% 5.15% 5.38% 5.76%
======== ======== ======== ======== ========
Supplemental Net assets, end of year (in thousands). $480,668 $616,199 $726,888 $821,220 $729,569
Data: ======== ======== ======== ======== ========
Portfolio turnover 53.79% 53.40% 75.66% 61.24% 52.31%
======== ======== ======== ======== ========
<CAPTION>
Class C Class D
For the For the
For the Period For the Period
The following per share data and ratios have been derived Year Oct. 21, Year Oct. 21,
from information provided in the financial statements. Ended 1994++ to Ended 1994++ to
August 31, August 31, August 31, August 31,
Increase (Decrease) in Net Asset Value: 1996 1995 1996 1995
<S> <C> <C> <C> <C> <C>
Per Share Net asset value, beginning of period $ 11.40 $ 10.94 $ 11.40 $ 10.94
Operating -------- -------- --------- --------
Performance: Investment income--net .57 .49 .63 .54
Realized and unrealized gain on investments--net .09 .46 .09 .46
-------- -------- --------- --------
Total from investment operations .66 .95 .72 1.00
-------- -------- --------- --------
Less dividends from investment income--net (.57) (.49) (.63) (.54)
-------- -------- --------- --------
Net asset value, end of period $ 11.49 $ 11.40 $ 11.49 $ 11.40
======== ======== ========= ========
Total Investment Based on net asset value per share 5.88% 8.96%+++ 6.43% 9.42%+++
Return:** ======== ======== ========= ========
Ratios to Expenses 1.26% 1.27%* .75% .76%*
Average Net ======== ======== ========= ========
Assets: Investment income--net 4.91% 5.04%* 5.42% 5.59%*
======== ======== ========= ========
Supplemental Net assets, end of period (in thousands) $ 8,112 $ 3,131 $ 111,817 $ 3,846
Data: ======== ======== ========= ========
Portfolio turnover 53.79% 53.40% 53.79% 53.40%
======== ======== ========= ========
<FN>
*Annualized.
**Total investment returns exclude the effects
of sales loads.
++Commencement of Operations.
+++Aggregate total investment return.
See Notes to Financial Statements.
</TABLE>
69
<PAGE> 122
MERRILL LYNCH CALIFORNIA MUNICIPAL BOND FUND AUGUST 31, 1996
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.
70
<PAGE> 123
MERRILL LYNCH CALIFORNIA MUNICIPAL BOND FUND AUGUST 31, 1996
(g) Reclassification--Generally accepted accounting principles
require that certain components of net assets be reclassified to
reflect permanent differences between financial reporting and tax
purposes. Accordingly, current year's permanent book/tax differences
of $98 have been reclassified from paid-in capital in excess of par
to accumulated net realized capital losses. These reclassifications
have no effect on net assets or net asset values per share.
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, 1996, 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 $2,185 $18,776
Class D $2,960 $28,248
For the year ended August 31, 1996, MLPF&S received contingent
deferred sales charges of $427,650 and $4,398 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, 1996 were $336,637,182 and
$422,327,530, respectively.
71
<PAGE> 124
MERRILL LYNCH CALIFORNIA MUNICIPAL BOND FUND AUGUST 31, 1996
NOTES TO FINANCIAL STATEMENTS (concluded)
Net realized and unrealized gains (losses) as of August 31, 1996
were as follows:
Realized Unrealized
Gains (Losses) Gains
Long-term investments $ 5,618,244 $ 35,995,384
Short-term investments (1,868) --
Financial futures
contracts (1,310,156) --
------------ ------------
Total $ 4,306,220 $ 35,995,384
============ ============
As of August 31, 1996, net unrealized depreciation for Federal
income tax purposes aggregated $35,995,384, of which $38,074,511
related to appreciated securities and $2,079,127 related to
depreciated securities. The aggregate cost of investments at August
31, 1996 for Federal income tax purposes was $598,689,871.
4. Beneficial Interest Transactions:
Net decrease in net assets derived from beneficial interest
transactions was $29,652,521 and $120,046,349 for the years ended
August 31, 1996 and August 31, 1995, respectively.
Transactions in shares of beneficial interest for each class were as
follows:
Class A Shares for the Year Dollar
Ended August 31, 1996 Shares Amount
Shares sold 343,484 $ 3,993,921
Shares issued to share-
holders in reinvestment
of dividends 91,475 1,056,965
------------- -------------
Total issued 434,959 5,050,886
Shares redeemed (602,254) (6,955,693)
------------- -------------
Net decrease (167,295) $ (1,904,807)
============= =============
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 B Shares for the Year Dollar
Ended August 31, 1996 Shares Amount
Shares sold 3,684,831 $ 42,602,905
Shares issued to share-
holders in reinvestment
of dividends 1,050,882 12,150,317
------------- -------------
Total issued 4,735,713 54,753,222
Shares redeemed (7,544,434) (87,132,865)
Automatic conversion
of shares (9,424,309) (109,009,248)
------------- -------------
Net decrease (12,233,030) $(141,388,891)
============= =============
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 C Shares for the Year Dollar
Ended August 31, 1996 Shares Amount
Shares sold 544,866 $ 6,303,679
Shares issued to share-
holders in reinvestment
of dividends 12,095 139,565
------------- -------------
Total issued 556,961 6,443,244
Shares redeemed (125,720) (1,452,025)
------------- -------------
Net increase 431,241 $ 4,991,219
============= =============
Class C Shares for the Period Dollar
Oct. 21, 1994++ to Aug. 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
============= =============
[FN]
++Commencement of Operations.
72
<PAGE> 125
MERRILL LYNCH CALIFORNIA MUNICIPAL BOND FUND AUGUST 31, 1996
Class D Shares for the Year Dollar
Ended August 31, 1996 Shares Amount
Shares sold 623,197 $ 7,211,474
Automatic conversion
of shares 9,424,309 109,009,248
Shares issued to share-
holders in reinvestment
of dividends 142,594 1,645,562
------------- -------------
Total issued 10,190,100 117,866,284
Shares redeemed (797,598) (9,216,326)
------------- -------------
Net increase 9,392,502 $ 108,649,958
============= =============
Class D Shares for the Period Dollar
Oct. 21, 1994++ to Aug. 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
============= =============
[FN]
++Commencement of Operations.
5. Capital Loss Carryforward:
At August 31, 1996, the Fund had a net capital loss carryforward of
approximately $16,951,000, of which $9,806,000 expires in 2003 and
$7,145,000 expires in 2004. This amount will be available to offset
like amounts of any future taxable gains.
73
<PAGE> 126
- -----
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................. 13
Management of the Trust................. 15
Trustees and Officers................. 15
Compensation of Trustees.............. 17
Management and Advisory
Arrangements........................ 17
Purchase of Shares...................... 19
Initial Sales Charge
Alternatives--Class A and Class D
Shares.............................. 19
Reduced Initial Sales Charges......... 21
Distribution Plans.................... 23
Limitations on the Payment of Deferred
Sales Charges....................... 24
Redemption of Shares.................... 25
Deferred Sales Charges--Class B and
Class C Shares...................... 25
Portfolio Transactions.................. 25
Determination of Net Asset Value........ 27
Shareholder Services.................... 27
Investment Account.................... 28
Automatic Investment Plans............ 28
Automatic Reinvestment of Dividends
and Capital Gains Distributions..... 28
Systematic Withdrawal Plans--Class A
and Class D Shares.................. 29
Exchange Privilege.................... 30
Distributions and Taxes................. 32
Environmental Tax..................... 35
Tax Treatment of Futures and Options
Transactions........................ 35
Performance Data........................ 36
General Information..................... 38
Description of Shares................. 38
Computation of Offering Price Per
Share............................... 39
Independent Auditors.................. 39
Custodian............................. 39
Transfer Agent........................ 40
Legal Counsel......................... 40
Reports to Shareholders............... 40
Additional Information................ 40
Appendix I
Economic and Other Conditions in
California.......................... 41
Appendix II
Ratings of Municipal Bonds............ 51
Independent Auditors' Report............ 60
Code #10328-1296
</TABLE>
YZa
Merrill Lynch
California Municipal
Bond Fund
Merrill Lynch California
Municipal Series Trust
mlynch compass
STATEMENT OF
ADDITIONAL
INFORMATION
December 20, 1996
Distributor:
Merrill Lynch
Funds Distributor, Inc.
<PAGE> 127
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>
<PAGE> 128
PART C. OTHER INFORMATION
ITEM 24. FINANCIAL STATEMENTS AND EXHIBITS.
(a) FINANCIAL STATEMENTS:
CONTAINED IN PART A:
Financial Highlights for each of the years in the ten-year period
ended August 31, 1996.
CONTAINED IN PART B:
Schedule of Investments as of August 31, 1996.
Statement of Assets and Liabilities as of August 31, 1996.
Statement of Operations for the year ended August 31, 1996.
Statements of Changes in Net Assets for each of the years in the
two-year period ended August 31, 1996.
Financial Highlights for each of the years in the five-year
period ended August 31, 1996.
(b) EXHIBITS:
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------ ----------------------------------------------------------------------------
<S> <C> <C>
1(a) -- Declaration of Trust of the Registrant, dated March 20, 1985.(a)
(b) -- Amendment to Declaration of Trust, dated July 25, 1985.(a)
(c) -- Amendment to Declaration of Trust, dated October 3, 1988.(a)
(d) -- Instrument establishing Merrill Lynch California Municipal Bond Fund (the
"Fund") as a series of Registrant.(a)
(e) -- Instrument establishing Class A and Class B shares of beneficial interest of
the Fund.(a)
(f) -- Amendment to Instrument establishing the Fund as a series of Registrant.(a)
(g) -- Amendment to Declaration of Trust, dated October 17, 1994 and instrument
establishing Class C and Class D shares of beneficial interest.(a)
2 -- By-Laws of Registrant.(a)
3 -- None.
4 -- Portions of the Declaration of Trust, Establishment and Designation and
By-Laws of the Registrant defining the rights of holders of the Fund as a
series of the Registrant.(b)
5(a) -- Management Agreement between Registrant and Fund Asset Management, L.P.(a)
(b) -- Supplement to Management Agreement between Registrant and Fund Asset
Management, L.P.(d)
6(a) -- Form of Revised Class A Shares Distribution Agreement between Registrant and
Merrill Lynch Funds Distributor, Inc. (including Form of Selected Dealers
Agreement).(d)
(b) -- Class B Shares Distribution Agreement between Registrant and Merrill Lynch
Funds Distributor, Inc.(a)
(c) -- Form of Class C Shares Distribution Agreement between Registrant and Merrill
Lynch Funds Distributor, Inc. (including Form of Selected Dealers
Agreement).(d)
(d) -- Form of Class D Shares Distribution Agreement between Registrant and Merrill
Lynch Funds Distributor, Inc. (including Form of Selected Dealers
Agreement).(d)
(e) -- Letter Agreement between the Fund and Merrill Lynch Funds Distributor, Inc.,
dated September 15, 1993, in connection with the Merrill Lynch Mutual Fund
Adviser program.(c)
7 -- None.
8 -- Custody Agreement between Registrant and The Bank of New York.(a)
9 -- Transfer Agency, Dividend Disbursing Agency and Shareholder Servicing Agency
Agreement between Registrant and Merrill Lynch Financial Data Services,
Inc.(a)
10 -- Opinion of Brown & Wood LLP, counsel for the Registrant.
11 -- Consent of Deloitte & Touche LLP, independent auditors for the Registrant.
12 -- None.
13 -- Certificate of Fund Asset Management, Inc.(a)
14 -- None.
15(a) -- Amended and Restated Class B Shares Distribution Plan and Class B Shares
Distribution Plan Sub-Agreement.(c)
</TABLE>
C-1
<PAGE> 129
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------ ----------------------------------------------------------------------------
<S> <C> <C>
(b) -- Form of Class C Shares Distribution Plan and Class C Shares Distribution
Plan Sub-Agreement of the Registrant.(d)
(c) -- Form of Class D Shares Distribution Plan and Class D Shares Distribution
Plan Sub-Agreement of the Registrant.(d)
16(a) -- Schedule for computation of each performance quotation provided in the
Registration Statement in response to Item 22 relating to Class A Shares.(a)
(b) -- Schedule for computation of each performance quotation provided in the
Registration Statement in response to Item 22 relating to Class B Shares.(a)
(c) -- Schedule for computation of each performance quotation provided in the
Registration Statement in response to Item 22 relating to Class C Shares.(a)
(d) -- Schedule for computation of each performance quotation provided in the
Registration Statement in response to Item 22 relating to Class D Shares.(a)
17(a) -- Financial Data Schedule for Class A Shares.
(b) -- Financial Data Schedule for Class B Shares.
(c) -- Financial Data Schedule for Class C Shares.
(d) -- Financial Data Schedule for Class D Shares.
18 -- Merrill Lynch Select Pricing(SM) System Plan pursuant to Rule 18f-3.(e)
</TABLE>
- ---------------
(a) Filed on December 29, 1995 as an Exhibit to Post-Effective Amendment No. 11
to Registrant's Registration Statement on Form N-1A under the Securities Act
of 1933, as amended, relating to shares of the Fund (File No. 2-96581) (the
"Registration Statement").
(b) Reference is made to Article II, Section 2.3 and Articles V, VI, VIII, IX, X
and XI of the Registrant's Declaration of Trust, as amended, filed as
Exhibits 1(a), 1(b), 1(c) and 1(g) with Post-Effective Amendment No. 11 to
the Registration Statement; to the Certificates of Establishment and
Designation establishing the Fund as a series of the Registrant and
establishing Class A and Class B shares of beneficial interest of the Fund,
filed as Exhibits 1(d), 1(e) and 1(f), respectively, with Post-Effective
Amendment No. 11 to the Registration Statement; and to Articles I, V and VI
of the Registrant's By-Laws, filed as Exhibit 2 with Post-Effective
Amendment No. 11 to the Registration Statement.
(c) Filed on December 23, 1993 as an Exhibit to Post-Effective Amendment No. 9
to the Registration Statement.
(d) Filed on October 21, 1994 as an Exhibit to Post-Effective Amendment No. 10
to the Registration Statement.
(e) Incorporated by reference to Exhibit 18 to Post-Effective Amendment No. 13
to the Registration Statement on Form N-1A under the Securities Act of 1933,
as amended, filed on January 25, 1996, relating to shares of Merrill Lynch
New York Municipal Bond Fund Series of Merrill Lynch Multi-State Municipal
Series Trust (File No. 2-99473).
ITEM 25. PERSONS CONTROLLED BY OR UNDER COMMON CONTROL WITH REGISTRANT.
The Registrant is not controlled by or under common control with any
person.
ITEM 26. NUMBER OF HOLDERS OF SECURITIES.
<TABLE>
<CAPTION>
NUMBER OF
HOLDERS AT
TITLE OF CLASS NOVEMBER 30, 1996*
----------------------------------------------------------- -------------------
<S> <C>
Class A shares of beneficial interest, par value $0.10 per
share 935
Class B shares of beneficial interest, par value $0.10 per
share 10,043
Class C shares of beneficial interest, par value $0.10 per
share 310
Class D shares of beneficial interest, par value $0.10 per
share 3,869
</TABLE>
- ---------------
* The number of holders includes holders of record plus beneficial owners, whose
shares are held of record by Merrill Lynch, Pierce, Fenner & Smith
Incorporated.
C-2
<PAGE> 130
ITEM 27. INDEMNIFICATION.
Section 5.3 of the Registrant's Declaration of Trust provides as follows:
"The Trust shall indemnify each of its Trustees, officers, employees, and
agents (including persons who serve at its request as directors, officers
or trustees of another organization in which it has any interest as a
shareholder, creditor or otherwise) against all liabilities and expenses
(including amounts paid in satisfaction of judgments, in compromise, as
fines and penalties, and as counsel fees) reasonably incurred by him in
connection with the defense or disposition of any action, suit or other
proceeding, whether civil or criminal, in which he may be involved or with
which he may be threatened, while in office or thereafter, by reason of his
being or having been such a trustee, officer, employee or agent, except
with respect to any matter as to which he shall have been adjudicated to
have acted in bad faith, willful misfeasance, gross negligence or reckless
disregard of his duties; provided, however, that as to any matter disposed
of by a compromise payment by such person, pursuant to a consent decree or
otherwise, no indemnification either for said payment or for any other
expenses shall be provided unless the Trust shall have received a written
opinion from independent legal counsel approved by the Trustees to the
effect that if either the matter of willful misfeasance, gross negligence
or reckless disregard of duty, or the matter of good faith and reasonable
belief as to the best interests of the Trust, had been adjudicated, it
would have been adjudicated in favor of such person. The rights accruing to
any Person under these provisions shall not exclude any other right to
which he may be lawfully entitled; provided that no Person may satisfy any
right in indemnity or reimbursement granted herein or in Section 5.1 or to
which he may be otherwise entitled except out of the property of the Trust,
and no Shareholder shall be personally liable to any Person with respect to
any claim for indemnity or reimbursement or otherwise. The Trustees may
make advance payments in connection with indemnification under this Section
5.3, provided that the indemnified person shall have given a written
undertaking to reimburse the Trust in the event it is subsequently
determined that he is not entitled to such indemnification."
Insofar as the conditional advancing of indemnification monies for actions
based upon the Investment Company Act of 1940, as amended, may be concerned,
such payments will be made only on the following conditions: (i) the advances
must be limited to amounts used, or to be used, for the preparation or
presentation of a defense to the action, including costs connected with the
preparation of a settlement; (ii) advances may be made only upon receipt of a
written promise by, or on behalf of, the recipient to repay that amount of the
advance which exceeds the amount which it is ultimately determined he is
entitled to receive from the Registrant by reason of indemnification; and
(iii)(a) such promise must be secured by a surety bond, other suitable insurance
or an equivalent form of security which assures that any repayments may be
obtained by the Registrant without delay or litigation, which bond, insurance or
other form of security must be provided by the recipient of the advance, or (b)
a majority of a quorum of the Registrant's disinterested, non-party Trustees, or
an independent legal counsel in a written opinion, shall determine, based upon a
review of readily available facts, that the recipient of the advance ultimately
will be found entitled to indemnification.
In Section 9 of the Distribution Agreements relating to the securities
being offered hereby, the Registrant agrees to indemnify the Distributor and
each person, if any, who controls the Distributor within the meaning of the
Securities Act of 1933, as amended (the "1933 Act"), against certain types of
civil liabilities arising in connection with the Registration Statement or
Prospectus and Statement of Additional Information.
Insofar as indemnification for liabilities arising under the 1933 Act may
be permitted to Trustees, officers and controlling persons of the Registrant and
the principal underwriter pursuant to the foregoing provisions or otherwise, the
Registrant has been advised that in the opinion of the Securities and Exchange
Commission such indemnification is against public policy as expressed in the
1933 Act and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by the
Registrant of expenses incurred or paid by a Trustee, officer, or controlling
person of the Registrant and the principal underwriter in connection with the
successful defense of any action, suit or proceeding) is asserted by such
Trustee, officer or controlling person or the principal underwriter in
connection with the shares being registered, the Registrant will, unless in the
opinion of its counsel the matter has been settled by controlling
C-3
<PAGE> 131
precedent, submit to a court of appropriate jurisdiction the question whether
such indemnification by it is against public policy as expressed in the 1933 Act
and will be governed by the final adjudication of such issue.
ITEM 28. BUSINESS AND OTHER CONNECTIONS OF INVESTMENT ADVISER.
Fund Asset Management, L.P. (the "Manager" or "FAM") acts as the investment
adviser for the following open-end investment companies: CBA Money Fund, CMA
Government Securities Fund, CMA Money Fund, CMA Multi-State Municipal Series
Trust, CMA Tax-Exempt Fund, CMA Treasury Fund, The Corporate Fund Accumulation
Program, Inc., Financial Institutions Series Trust, Merrill Lynch Basic Value
fund, Inc., Merrill Lynch California Municipal Series Trust, Merrill Lynch
Corporate Bond Fund, Inc., Merrill Lynch Emerging Tigers Fund, Inc., Merrill
Lynch Federal Securities Trust, Merrill Lynch Funds for Institutions Series,
Merrill Lynch Multi-State Limited Maturity Municipal Series Trust, Merrill Lynch
Multi-State Municipal Series Trust, Merrill Lynch Municipal Bond Fund, Inc.,
Merrill Lynch Phoenix Fund, Inc., Merrill Lynch Special Value Fund Inc., Merrill
Lynch World Income Fund, Inc., and The Municipal Fund Accumulation Program, Inc.
and the following closed-end investment companies: Apex Municipal Fund, Inc.,
Corporate High Yield Fund, Inc., Corporate High Yield Fund II, Inc., Income
Opportunities Fund 1999, Inc., Income Opportunities Fund 2000, Inc., Merrill
Lynch Municipal Strategy Fund, Inc., MuniAssets Fund Inc., MuniEnhanced Fund,
Inc., MuniInsured Fund, Inc., MuniVest Fund, Inc., MuniVest Fund II, Inc.,
MuniVest California Insured Fund, Inc., MuniVest Florida Fund, MuniVest Michigan
Insured Fund, Inc., MuniVest New Jersey Fund, Inc., MuniVest New York Insured
Fund, Inc., MuniVest Pennsylvania Insured Fund, MuniYield Arizona Fund, Inc.,
MuniYield California Fund, Inc., MuniYield California Insured Fund, Inc.,
MuniYield California Insured Fund II, Inc., MuniYield Florida Fund, MuniYield
Florida Insured Fund, MuniYield Fund, Inc., MuniYield Insured Fund, Inc.,
MuniYield Insured Fund II, Inc., MuniYield Michigan Fund, Inc., MuniYield
Michigan Insured Fund, Inc., MuniYield New Jersey Fund, Inc., MuniYield New
Jersey Insured Fund, Inc., MuniYield New York Insured Fund, Inc., MuniYield New
York Insured Fund II, Inc., MuniYield New York Insured Fund III, Inc., MuniYield
Pennsylvania Fund, MuniYield Quality Fund, Inc., MuniYield Quality Fund II,
Inc., Senior High Income Portfolio, Inc., Taurus MuniCalifornia Holdings, Inc.,
Taurus MuniNew York Holdings, Inc. and Worldwide DollarVest Fund, Inc.
Merrill Lynch Asset Management, L.P. ("MLAM"), an affiliate of the Manager,
acts as the investment adviser for the following open-end investment companies:
Merrill Lynch Adjustable Rate Securities Fund, Inc., Merrill Lynch Americas
Income Fund, Inc., Merrill Lynch Asset Builder Program, Inc., Merrill Lynch
Asset Growth Fund, Inc., Merrill Lynch Asset Income Fund, Inc., Merrill Lynch
Capital Fund, Inc., Merrill Lynch Developing Capital Markets Fund, Inc., Merrill
Lynch Dragon Fund, Inc., Merrill Lynch EuroFund, Merrill Lynch Fund for
Tomorrow, Inc., Merrill Lynch Fundamental Growth Fund, Inc., Merrill Lynch
Global Bond Fund for Investment and Retirement, Merrill Lynch Global Allocation
Fund, Inc., Merrill Lynch Global Convertible Fund, Inc., Merrill Lynch Global
Holdings, Inc., Merrill Lynch Global Resources Trust, Merrill Lynch Global
SmallCap Fund, Inc., Merrill Lynch Global Utility Fund, Inc. Merrill Lynch
Global Value Fund, Inc., Merrill Lynch Growth Fund, Merrill Lynch Healthcare
Fund, Inc., Merrill Lynch Institutional Intermediate Fund, Merrill Lynch
International Equity Fund, Merrill Lynch Latin America Fund, Inc., Merrill Lynch
Middle East/Africa Fund, Inc., Merrill Lynch Municipal Series Trust, Merrill
Lynch Pacific Fund, Inc., Merrill Lynch Ready Assets Trust, Merrill Lynch
Retirement Series Trust, Merrill Lynch Series Fund, Inc., Merrill Lynch
Short-Term Global Income Fund, Inc., Merrill Lynch Strategic Dividend Fund,
Merrill Lynch Technology Fund, Inc., Merrill Lynch U.S. Treasury Money Fund,
Merrill Lynch U.S.A. Government Reserves, Merrill Lynch Utility Income Fund,
Inc., and Merrill Lynch Variable Series Funds, Inc. and the following closed-end
investment companies: Convertible Holdings, Inc., Merrill Lynch High Income
Municipal Bond Fund, Inc. and Merrill Lynch Senior Floating Rate Fund, Inc.
The address of each of these investment companies is P.O. Box 9011,
Princeton, New Jersey 08543-9011, except that the address of Merrill Lynch Funds
for Institutions Series and Merrill Lynch Institutional Intermediate Fund is One
Financial Center, 15th Floor, Boston, Massachusetts 02111-2646. The address of
the Manager, MLAM, Princeton Services, Inc. ("Princeton Services") and Princeton
Administrators, L.P. is also P.O. Box 9011, Princeton, New Jersey 08543-9011.
The address of Merrill Lynch Funds Distributor, Inc.
C-4
<PAGE> 132
("MLFD") is P.O. Box 9081, Princeton, New Jersey 08543-9081. The address of
Merrill Lynch, Pierce, Fenner & Smith Incorporated ("Merrill Lynch") and Merrill
Lynch & Co., Inc. ("ML & Co.") is World Financial Center, North Tower, 250 Vesey
Street, New York, New York 10281. The address of the Fund's transfer agent,
Merrill Lynch Financial Data Services, Inc. ("MLFDS") is 4800 Deer Lake Drive
East, Jacksonville, Florida 32246-6484.
Set forth below is a list of each executive officer and partner of the
Manager indicating each business, profession, vocation or employment of a
substantial nature in which each such person has been engaged since September 1,
1994 for his or its own account or in the capacity of director, officer, partner
or trustee. In addition, Mr. Zeikel is President, Mr. Richard is Treasurer and
Mr. Glenn is Executive Vice President of substantially all of the investment
companies described in the first two paragraphs of this item and Messrs.
Giordano, Harvey, Hewitt, Kirstein and Monagle are directors, trustees or
officers of one or more of such companies.
OFFICERS AND PARTNERS OF FAM ARE SET FORTH AS FOLLOWS:
<TABLE>
<CAPTION>
OTHER SUBSTANTIAL BUSINESS,
NAME POSITION(S) WITH MANAGER PROFESSION, VOCATION OR EMPLOYMENT
- -------------------------- ------------------------ ----------------------------------------
<S> <C> <C>
ML & Co. ................. Limited Partner Financial Services Holding Company;
Limited Partner of MLAM
Princeton Services ....... General Partner General Partner of MLAM
Arthur Zeikel............. President President of MLAM; President and
Director of Princeton Services; Director
of MLFD; Executive Vice President of
ML & Co.
Terry K. Glenn............ Executive Vice President Executive Vice President of MLAM;
Executive Vice President and Director
of Princeton Services; President and
Director of MLFD; Director of MLFDS;
President of Princeton Administrators,
L.P.
Vincent R. Giordano....... Senior Vice President Senior Vice President of MLAM; Senior
Vice President of Princeton Services
Elizabeth Griffin......... Senior Vice President Senior Vice President of MLAM
Norman R. Harvey.......... Senior Vice President Senior Vice President of MLAM; Senior
Vice President of Princeton Services
Michael J. Hennewinkel.... Senior Vice President Senior Vice President of MLAM; Senior
Vice President of Princeton Services
N. John Hewitt............ Senior Vice President Senior Vice President of MLAM; Senior
Vice President of Princeton Services
Philip L. Kirstein........ Senior Vice President, Senior Vice President, General Counsel
General Counsel and and Secretary of MLAM; Senior Vice
Secretary President, General Counsel, Director
and Secretary of Princeton Services;
Director of MLFD
Ronald M. Kloss........... Senior Vice President Senior Vice President and Controller of
and Controller MLAM; Senior Vice President and
Controller of Princeton Services
Stephen M.M. Miller....... Senior Vice President Executive Vice President of Princeton
Administrators, L.P.; Senior Vice
President of Princeton Services
Joseph T. Monagle, Jr..... Senior Vice President Senior Vice President of MLAM; Senior
Vice President of Princeton Services
</TABLE>
C-5
<PAGE> 133
<TABLE>
<CAPTION>
OTHER SUBSTANTIAL BUSINESS,
NAME POSITION(S) WITH MANAGER PROFESSION, VOCATION OR EMPLOYMENT
- -------------------------- ------------------------ ----------------------------------------
<S> <C> <C>
Michael L. Quinn.......... Senior Vice President Senior Vice President of MLAM; Senior
Vice President of Princeton Services;
Managing Director and First Vice
President of Merrill Lynch from 1989
to 1995
Richard L. Reller......... Senior Vice President Senior Vice President of MLAM; Senior
Vice President of Princeton Services
Gerald M. Richard......... Senior Vice President Senior Vice President and Treasurer of
and Treasurer MLAM; Senior Vice President and
Treasurer of Princeton Services; Vice
President and Treasurer of MLFD
Ronald L. Welburn......... Senior Vice President Senior Vice President of MLAM; Senior
Vice President of Princeton Services
Anthony Wiseman........... Senior Vice President Senior Vice President of MLAM; Senior
Vice President of Princeton Services
</TABLE>
ITEM 29. PRINCIPAL UNDERWRITERS.
(a) MLFD acts as the principal underwriter for the Registrant and for each
of the open-end investment companies referred to in the first two paragraphs of
Item 28 except CBA Money Fund, CMA Government Securities Fund, CMA Money Fund,
CMA Multi-State Municipal Series Trust, CMA Tax-Exempt Fund, CMA Treasury Fund,
The Corporate Fund Accumulation Program, Inc., MuniAssets Fund, Inc., and The
Municipal Fund Accumulation Program, Inc. and MLFD also acts as the principal
underwriter for the following closed-end investment companies: Merrill Lynch
High Income Municipal Bond Fund, Inc., Merrill Lynch Municipal Strategy Fund,
Inc. and Merrill Lynch Senior Floating Rate Fund, Inc.
(b) Set forth below is information concerning each director and officer of
MLFD. The principal business address of each such person is P.O. Box 9011,
Princeton, New Jersey 08543-9011, except that the address of Messrs. Aldrich,
Brady, Breen, Crook, Fatseas and Wasel is One Financial Center, 23rd floor,
Boston, Massachusetts 02111-2646.
<TABLE>
<CAPTION>
(1) (2) (3)
POSITION(S) AND OFFICES POSITIONS AND OFFICES
NAME WITH MLFD WITH REGISTRANT
- ------------------------------ ------------------------------------- ------------------------
<S> <C> <C>
Terry K. Glenn................ President and Director Executive Vice President
Arthur Zeikel................. Director President and Trustee
Philip L. Kirstein............ Director None
William E. Aldrich............ Senior Vice President None
Robert W. Crook............... Senior Vice President None
Kevin P. Boman................ Vice President None
Michael J. Brady.............. Vice President None
William M. Breen.............. Vice President None
Mark A. DeSario............... Vice President None
James T. Fatseas.............. Vice President None
Debra W. Landsman-Yaros....... Vice President None
Michelle T. Lau............... Vice President None
Gerald M. Richard............. Vice President and Treasurer Treasurer
Salvatore Venezia............. Vice President None
William Wasel................. Vice President None
Robert Harris................. Secretary None
</TABLE>
(c) Not applicable.
C-6
<PAGE> 134
ITEM 30. LOCATION OF ACCOUNTS AND RECORDS.
All accounts, books and other documents required to be maintained by
Section 31(a) of the Investment Company Act of 1940, as amended, and the rules
thereunder are maintained at the offices of the Registrant, 800 Scudders Mill
Road, Plainsboro, New Jersey 08536, and Merrill Lynch Financial Data Services,
Inc., 4800 Deer Lake Drive East, Jacksonville, Florida 32246-6484.
ITEM 31. MANAGEMENT SERVICES.
Other than as set forth under the caption "Management of the
Trust--Management and Advisory Arrangements" in the Prospectus constituting Part
A of the Registration Statement and under "Management of the Trust--Management
and Advisory Arrangements" in the Statement of Additional Information
constituting Part B of the Registration Statement, the Registrant is not a party
to any management-related service contract.
ITEM 32. UNDERTAKINGS.
(a) Not applicable.
(b) Not applicable.
(c) Registrant undertakes to furnish each person to whom a prospectus is
delivered with a copy of the Registrant's latest annual report to
shareholders, upon request and without charge.
C-7
<PAGE> 135
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933 and the
Investment Company Act of 1940, the Registrant certifies that it meets all of
the requirements for effectiveness of this Post-Effective Amendment to its
Registration Statement pursuant to Rule 485(b) under the Securities Act of 1933
and has duly caused this Registration Statement to be signed on its behalf by
the undersigned, thereunto duly authorized, in the Township of Plainsboro, and
State of New Jersey, on the 20th day of December, 1996.
MERRILL LYNCH CALIFORNIA MUNICIPAL
SERIES TRUST
(REGISTRANT)
BY /S/ GERALD M. RICHARD
------------------------------------
Gerald M. Richard, Treasurer
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed below by the following persons in the
capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- --------------------------------------------- ------------------------ ------------------
<C> <S> <C>
ARTHUR ZEIKEL* President and Trustee
- --------------------------------------------- (Principal Executive
(Arthur Zeikel) Officer)
/s/ GERALD M. RICHARD* Treasurer (Principal December 20, 1996
- --------------------------------------------- Financial and
(Gerald M. Richard) Accounting Officer)
JAMES H. BODURTHA* Trustee
- ---------------------------------------------
(James H. Bodurtha)
HERBERT I. LONDON* Trustee
- ---------------------------------------------
(Herbert I. London)
ROBERT R. MARTIN* Trustee
- ---------------------------------------------
(Robert R. Martin)
JOSEPH L. MAY* Trustee
- ---------------------------------------------
(Joseph L. May)
ANDRE F. PEROLD* Trustee
- ---------------------------------------------
(Andre F. Perold)
*By /s/ GERALD M. RICHARD December 20, 1996
- ---------------------------------------------
(Gerald M. Richard, Attorney-in-fact)
</TABLE>
C-8
<PAGE> 136
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------ -------------------------------------------------------------------
<S> <C> <C>
10 -- Opinion of Brown & Wood LLP, counsel for the Registrant.
11 -- Consent of Deloitte & Touche LLP, independent auditors for the
Registrant.
17(a) -- Financial Data Schedule for Class A shares.
(b) -- Financial Data Schedule for Class B shares.
(c) -- Financial Data Schedule for Class C shares.
(d) -- Financial Data Schedule for Class D shares.
</TABLE>
<PAGE> 1
BROWN & WOOD LLP
ONE WORLD TRADE CENTER
NEW YORK, N.Y. 10048-0557
TELEPHONE 212-839-5300
FACSIMILE 212-839-5599
December 20, 1996
Merrill Lynch California Municipal Bond Fund
of Merrill Lynch California Municipal Series Trust
P.O. Box 9011
Princeton, New Jersey 08543-9011
Ladies and Gentlemen:
This opinion is furnished in connection with the registration by
Merrill Lynch California Municipal Series Trust, a Massachusetts business trust
(the "Trust"), of shares of beneficial interest, par value $0.10 per share (the
"Shares") of the Merrill Lynch California Municipal Bond Fund, a series of the
Trust, under the Securities Act of 1933, as amended, pursuant to a registration
statement on Form N-1A (File No. 2-96581), as amended (the "Registration
Statement"), in the amount set forth under "Amount Being Registered" on the
facing page of the Registration Statement.
As counsel for the Trust, we are familiar with the proceedings taken by
it in connection with the authorization, issuance and sale of the Shares. In
addition, we have examined and are familiar with the Declaration of Trust of the
Trust, as amended, the By-Laws of the Trust and such other documents as we have
deemed relevant to the matters referred to in this opinion.
<PAGE> 2
Based upon the foregoing, we are of the opinion that the Shares, upon
issuance and sale in the manner referred to in the Registration Statement for
consideration not less than the par value thereof, will be legally issued, fully
paid and non-assessable shares of beneficial interest, except that shareholders
of the Trust may under certain circumstances be held personally liable for the
Trust's obligations.
In rendering this opinion, we have relied as to matters of
Massachusetts law upon an opinion of Bingham, Dana & Gould rendered to the
Trust.
We hereby consent to the filing of this opinion as an exhibit to the
Registration Statement and to the use of our name in the Prospectus and
Statement of Additional Information constituting parts thereof.
Very truly yours,
/s/ Brown & Wood LLP
2
<PAGE> 1
EXHIBIT 11
INDEPENDENT AUDITORS' CONSENT
Merrill Lynch California Municipal Bond Fund of
Merrill Lynch California Municipal Series Trust:
We consent to the use in Post-Effective Amendment No. 12 to Registration
Statement No. 2-96581 of our report dated October 1, 1996 appearing in the
Statement of Additional Information, which is a part of such Registration
Statement, and to the reference to us under the caption "Financial Highlights"
appearing in the Prospectus, which also is a part of such Registration
Statement.
Deloitte & Touche LLP
Princeton, New Jersey
December 20, 1996
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