<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON NOVEMBER 26, 1997
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. [_]
[X]
POST-EFFECTIVE AMENDMENT NO. 13
AND/OR
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940 [X]
[X]
AMENDMENT NO. 21
(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)
800 SCUDDERS MILL ROAD 08536
PLAINSBORO, NEW JERSEY (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE
OFFICES)
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:
COUNSEL FOR THE TRUST: BROWN & WOOD LLP PHILIP L. KIRSTEIN, ESQ.
ONE WORLD TRADE CENTER NEW YORK, FUND ASSET MANAGEMENT
NEW YORK 10048-0557 ATTENTION: P.O. BOX 9011
THOMAS R. SMITH, JR. PRINCETON,NEW JERSEY 08543-9011
----------------
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.
TITLE OF SECURITIES BEING REGISTERED: Shares of Beneficial
Interest, par value $.10 per share.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
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
------------- --------
<C> <S> <C>
PART A
Item 1. Cover Page.................. Cover Page
Item 2. Synopsis.................... Fee Table
Item 3. Condensed Financial
Information ............... Financial Highlights; Performance
Item 4. General Description of Data
Registrant................. Investment Objective and Policies;
Additional Information
Item 5. Management of the Fund...... Fee Table; Management of the Trust;
Portfolio Transactions; Inside Back
Item 5A. Management's Discussion of Cover Page
Fund
Performance................ Not Applicable
Item 6. Capital Stock and Other
Securities................. Cover Page; Merrill Lynch Select
Pricing SM System; Additional
Item 7. Purchase of Securities Being Information
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 Objective 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
Item 16. Investment Advisory and Information--Additional Information
Other Services............. Management of the Trust; Purchase of
Item 17. Brokerage Allocation and Shares; General Information
Other Practices............ Portfolio Transactions
Item 18. Capital Stock and Other
Securities................. General Information--Description of
Item 19. Purchase, Redemption and Shares
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
</TABLE>
PART C
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>
PROSPECTUS
NOVEMBER 26, 1997
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 that seeks 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 U.S. 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 except that for participants in
certain fee-based programs the minimum initial purchase is $500 and the
minimum subsequent purchase is $50. Merrill Lynch may charge its customers a
processing fee (presently $5.35) for confirming purchases and repurchases.
Purchases and redemptions made directly through Merrill Lynch Financial Data
Services, Inc. (the "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 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 November 26, 1997 (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 Commission maintains a Web site
(http://www.sec.gov) that contains the Statement of Additional Information,
material incorporated by reference and other information regarding the Fund.
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>
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> <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 Reinvest-
ments................. 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 year, 1.0% for None(d)
decreasing 1.0% annually to one year(f)
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)..... 0.54% 0.54% 0.54% 0.54%
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:
Custodian Fees....... 0.01% 0.01% 0.01% 0.01%
Shareholder Servicing
Costs(i)............ 0.03% 0.04% 0.04% 0.03%
Other................ 0.05% 0.05% 0.05% 0.05%
---- ---- ---- ----
TOTAL OTHER EXPENSES.... 0.09% 0.10% 0.10% 0.09%
---- ---- ---- ----
TOTAL FUND OPERATING
EXPENSES............... 0.63% 1.14% 1.24% 0.73%
==== ==== ==== ====
</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 by participants 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 that
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 certain fee-based programs. See
"Shareholder Services--Fee-Based Programs"--page 35.
(e) The CDSC may be modified in connection with certain fee-based programs.
See "Shareholder Services--Fee-Based Programs"-- page 35.
(f) The CDSC may be waived in connection with certain fee-based programs. See
"Shareholder Services--Fee-Based Programs"-- page 35.
(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.
2
<PAGE>
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 (including any
applicable CDSC for Class B and
Class C shares):
Class A........................ $46 $59 $74 $115
Class B........................ $52 $56 $63 $139
Class C........................ $23 $39 $68 $150
Class D........................ $47 $62 $79 $127
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 $59 $74 $115
Class B........................ $12 $36 $63 $139
Class C........................ $13 $39 $68 $150
Class D........................ $47 $62 $79 $127
</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
$5.35) for confirming purchases and repurchases. Purchases and redemptions
made directly through the Fund's transfer agent are not subject to the
processing fee. See "Purchase of Shares" and "Redemption of Shares."
MERRILL LYNCH SELECT PRICING(SM) SYSTEM
The Fund offers four classes of shares under the Merrill Lynch Select
Pricing(SM) System. The shares of each class may be purchased at a price equal
to the next determined net asset value per share subject to the sales charges
and ongoing fee arrangements described below. Shares of Class A and Class D
are sold to investors choosing the initial sales charge alternatives and
shares of Class B and Class C are sold to investors choosing the deferred
sales charge alternatives. The Merrill Lynch Select Pricing(SM) System is used
by more than 50 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 that use 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
3
<PAGE>
charge arrangements. The CDSCs, distribution 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 CDSCs and distribution fees with respect to the Class B and Class
C shares in that the sales charges and distribution fees applicable to each
class provide for the financing of the distribution of the shares of the Fund.
The distribution-related revenues paid with respect to a class will not be
used to finance the distribution expenditures of another class. Sales
personnel may receive different compensation for selling different classes of
shares.
The following table sets forth a summary of the distribution arrangements
for each class of shares under the Merrill Lynch Select Pricing(SM) System,
followed by a more detailed description of each class and a discussion of the
factors that investors should consider in determining the method of purchasing
shares under the Merrill Lynch Select Pricing(SM) System that the investor
believes is most beneficial under his or her particular circumstances. More
detailed information as to each class of shares is set forth under "Purchase
of Shares."
<TABLE>
<CAPTION>
ACCOUNT
MAINTENANCE DISTRIBUTION
CLASS SALES CHARGE(/1/) FEE FEE CONVERSION FEATURE
- -----------------------------------------------------------------------------------------------------
<C> <S> <C> <C> <C>
A Maximum 4.00% initial sales No No No
charge(/2/)(/3/)
- -----------------------------------------------------------------------------------------------------
B CDSC for a period of four years, 0.25% 0.25% B shares convert to D
at a rate of 4.0% during the shares automatically after
first year, decreasing 1.0% approximately ten
annually to 0.0%(/4/) years(/5/)
- -----------------------------------------------------------------------------------------------------
1.0% CDSC for one
C year(/6/) 0.25% 0.35% No
- -----------------------------------------------------------------------------------------------------
Maximum 4.00% initial sales
D charge(/3/) 0.10% No No
</TABLE>
(1) Initial sales charges are imposed at the time of purchase as a percentage
of the offering price. CDSCs 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 by participants 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 certain fee-based programs. See "Class A" and "Class D" below.
(4) The CDSC may be modified in connection with certain fee-based programs.
(5) The conversion period for dividend reinvestment shares and certain fee-
based programs 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 certain fee-based programs.
4
<PAGE>
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."), 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 of 4.00%, is reduced for purchases of $25,000 and
over and waived for purchases by participants 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 certain fee-based programs. Sales charges are also
reduced under a right of accumulation that 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 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 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 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
5
<PAGE>
who 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. The maximum initial sales charge of 4.00% is
reduced for purchases of $25,000 and over. Purchases of $1,000,000 or
more may not be subject to an initial sales charge, but if the
initial sales charge is waived such purchases 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 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 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
Pricing(SM) System that the investor believes is most beneficial under his or
her particular circumstances.
Initial Sales Charge Alternatives. Investors who prefer an initial sales
charge alternative may elect to purchase Class D shares or, if an eligible
investor, Class A shares. Investors choosing the initial sales charge
alternative who are eligible to purchase Class A shares should purchase Class
A shares rather than Class D shares because there is an account maintenance
fee imposed on Class D shares. Investors qualifying for significantly reduced
initial sales charges may find the initial sales charge alternative
particularly attractive because similar sales 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 that may qualify the investor for reduced initial sales
charges on new initial sales charge purchases. In addition, the ongoing Class
B and Class C account maintenance and distribution fees will cause Class B and
Class C shares to have higher expense ratios, pay lower dividends and have
lower total returns than the initial sales charge shares. The ongoing Class D
account maintenance fees will cause Class D shares to have a higher expense
ratio, pay lower dividends and have a lower total return than Class A shares.
Deferred Sales Charge Alternatives. Because no initial sales charges are
deducted at the time of purchase, Class B and Class C shares provide the
benefit of putting all of the investor's dollars to work from the time the
investment is made. The deferred sales charge alternatives may be particularly
appealing to investors who do not qualify for a reduction in initial sales
charges. Both Class B and Class C shares are 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
6
<PAGE>
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>
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, 1997 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 PERIOD
OCTOBER 25,
FOR THE YEAR ENDED AUGUST 31, 1988+ TO
---------------------------------------------------------------------- AUGUST 31,
1997 1996 1995 1994 1993 1992 1991 1990 1989
------- ------- ------- ------- ------- ------- ------- ------- --------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Increase (Decrease) in
Net Asset
Value:
PER SHARE OPERATING PER-
FORMANCE:
Net asset value,
beginning of year...... $11.49 $ 11.40 $ 11.32 $ 12.38 $ 11.80 $ 11.44 $ 11.03 $ 11.22 $ 11.02
------- ------- ------- ------- ------- ------- ------- ------- -------
Investment income--net.. .64 .64 .64 .68 .70 .72 .74 .77 .63
In excess of realized
and unrealized gain
(loss) on investments--
net.................... .32 .09 .08 (.78) .78 .41 .41 (.19) .20
------- ------- ------- ------- ------- ------- ------- ------- -------
Total from investment
operations............. .96 .73 .72 (.10) 1.48 1.13 1.15 .58 .83
------- ------- ------- ------- ------- ------- ------- ------- -------
Less dividends and
distributions:
Investment income--net.. (.64) (.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) (.64) (.96) (.90) (.77) (.74) (.77) (.63)
------- ------- ------- ------- ------- ------- ------- ------- -------
Net asset value, end of
year................... $11.81 $ 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.............. 8.55% 6.53% 6.75% (.92)% 13.19% 10.23% 10.73% 5.21% 7.96%#
======= ======= ======= ======= ======= ======= ======= ======= =======
RATIOS TO AVERAGE NET
ASSETS:
Expenses................ .63% .65% .65% .62% .63% .63% .64% .65% .65%*
======= ======= ======= ======= ======= ======= ======= ======= =======
Investment income--net.. 5.49% 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)......... $44,652 $42,668 $44,228 $60,017 $64,526 $46,556 $37,499 $29,558 $19,451
======= ======= ======= ======= ======= ======= ======= ======= =======
Portfolio turnover...... 73.60% 53.79% 53.40% 75.66% 61.24% 52.31% 116.09% 119.66% 114.49%
======= ======= ======= ======= ======= ======= ======= ======= =======
</TABLE>
- --------
+ Commencement of Operations.
# Aggregate total investment return.
* Annualized.
** Total investment returns exclude the effects of sales loads.
8
<PAGE>
<TABLE>
<CAPTION>
CLASS B
-------------------------------------------------------------------------------------------------------
FOR THE YEAR ENDED AUGUST 31,
--------------------------------------------------------------------------------------------------
1997 1996 1995 1994 1993 1992 1991 1990 1989 1988
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Increase (Decrease) in
Net Asset Value:
PER SHARE OPERATING
PERFORMANCE:
Net asset value,
beginning of year..... $ 11.49 $ 11.40 $ 11.32 $ 12.38 $ 11.80 $ 11.44 $ 11.03 $ 11.23 $ 10.77 $ 10.96
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Investment income--
net................... .58 .58 .59 .61 .64 .67 .68 .71 .71 .71
In excess of realized
and unrealized gain
(loss) on
investments--net...... .33 .09 .08 (.78) .78 .41 .41 (.20) .46 (.19)
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Total from investment
operations............ .91 .67 .67 (.17) 1.42 1.08 1.09 .51 1.17 .52
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Less dividends and
distributions:
Investment income--
net................... (.58) (.58) (.59) (.61) (.64) (.67) (.68) (.71) (.71) (.71)
Realized gain on
investments--net...... -- -- -- (.19) (.20) (.05) -- -- -- --
In excess of realized
gain on investments--
net................... -- -- -- (.09) -- -- -- -- -- --
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Total dividends and
distributions......... (.58) (.58) (.59) (.89) (.84) (.72) (.68) (.71) (.71) (.71)
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Net asset value, end of
year.................. $ 11.82 $ 11.49 $ 11.40 $ 11.32 $ 12.38 $ 11.80 $ 11.44 $ 11.03 $ 11.23 $ 10.77
======== ======== ======== ======== ======== ======== ======== ======== ======== ========
TOTAL INVESTMENT
RETURN:*
Based on net asset
value per share....... 8.09% 5.99% 6.25% (1.50)% 12.62% 9.68% 10.18% 4.58% 11.14% 5.05%
======== ======== ======== ======== ======== ======== ======== ======== ======== ========
RATIOS TO AVERAGE NET
ASSETS:
Expenses............... 1.14% 1.16% 1.16% 1.13% 1.13% 1.13% 1.15% 1.15% 1.16% 1.16%
======== ======== ======== ======== ======== ======== ======== ======== ======== ========
Investment income--
net................... 4.98% 5.01% 5.32% 5.15% 5.38% 5.76% 6.07% 6.27% 6.42% 6.63%
======== ======== ======== ======== ======== ======== ======== ======== ======== ========
SUPPLEMENTAL DATA:
Net assets, end of year
(in thousands)........ $376,018 $480,668 $616,199 $726,888 $821,220 $729,569 $690,885 $663,551 $665,566 $611,454
======== ======== ======== ======== ======== ======== ======== ======== ======== ========
Portfolio turnover..... 73.60% 53.79% 53.40% 75.66% 61.24% 52.31% 116.09% 119.66% 114.49% 77.99%
======== ======== ======== ======== ======== ======== ======== ======== ======== ========
</TABLE>
- -------
* Total investment returns exclude the effects of sales loads.
9
<PAGE>
<TABLE>
<CAPTION>
CLASS C CLASS D
---------------------------- -------------------------------
FOR THE FOR THE
FOR THE PERIOD FOR THE PERIOD
YEAR ENDED OCTOBER 21, YEAR ENDED OCTOBER 21,
AUGUST 31, 1994+ TO AUGUST 31, 1994+ TO
--------------- AUGUST 31, ------------------ AUGUST 31,
1997 1996 1995 1997 1996 1995
---- ---- ----------- ---- ---- -----------
<S> <C> <C> <C> <C> <C> <C>
Increase (Decrease) in
Net Asset Value:
PER SHARE OPERATING PER-
FORMANCE:
Net asset value,
beginning of period.... $ 11.49 $11.40 $10.94 $ 11.49 $ 11.40 $10.94
------- ------ ------ -------- -------- ------
Investment income--net.. .57 .57 .49 .63 .63 .54
In excess of realized
and unrealized gain on
investments--net....... .33 .09 .46 .33 .09 .46
------- ------ ------ -------- -------- ------
Total from investment
operations............. .90 .66 .95 .96 .72 1.00
------- ------ ------ -------- -------- ------
Less dividends from
investment income--
net.................... (.57) (.57) (.49) (.63) (.63) (.54)
------- ------ ------ -------- -------- ------
Net asset value, end of
period................. $ 11.82 $11.49 $11.40 $ 11.82 $ 11.49 $11.40
======= ====== ====== ======== ======== ======
TOTAL INVESTMENT
RETURN:**
Based on net asset value
per share.............. 7.98% 5.88% 8.91%# 8.53% 6.43% 9.39%#
======= ====== ====== ======== ======== ======
RATIOS TO AVERAGE NET
ASSETS:
Expenses................ 1.24% 1.26% 1.27%* .73% .75% .76%*
======= ====== ====== ======== ======== ======
Investment income--net.. 4.87% 4.91% 5.04%* 5.39% 5.42% 5.59%*
======= ====== ====== ======== ======== ======
SUPPLEMENTAL DATA:
Net assets, end of
period (in thousands).. $10,904 $8,112 $3,131 $185,300 $111,817 $3,846
======= ====== ====== ======== ======== ======
Portfolio turnover...... 73.60% 53.79% 53.40% 73.60% 53.79% 53.40%
======= ====== ====== ======== ======== ======
</TABLE>
- --------
+ Commencement of operations.
# Aggregate total investment return.
* Annualized.
** Total investment returns exclude the effects of sales loads.
10
<PAGE>
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 U.S. 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 operating history, the quality of its
management and regulatory matters. See "Investment Objective and Policies" in
the Statement of
11
<PAGE>
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 Fund's investments may also 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 to the issuer, 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 (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
12
<PAGE>
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 Fund's hedging strategies, which are
described in more detail under "Financial Futures Transactions and Options,"
are not fundamental policies and may be modified by the Trustees of the Trust
without the approval of the Fund's shareholders.
POTENTIAL BENEFITS
Investment in shares of the Fund offers several benefits. The Fund offers
investors the opportunity to receive income exempt from Federal and California
income taxes and to own shares in a professionally managed portfolio
consisting primarily of long-term California Municipal Bonds. The Fund also
provides liquidity because of its redemption features and relieves the
investor of the burdensome administrative details involved in managing a
portfolio of tax-exempt securities. The benefits of investing in the Fund are
at least partially offset by the expenses involved in operating an investment
company. Such expenses primarily consist of the management fee and operational
costs and, in the case of certain classes of shares, the account maintenance
and distribution fees.
SPECIAL AND RISK CONSIDERATIONS RELATING TO MUNICIPAL BONDS
The risks and special considerations involved in investments in Municipal
Bonds vary with the types of instruments being acquired. Investments in Non-
Municipal Tax-Exempt Securities may present similar risks, depending on the
particular product. Certain instruments in which the Fund may invest may be
characterized as derivative instruments. See "Description of Municipal Bonds"
and "Financial Futures Transactions and Options."
Moreover, the Fund ordinarily will invest at least 65% of its total assets
in California Municipal Bonds, and therefore it is more susceptible to factors
adversely affecting issuers of California Municipal Bonds than is 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.
13
<PAGE>
The value of Municipal Bonds generally may be affected by uncertainties in
the municipal markets as a result of legislation or litigation changing the
taxation of Municipal Bonds or the rights of Municipal Bond holders in the
event of bankruptcy. Municipal bankruptcies are rare, and certain provisions
of the U.S. Bankruptcy Code governing such bankruptcies are unclear. Further,
the application of state law to Municipal Bond issuers could produce varying
results among the states or among Municipal Bond issuers within a state. These
uncertainties could have a significant impact on the prices of the California
Municipal Bonds or Municipal Bonds in which the Fund invests.
The Manager does not believe that the current economic conditions in
California or other factors described above will have a significant adverse
effect on the Fund's ability to invest in high quality California Municipal
Bonds. Because the Fund's portfolio will be comprised primarily of investment
grade securities, the Fund is expected to be less subject to market and credit
risks than a fund that invests primarily in lower quality California Municipal
Bonds. See "Description of Municipal Bonds" in the Statement of Additional
Information and see also Appendix I--"Economic and Other Conditions in
California" 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 (such as 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
"private activity bonds" as discussed below.
The two principal classifications of Municipal Bonds are "general
obligation" bonds and "revenue" bonds which latter category includes
industrial development bonds ("IDBs") and, for bonds issued after August 15,
1986, private activity bonds. General obligation bonds are secured by the
issuer's pledge of its faith, credit and taxing power for the repayment of
principal and the payment of interest. The taxing power of any governmental
entity may be limited, however, by provisions of 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>
The Fund may purchase IDBs and private activity bonds. IDBs and 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 facilities. Although
lease obligations do not constitute general obligations of the issuer for
which the issuer's unlimited taxing power is
15
<PAGE>
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
entity 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.
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
16
<PAGE>
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. Recent
legislation has created new categories of capital gains taxable at different
rates which the Fund may pass through to shareholders. 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.
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.
17
<PAGE>
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 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
18
<PAGE>
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 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
19
<PAGE>
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");
and Executive Vice President of ML & Co.
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.
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 140 other registered investment companies.
MLAM also provides investment advisory services to individual and
institutional accounts. As of October 31, 1997, the Manager and MLAM had a
total of approximately $271.9 billion in investment company and other
portfolio assets under management, including accounts of certain affiliates of
the Manager.
20
<PAGE>
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 is the Vice President and Portfolio Manager of the Fund and
has been responsible for the day-to-day management of the Fund's investment
portfolio since December, 1995. He has been a Vice President of MLAM since
1993 and was an Assistant Vice President thereof from 1991 to 1993.
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 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 average daily net assets
not exceeding $500 million; 0.525% 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, 1997, the total fee paid by the Fund to the Manager was $3,422,246
(based on daily average net assets of approximately $629.8 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, 1997, the Fund reimbursed the Manager $64,769 for accounting
services. For the fiscal year ended August 31, 1997, the ratio of total
expenses to average net assets was .63% for Class A shares, 1.14% for Class B
shares, 1.24% for Class C shares and .73% 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 that incorporates the Code of Ethics of the Manager
(together, the "Codes"). The Codes significantly restrict the personal
investing activities of all employees of the Manager and, as described below,
impose additional, more onerous, restrictions on fund investment personnel.
The Codes require that all employees of the Manager preclear any personal
securities investment (with limited exceptions, such as government
securities). The preclearance requirement and associated procedures are
designed to identify any substantive prohibition or limitation applicable to
the proposed investment. The substantive restrictions applicable to all
employees of the Manager include a ban on acquiring any securities in a "hot"
initial public offering and a prohibition from profiting on short-term trading
in securities. In addition, no employee may purchase or sell any security that
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).
21
<PAGE>
TRANSFER AGENCY SERVICES
The Transfer Agent, which is a 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 Transfer Agent receives an annual fee of up to $11.00 per Class
A or Class D account and up to $14.00 per Class B or Class C account, and is
entitled to reimbursement for certain transaction charges and out-of-pocket
expenses incurred by the Transfer Agent under the Transfer Agency Agreement.
Additionally, a $.20 monthly closed account charge will be assessed on all
accounts which close during the calendar year. Application of this fee will
commence the month following the month the account is closed. At the end of
the calendar year, no further fees will be due. For purposes of the Transfer
Agency Agreement, the term "account" includes a shareholder account maintained
directly by the Transfer Agent and any other account representing the
beneficial interest of a person in the relevant share class on a recordkeeping
system, provided the recordkeeping system is maintained by a subsidiary of ML
& Co. For the fiscal year ended August 31, 1997, the total fee paid by the
Fund to the Transfer Agent was $223,993 pursuant to the Transfer Agency
Agreement.
PURCHASE OF SHARES
The Distributor, an affiliate of each 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, except that for participants in certain fee-based
programs, the minimum initial purchase is $500 and the minimum subsequent
purchase is $50.
The Fund offers its shares in four classes at a public offering price equal
to the next determined net asset value per share plus sales charges imposed
either at the time of purchase or on a deferred basis depending upon the class
of shares selected by the investor under the Merrill Lynch Select Pricing(SM)
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 received by the Distributor prior to 30 minutes after
the close of business on the NYSE on that day, 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 $5.35) to confirm a sale of shares to such customers. Purchases
made directly through the Fund's Transfer Agent are not subject to the
processing fee.
22
<PAGE>
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 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 (except that Class B shareholders may vote
upon any material changes to expenses charged under the Class D Distribution
Plan). 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 CDSCs and distribution fees with respect to Class B and Class C shares
in that the sales charges and distribution fees 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, that are
eligible to sell shares.
23
<PAGE>
The following table sets forth a summary of the distribution arrangements
for each class of shares under the Merrill Lynch Select PricingSM System.
<TABLE>
<CAPTION>
ACCOUNT
MAINTENANCE DISTRIBUTION
CLASS SALES CHARGE(/1/) FEE FEE CONVERSION FEATURE
- -----------------------------------------------------------------------------------------------------
<C> <S> <C> <C> <C>
A Maximum 4.00% initial sales No No No
charge(/2/)(/3/)
- -----------------------------------------------------------------------------------------------------
B CDSC for a period of four years, 0.25% 0.25% B shares convert to D
at a rate of 4.0% during the shares automatically after
first year, decreasing 1.0% approximately ten
annually to 0.0%(/4/) years(/5/)
- -----------------------------------------------------------------------------------------------------
1.0% CDSC for one
C year(/6/) 0.25% 0.35% No
- -----------------------------------------------------------------------------------------------------
Maximum 4.00% initial sales
D charge(/3/) 0.10% No No
</TABLE>
(1) Initial sales charges are imposed at the time of purchase as a percentage
of the offering price. CDSCs 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 by participants 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 certain fee-based programs.
(4) The CDSC may be modified in connection with certain fee-based programs.
(5) The conversion period for dividend reinvestment shares and certain fee-
based programs 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 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 CHARGE AS DISCOUNT TO
SALES CHARGE AS PERCENTAGE* OF SELECTED DEALERS
PERCENTAGE OF THE NET AMOUNT AS PERCENTAGE OF
AMOUNT OF PURCHASE OFFERING 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>
(Footnotes on next page)
24
<PAGE>
(Footnotes from previous page)
- --------
* 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 by participants 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 1.0% CDSC if the shares are redeemed within one year after
purchase. Such CDSC may be waived in connection with 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.
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, 1997, the Fund sold 784,082 Class A
shares for aggregate net proceeds of $9,128,183. The gross sales charges for
the sale of Class A shares of the Fund for that year were $11,680, of which
$1,003 and $10,677 were received by the Distributor and Merrill Lynch,
respectively. For the fiscal year ended August 31, 1997, 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, 1997, the Fund sold 788,405 Class D shares for
aggregate net proceeds of $9,195,140. The gross sales charges for the sale of
Class D shares of the Fund for the year were $50,567, of which $4,949 and
$45,618 were received by the Distributor and Merrill Lynch, respectively. For
the fiscal year ended August 31, 1997, 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 and U.S. branches
of foreign banking institutions provided that the program or branch 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
25
<PAGE>
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."
Provided applicable threshold requirements are met, either Class A or Class
D shares are offered at net asset value to Employee Access(SM) Accounts
available through authorized employers. 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 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,
which declines each year, 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."
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. The proceeds from the account
maintenance fees are used to compensate the Distributor and Merrill Lynch
(pursuant to a sub-
26
<PAGE>
agreement) for providing continuing account maintenance activities.
Approximately ten years after issuance, Class B shares will convert
automatically into Class D shares of the Fund, which are subject to a lower
account maintenance fee and no distribution fee; Class B shares of certain
other MLAM-advised mutual funds into which exchanges may be made convert into
Class D shares automatically after approximately eight years. If Class B
shares of the Fund are exchanged for Class B shares of another MLAM-advised
mutual fund, the conversion period applicable to the Class B shares acquired
in the exchange will apply, and the holding period for the shares exchanged
will be tacked onto the holding period for the shares acquired.
Imposition of the CDSC and the distribution fee on Class B and Class C
shares is limited by the NASD asset-based sales charge rule. See "Limitations
on the Payment of Deferred Sales Charges" below. 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 that 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>
CDSC AS A
PERCENTAGE OF
YEAR SINCE PURCHASE DOLLAR AMOUNT
PAYMENT MADE SUBJECT TO CHARGE
------------------- -----------------
<S> <C>
0-1................................................... 4.0%
1-2................................................... 3.0%
2-3................................................... 2.0%
3-4................................................... 1.0%
4 and thereafter...................................... None
</TABLE>
For the fiscal year ended August 31, 1997, the Distributor received CDSCs of
$307,864 with respect to redemptions of Class B shares, all of which were paid
to Merrill Lynch. Additional CDSCs payable to the Distributor may have been
waived or converted to a contingent obligation in connection with a
shareholder's participation in certain fee-based programs.
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
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<PAGE>
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. The Class B CDSC also is
waived for any Class B shares that are purchased within qualifying Employee
Access(SM) Accounts. 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 certain fee-based programs. See
"Shareholder Services--Fee-Based Programs."
Contingent Deferred Sales Charges--Class C Shares. Class C shares that 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. The Class C CDSC may be waived in
connection with certain fee-based programs. See "Shareholder Services--Fee-
Based Programs." For the fiscal year ended August 31, 1997, the Distributor
received CDSCs of $5,077 with respect to redemptions of Class C shares, all of
which were paid to Merrill Lynch.
In determining whether a Class C CDSC is applicable to a redemption, the
calculation will be determined in the manner that results in the lowest
possible rate being charged. Therefore, it will be assumed that the redemption
is first of shares held for over one-year or shares acquired pursuant to
reinvestment of dividends or distributions and then of shares held longest
during the one-year period. The charge will not be applied to dollar amounts
representing an increase in the net asset value since the time of purchase. A
transfer of shares from a shareholder's account to another account will be
assumed to be made in the same order as a redemption.
Conversion of Class B Shares to Class D Shares. After approximately ten
years (the "Conversion Period"), Class B shares will be converted
automatically into Class D shares of the Fund. Class D shares are subject to
an ongoing account maintenance fee of 0.10% of net assets but are not subject
to the distribution fee that is borne by Class B shares. Automatic conversion
of Class B shares into Class D shares will occur at least once each month (on
the "Conversion Date") on the basis of the relative net asset values of the
shares of the two classes on the Conversion Date, without the imposition of
any sales load, fee or other charge. Conversion of Class B shares to Class D
shares will not be deemed a purchase or sale of the shares for Federal income
tax purposes.
In addition, shares purchased through reinvestment of dividends on Class B
shares also will convert automatically to Class D shares. The Conversion Date
for dividend reinvestment shares will be calculated taking into account the
length of time the shares underlying such dividend reinvestment shares were
outstanding. If at a Conversion Date the conversion of Class B shares to Class
D shares of the Fund in a single account will result in less than $50 worth of
Class B shares being left in the account, all of the Class B shares of the
Fund held in the account on the Conversion Date will be converted to Class D
shares of the Fund.
Share certificates for Class B shares of the Fund to be converted must be
delivered to the Transfer Agent at least one week prior to the Conversion Date
applicable to those shares. In the event such certificates are not
28
<PAGE>
received by the Transfer Agent at least one week prior to the Conversion Date,
the related Class B shares will convert to Class D shares on the next
scheduled Conversion Date after such certificates are delivered.
In general, Class B shares of equity MLAM-advised mutual funds will convert
approximately eight years after initial purchase, and Class B shares of
taxable and tax-exempt fixed income MLAM-advised mutual funds will convert
approximately ten years after initial purchase. If, during the Conversion
Period, a shareholder exchanges Class B shares with an eight-year Conversion
Period for Class B shares with a ten-year Conversion Period, or vice versa,
the Conversion Period applicable to the Class B shares acquired in the
exchange will apply, and the holding period for the shares exchanged will be
tacked onto the holding period for the shares acquired.
The Conversion Period also may be modified for investors who participate in
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, 1997, the Fund paid the Distributor
$2,104,015 pursuant to the Class B Distribution Plan (based on average daily
net assets subject to such Class B Distribution Plan of approximately $422.0
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, 1997, the Fund paid
the Distributor $54,528 pursuant to the Class C Distribution Plan (based on
average daily net assets subject to such Class C Distribution Plan of
approximately $9.1 million), all of which was paid to Merrill Lynch
29
<PAGE>
for providing account maintenance and distribution-related activities and
services in connection with Class C shares. For the fiscal year ended August
31, 1997, the Fund paid the Distributor $155,124 pursuant to the Class D
Distribution Plan (based on average daily net assets subject to such Class D
Distribution Plan of approximately $155.5 million), all of which was paid to
Merrill Lynch for providing account maintenance activities in connection with
Class D shares.
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, 1996, 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
$4,657,000 (1.04% of Class B net assets at that date). As of August 31, 1997,
direct cash revenues for the period since the commencement of operations of
Class B shares exceeded direct cash expenses by $23,306,162 (6.20% of Class B
net assets at that date). As of December 31, 1996, the fully allocated accrual
expenses incurred by the Distributor and Merrill Lynch for the period since
commencement of operations of Class C shares exceeded fully allocated accrual
revenues by approximately $49,000 (.55% of Class C net assets at that date).
As of August 31, 1997, direct cash revenues for the period since the
commencement of operations of Class C shares exceeded direct cash expenses by
$52,427 (0.48% 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 Fund rather than to the
Distributor; however, the Fund will continue to make payments of the account
maintenance fee. In certain circumstances, the amount
30
<PAGE>
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 that 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 redemption request in either event requires the
signature(s) of all persons in whose name(s) the shares are registered, signed
exactly as such name(s) appear(s) on the Transfer Agent's register. The
signature(s) on the redemption request must be guaranteed by an "eligible
guarantor institution" as such is defined in Rule 17Ad-15 under the Securities
and Exchange Act of 1934, as amended, the existence and validity of which may
be verified by the Transfer Agent through the use of industry publications.
Notarized signatures are not sufficient. In certain instances, the Transfer
Agent may require additional documents such as, but not limited to, trust
instruments, death certificates, appointments as executor or administrator, or
certificates of corporate authority. For shareholders redeeming directly with
the Transfer Agent, payments will be mailed within seven days of receipt of a
proper notice of redemption.
At various times the Trust may be requested to redeem Fund shares for which
it has not yet received good payment (e.g., cash, Federal Funds or certified
check drawn on a United States bank). The Trust may delay or
31
<PAGE>
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 $5.35) to confirm a repurchase of
shares to such customers. Repurchases made 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
described below that are 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 can be obtained
from the Trust by calling the telephone number on the cover page hereof or
from the Distributor or Merrill Lynch.
32
<PAGE>
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. 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 such shares
and then must turn the certificates over to the new firm for re-registration
as described in the preceding sentence.
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 the account in which the exchange is made at the time of the exchange
or is otherwise eligible to purchase Class A shares of the second fund. If the
Class A shareholder wants to exchange Class A shares for shares of a second
MLAM-advised mutual fund, and the shareholder does not hold Class A shares of
the second fund in his or her account at the time of the exchange and is not
otherwise eligible to acquire Class A shares of the second fund, the
shareholder will receive Class D shares of the second fund as a result of the
exchange. Class D shares also may be exchanged for Class A shares of a second
MLAM-advised mutual fund at any time as long as, at the time of the exchange,
the shareholder holds Class A shares of the second fund in the account in
which the exchange is made or is otherwise eligible to purchase Class A shares
of the second fund.
Exchanges of Class A and Class D shares are made on the basis of the
relative net asset values per Class A or Class D share, respectively, plus an
amount equal to the difference, if any, between the sales charge previously
paid on the Class A or Class D shares being exchanged and the sales charge
payable at the time of the exchange on the shares being acquired.
33
<PAGE>
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 that 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 to Merrill Lynch, if the shareholder's account is maintained with
Merrill Lynch, or by written notification or telephone (1-800-MER-FUND) to the
Transfer Agent if the shareholder's account is maintained with 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. The Fund is not responsible for any failure of
delivery to the shareholder's address of record and no interest will accrue on
amounts represented by uncashed distribution or redemption checks. 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 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 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. With
respect
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<PAGE>
to redemptions of Class B or Class C shares pursuant to a systematic
withdrawal plan, the maximum number of Class B or Class C shares that can be
redeemed from an account annually shall not exceed 10% of the value of shares
of such class in that account at the time the election to join the systematic
withdrawal plan was made. Any CDSC that otherwise might be due on such
redemption of Class B or Class C shares will be waived. Shares redeemed
pursuant to a systematic withdrawal plan will be redeemed in the same order as
Class B or Class C shares are otherwise redeemed. See "Purchase of Shares--
Deferred Sales Charge Alternatives--Class B and Class C Shares--Contingent
Deferred Sales Charges--Class B Shares" and "--Contingent Deferred Sales
Charges--Class C Shares." Where the systematic withdrawal plan is applied to
Class B shares, upon conversion of the last Class B shares in an account to
Class D shares, the systematic withdrawal plan will automatically be applied
thereafter to Class D shares. See "Purchase of Shares--Deferred Sales Charge
Alternatives--Class B and Class C Shares--Conversion of Class B Shares to
Class D Shares."
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 the Transfer
Agent at (800) MER-FUND or (800) 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
35
<PAGE>
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 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
Fund may not purchase securities, including Municipal Bonds, during the
existence of any underwriting syndicate of which Merrill Lynch is a member or
in a private placement in which Merrill Lynch serves as placement agent except
pursuant to procedures approved by the Trustees of the Trust which either
comply with rules adopted by the Commission or with interpretations of the
Commission staff. 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.
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 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.
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.
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<PAGE>
TAXES
The Trust intends to continue to qualify the Fund for the special tax
treatment afforded regulated investment companies ("RICs") under the Code. As
long as 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 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
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.
Distributions from investment income and capital gains of the Fund, including
exempt-interest dividends, may also be subject to state taxes in states other
than California and may be subject to local taxes in other states.
Accordingly, investors in the Fund, in particular, corporate investors which
may be subject to the California franchise tax, should consult their tax
advisors with respect to the application of such taxes to the receipt of Fund
dividends and to the holding of shares in the Fund.
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. Recent legislation creates additional categories of capital
gains taxable at different rates. Not later than 60 days after the close of
its taxable year, the Fund will provide its shareholders with a written notice
designating the amounts of any exempt-interest dividends, ordinary income
dividends or capital gain dividends, as well as the amount of capital gain
dividends in the different categories of capital gain referred to above.
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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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"). Generally,
shareholders subject to backup withholding will be those for whom no certified
taxpayer identification
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<PAGE>
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 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 than
average annual total return data since the average annual rates of return
reflect compounding; aggregate total
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<PAGE>
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
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, 1997 was 4.26% for Class A shares, 3.93% for Class B
shares, 3.82% for Class C shares and 4.16% for Class D shares and the tax-
equivalent yield for the same period (based on a Federal income tax rate of
28%) was 5.92% for Class A shares, 5.46% for Class B shares, 5.30% for Class C
shares and 5.78% 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 (including interest and dividends accrued but not yet received) minus
all liabilities (including accrued expenses) by the total number of shares
outstanding at such time, rounded to the nearest cent. Expenses, including
management fees and distribution fees, are accrued daily.
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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 a 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 beneficial interest, $.10
par value per share, 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 relating to the account maintenance associated with such
shares, and Class B and Class C shares bear certain expenses relating to the
distribution of such shares. Each class has exclusive voting rights with
respect to matters relating to distributions and/or account maintenance
expenditures, as applicable. See "Purchase of Shares." The Trustees of the
Trust may classify and reclassify the shares of any Series into additional or
other 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. Upon liquidation or dissolution of a Series, each issued
and outstanding share of that Series is entitled to participate equally in
dividends and distributions declared by the respective Series and in net
assets of such Series remaining after satisfaction of outstanding liabilities
except that, as noted above, the Class B, Class C and Class D shares bear
certain additional expenses. The obligations and liabilities of a particular
Series are restricted to the assets of that Series and do not extend to the
assets of the Trust generally. The shares of each Series, when issued, will be
fully-paid and non-assessable by the Trust.
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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)
Occupation........................... Name and Address of Employer ........
..................................... .....................................
Signature of Owner Signature of Co-Owner (if any)
(In the case of co-owner, a joint tenancy with rights of survivorship will be
presumed unless otherwise specified.)
- -------------------------------------------------------------------------------
2. DIVIDEND AND CAPITAL GAIN DISTRIBUTION OPTION
Ordinary Income Dividends Long-Term Capital
Gains
Select One:
[_] Reinvest SelectOne:
[_] Reinvest
[_] Cash [_] Cash
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>
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.
..................................... .....................................
Signature of Owner Signature of Co-Owner (if any)
- -------------------------------------------------------------------------------
4. LETTER OF INTENTION--CLASS A AND CLASS D SHARES ONLY (SEE TERMS AND
CONDITIONS IN THE STATEMENT OF ADDITIONAL INFORMATION)
..................., 19......
Date of Initial Purchase
Dear Sir/Madam:
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 this 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.
By .................................. .....................................
Signature of Owner Signature of Co-Owner (If registered
in joint names, both must sign)
In making purchases under this letter, the following are the related
accounts on which reduced offering prices are to apply:
(1) Name............................. (2) Name.............................
Account Number.......................
Account Number.......................
- -------------------------------------------------------------------------------
5. FOR DEALER ONLY
Branch Office, Address, Stamp. 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.
This form when completed should be .....................................
mailed to: Dealer Name and Address
Merrill Lynch California Municipal By ..................................
Bond Fund Authorized Signature of Dealer
c/o Merrill Lynch Financial Data
Services, Inc. [_][_][_] [_][_][_][_] ..............
P.O. Box 45289 Branch-Code F/C No. F/C Last Name
Jacksonville, Florida 32232-5289 [_][_][_] [_][_][_][_][_]
Dealer's Customer A/C No.
44
<PAGE>
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)
Name of Owner...................... Social Security No. or
Taxpayer Identification
Number
Name of Co-Owner (if any)..........
Address............................ Account Number ....................
(if existing account)
...................................
(Zip Code)
- -------------------------------------------------------------------------------
2. SYSTEMATIC WITHDRAWAL PLAN--(SEE TERMS AND CONDITIONS IN THE STATEMENT OF
ADDITIONAL INFORMATION)
MINIMUM REQUIREMENTS: $10,000 for monthly disbursements, $5,000 for
quarterly, of [_] Class A, [_] Class B*, [_] Class C* 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
or as soon as possible thereafter.
(month)
SPECIFY THE AMOUNT OF WITHDRAWAL YOU WOULD LIKE PAID TO YOU (CHECK ONE): [_]
$ of [_] Class A, Class B*, [_] Class C* 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.
* ANNUAL WITHDRAWAL CANNOT EXCEED 10% OF THE VALUE OF SHARES OF SUCH CLASS
HELD IN THE ACCOUNT AT THE TIME THE ELECTION TO JOIN THE SYSTEMATIC
WITHDRAWAL PLAN IS MADE.
45
<PAGE>
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 AUTHORIZATION TO HONOR ACH DEBITS
SERVICES, INC. DRAWN BY MERRILL LYNCH FINANCIAL
DATA SERVICES, INC.
You are hereby authorized to draw an
ACH debit each month on my bank To.............................. Bank
account for investment in Merrill (Investor's Bank)
Lynch California Municipal Bond
Fund, Inc. as indicated below: Bank Address.........................
Amount of each check or ACH debit City...... State...... Zip Code......
$.................................
As a convenience to me, I hereby
Account Number ................... request and authorize you to pay and
charge to my account ACH debits
Please date and invest ACH debits on drawn on my account by and payable
the 20th of each month beginning to Merrill Lynch Financial Data
Services, Inc., I agree that your
................... or as soon rights in respect to each such debit
(month) shall be the same as if it were a
thereafter as possible. check drawn on you and signed
personally by me. This authority is
I agree that you are drawing these to remain in effect until revoked
ACH debits voluntarily at my request personally by me in writing. Until
and that you shall not be liable for you receive such notice, you shall
any loss arising from any delay in be fully protected in honoring any
preparing or failure to prepare any such debit. I further agree that if
such debit. If I change banks or any such debit be dishonored,
desire to terminate or suspend this whether with or without cause and
program, I agree to notify you whether intentionally or
promptly in writing. I hereby inadvertently, you shall be under no
authorize you to take any action to liability.
correct erroneous ACH debits of my
bank account or purchases of Fund ............ .....................
shares including liquidating shares Date Signature of
of the Fund and crediting my bank Depositor
account. I further agree that if a
debit is not honored upon ............ .....................
presentation, Merrill Lynch Financial Bank Signature of Depositor
Data Services, Inc. is authorized to Account (If joint account,
discontinue immediately the Automatic Number both must sign)
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)
NOTE: IF AUTOMATIC INVESTMENT PLAN IS ELECTED, YOUR BLANK, UNSIGNED CHECK
MARKED "VOID" SHOULD ACCOMPANY THIS APPLICATION.
46
<PAGE>
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>
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.................. 16
Financial Futures Transactions and Options................................ 17
Repurchase Agreements..................................................... 19
Investment Restrictions................................................... 19
Management of the Trust.................................................... 20
Trustees.................................................................. 20
Management and Advisory Arrangements...................................... 20
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 #10327-1197
[LOGO] MERRILL LYNCH
Merrill Lynch
California Municipal
Bond Fund
Merrill Lynch California
Municipal Series Trust
[Art]
PROSPECTUS
November 26, 1997
Distributor:
Merrill Lynch
Funds Distributor, Inc.
This prospectus should be retained for future reference.
<PAGE>
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 U.S. 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 PricingSM 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 PricingSM 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 November
26, 1997 (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 November 26, 1997.
<PAGE>
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 U.S. 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 to the issuer, 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
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
2
<PAGE>
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 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.
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
3
<PAGE>
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 trading
market for high yield securities does exist, it generally is not as liquid as
the secondary market for higher rated securities.
4
<PAGE>
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 to the issuer, 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 also 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 against
the land (such as by foreclosure) and not against the individual property
owner, which could be time-consuming and costly.
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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
entity 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
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.
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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 VRDOs 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 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
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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.
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
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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
"marking to 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 ("CBT") and The Bond Buyer
(the "Municipal Bond Index"). The Municipal Bond Index is comprised of 40 tax-
exempt municipal revenue bonds and general obligation bonds. Each bond
included in the Municipal Bond Index must be rated A or higher by Moody's or
Standard & Poor's and must have a remaining maturity of 19 years or more.
Twice a month new issues satisfying the eligibility requirements are added to,
and an equal number of old issues are deleted from, the Municipal Bond Index.
The value of the Municipal Bond Index is computed daily according to a formula
based on the price of each bond in the Municipal Bond Index, as evaluated by
six dealer-to-dealer brokers.
The Municipal Bond Index financial futures contract is traded only on the
CBT. Like other contract markets, the CBT assures performance under financial
futures contracts through a clearing corporation, a non-profit organization
managed by the exchange membership which is also responsible for handling
daily accounting of deposits or withdrawals of margin.
As described in the Prospectus, the Fund may purchase and sell financial
futures contracts on U.S. Government securities as a hedge against adverse
changes in interest rates as described below. With respect to
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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 that 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 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.
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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 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
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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. 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.
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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. 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.
2. Make investments for the purpose of exercising control or management.
3. 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.
4. Make loans to other persons, except that the acquisition of bonds,
debentures or other corporate debt securities and investment in government
obligations, commercial paper, pass-through instruments, certificates of
deposit, bankers' acceptances, repurchase agreements or any similar
instruments shall not be deemed to be the making of a loan, and except
further that the Fund may lend its portfolio securities, provided that the
lending of portfolio securities may be made only in accordance with
applicable law and the guidelines set forth in the Fund's Prospectus and
Statement of Additional Information, as they may be amended from time to
time.
5. Issue senior securities to the extent such issuance would violate
applicable law.
6. 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
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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.
7. 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.
8. 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. As a matter of
policy, however, the Fund will not purchase shares of any registered open-
end investment company or registered unit investment trust, in reliance on
Section 12(d)(1)(F) or (G) (the "fund of funds" provisions) of the 1940
Act, at any time the Fund's shares are owned by another investment company
that is part of the same group of investment companies as the Fund.
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 (6) 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 (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
14
<PAGE>
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 of the Trust and the
portfolio manager of the Fund, 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 (65) -- President and Trustee(1)(2) -- President of the
Manager (which term, as used herein, includes its corporate predecessors)
since 1977; President of Merrill Lynch Asset Management, L.P. ("MLAM," which
term, as used herein, includes its 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.
James H. Bodurtha (53) -- 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 (58) -- 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; President, Hudson Institute since
1997 and Trustee since 1980; Dean, Gallatin Division of New York University
from 1976 to 1993; Distinguished Fellow, Herman Kahn Chair, Hudson Institute
from 1984 to 1985; Director, Damon Corporation from 1991 to 1995; Overseer,
Center for Naval Analyses from 1983 to 1993; Limited Partner, Hypertech LP in
1996.
Robert R. Martin (70) -- 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 (68) -- 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 (45) -- Trustee(2) -- Morgan Hall, Soldiers Field, Boston,
Massachusetts 02163. Professor, Harvard Business School since 1989 and
Associate Professor from 1983 to 1989; Trustee, The Common Fund since 1989;
Director, Quantec Limited since 1991 and TIBCO from 1994 to 1996.
15
<PAGE>
Terry K. Glenn (57) -- 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 Merrill Lynch Funds
Distributor, Inc. ("MLFD" or the "Distributor") since 1986 and Director
thereof since 1991; President of Princeton Administrators, L.P. since 1988.
Vincent R. Giordano (53) -- Senior Vice President(1)(2) -- 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 (46) -- Vice President(1)(2) -- First Vice President of
MLAM since 1997; Vice President of MLAM from 1984 to 1997; Vice President of
the Manager since 1984.
Walter O'Connor (36) -- Vice President and Portfolio Manager of the
Fund(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 (37) -- Vice President(1)(2) -- First Vice President of MLAM
since 1997; Vice President of MLAM from 1990 to 1997; Director of Taxation of
MLAM since 1990.
Gerald M. Richard (48) -- 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.
Robert E. Putney, III (37) -- Secretary(1)(2) -- Director (Legal Advisory)
of MLAM since 1997; Vice President of MLAM from 1994 to 1997; Attorney
employed by MLAM from 1991 to 1994; Attorney in private practice prior
thereto.
- --------
(1) Interested person, as defined in the 1940 Act, of the Trust.
(2) Such Trustee or officer is a director, trustee or officer of certain other
investment companies for which the Manager or MLAM acts as investment
adviser or manager.
At October 31, 1997, the Trustees and officers of the Trust as a group (13
persons) owned an aggregate of less than 1.0% of the outstanding shares of the
Fund. At such date, Mr. Zeikel, a Trustee and officer of the Trust, and the
other officers of the Trust owned an aggregate of less than 1.0% of the
outstanding shares of Common Stock of ML & Co.
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, 1997, fees and expenses paid to non-
affiliated Trustees that were allocated to the Fund aggregated $39,267.
The following table sets forth for the fiscal year ended August 31, 1997,
compensation paid by the Fund to the non-affiliated Trustees and, for the
calendar year ended December 31, 1996, the aggregate compensation paid
16
<PAGE>
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 TRUST AND OTHER
BENEFITS FAM/MLAM
ACCRUED AS ADVISED FUNDS
COMPENSATION PART OF TRUST'S PAID TO
NAME OF TRUSTEE FROM FUND EXPENSE TRUSTEE(1)
- --------------- ------------ --------------- --------------------
<S> <C> <C> <C>
James H. Bodurtha............. $7,817 None $148,500
Herbert I. London............. $7,817 None $148,500
Robert R. Martin.............. $7,817 None $148,500
Joseph L. May................. $7,817 None $148,000
Andre F. Perold............... $7,817 None $148,000
</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).
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 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, 1995, 1996 and 1997, the
total advisory fees paid by the Fund to the Manager aggregated $3,828,093,
$3,611,875 and $3,422,246, respectively.
17
<PAGE>
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 Merrill Lynch Funds Distributor, Inc. ("MLFD" or 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 that 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, 1995, 1996 and 1997, the Fund reimbursed the
Manager $64,518, $118,709 and $64,769, 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 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.
18
<PAGE>
The Fund issues four classes of shares under the Merrill Lynch Select
PricingSM 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
(except that Class B shareholders may vote upon any material changes to
expenses charged under the Class D Distribution Plan). Each class has
different exchange privileges. See "Shareholder Services--Exchange Privilege."
The Merrill Lynch Select PricingSM 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 that utilize the Merrill Lynch Select PricingSM
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, 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 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 A shares for the fiscal year ended
August 31, 1997 were $11,680 of which the Distributor received $1,003 and
Merrill Lynch received $10,677. For the fiscal years ended August 31, 1995,
1996 and 1997 the Distributor received no contingent deferred sales charges
("CDSCs") with respect to redemptions within one year after purchase of Class
A shares purchased subject to a front-end sales charge waiver. 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 $28,248. The gross sales charges for the sale of Class D shares
for the fiscal year ended August 31, 1997 were $50,567, of which the
Distributor received $4,949 and Merrill Lynch received $45,618. For the period
October 21, 1994 (commencement of operations) to August 31, 1995 and for the
fiscal years ended August 31, 1996 and 1997, 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.
19
<PAGE>
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 that 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, the
date the Merrill Lynch Select PricingSM System commenced operations, and wish
to reinvest the net proceeds from 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 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.
20
<PAGE>
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) 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(SM) Accounts. Provided applicable threshold requirements are
met, either Class A or Class D shares are offered at net asset value to
Employee Access(SM) Accounts available through authorized employers. 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.
21
<PAGE>
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 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 that might
result from an acquisition of assets having net unrealized appreciation that
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 that (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, that are not restricted as to transfer either by law or
liquidity of market (except that the Fund may
22
<PAGE>
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 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
23
<PAGE>
acquire 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, 1997
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, 1997
--------------------------------------------------------------------------------------
ANNUAL
ALLOWABLE AMOUNTS DISTRIBUTION
ELIGIBLE AGGREGATE INTEREST MAXIMUM PREVIOUSLY AGGREGATE FEE AT CURRENT
GROSS SALES ON UNPAID AMOUNT PAID TO UNPAID NET ASSET
SALES(1) CHARGES BALANCE(2) PAYABLE DISTRIBUTOR(3) BALANCE LEVEL(4)
---------- --------- ---------- -------------- -------------- --------- --------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
CLASS B SHARES FOR THE
PERIOD SEPTEMBER 30,
1985 (COMMENCEMENT OF
OPERATIONS) TO AUGUST
31, 1997:
Under NASD Rule as
Adopted................ $1,452,737 $90,796 $88,895 $179,691 $32,069 $147,622 $940
Under Distributor's
Voluntary Waiver....... $1,452,737 $90,796 $ 7,264 $ 98,060 $32,069 $ 65,991 $940
CLASS C SHARES FOR THE
PERIOD OCTOBER 21, 1994
(COMMENCEMENT OF
OPERATIONS) TO AUGUST
31, 1997:
Under NASD Rule as
Adopted................ $ 14,382 $ 899 $ 110 $ 1,009 $ 70 $ 939 $ 38
</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. See
"Purchase of Shares--Distribution Plans" in the Prospectus. This figure
may include CDSCs that were deferred when a shareholder redeemed shares
prior to the expiration of the applicable CDSC period and invested the
proceeds, without the imposition of a sales charge, in Class A shares in
conjunction with the shareholder's participation in the Merrill Lynch
Mutual Fund Adviser (Merrill Lynch MFA(TM)) Program (the "MFA Program").
The CDSC is booked as a contingent obligation that may be payable if the
shareholder terminates participation in the MFA Program.
(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.
24
<PAGE>
The right to redeem shares or to receive payment with respect to any such
redemption may be suspended for more than seven days only for any period
during which trading on the 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.
The value of shares at the time of the redemption may be more or less than
the shareholder's cost, depending in part on the market value of the
securities held by the Fund at such time.
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 in
certain circumstances including 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, 1995, 1996 and 1997 the Distributor received CDSCs of $866,830,
$427,650 and $307,864, respectively, with respect to redemptions of Class B
shares, all of which were paid to Merrill Lynch. Additional CDSCs payable to
the Distributor during the fiscal year ended August 31, 1997, may have been
waived or converted to a contingent obligation in connection with a
shareholder's participation in certain fee-based programs. For the fiscal
period October 21, 1994 (commencement of operations) to August 31, 1995, and
for the fiscal years ended August 31, 1996 and 1997 the Distributor received
CDSCs of $3,844, $4,398 and $5,077, 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 ("OTC") 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. For 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. For the
fiscal year ended August 31, 1997, the Fund engaged in four transactions
pursuant to such order for an aggregate market value of approximately $23.3
million. Affiliated persons of the Trust may serve as its broker in OTC
transactions conducted on an agency basis. Certain court decisions have raised
questions as to the extent to which investment
25
<PAGE>
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.
The Fund may not purchase securities, including Municipal Bonds, during the
existence of any underwriting syndicate of which Merrill Lynch is a member or
in a private placement in which Merrill Lynch serves as placement agent except
pursuant to procedures approved by the Trustees of the Trust which either
comply with rules adopted by the Commission or with interpretations of the
Commission Staff. Rule 10f-3 under the 1940 Act sets forth conditions under
which the Fund may purchase municipal bonds from an underwriting syndicate of
which Merrill Lynch is a member. 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.
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. As a result of the investment policies
described in the Prospectus, the Fund's annual portfolio turnover rate may be
higher than that of other investment companies, under normal circumstances.
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, 1996 and
1997 were 53.79% and 73.60%, 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 that
they manage unless the member (i) has obtained prior express authorization
from the account to effect such transactions, (ii) at least annually furnishes
the account with a statement setting forth the aggregate compensation received
by the member in effecting such transactions, and (iii) complies with any
rules the Commission has prescribed with respect to the requirements of
clauses (i) and (ii). To the extent Section 11(a) would apply to Merrill Lynch
acting as a broker for the Fund in any of its portfolio transactions executed
on any such securities exchange of which it is a member, appropriate consents
have been obtained from the Fund and annual statements as to aggregate
compensation will be provided to the Fund.
26
<PAGE>
DETERMINATION OF NET ASSET VALUE
Reference is made to "Additional Information--Determination of Net Asset
Value" in the Prospectus for information concerning the 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, Martin Luther King, Jr. 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 (including
interest and dividends accrued but not yet received) minus all liabilities
(including accrued expenses) 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 OTC municipal bond and money markets and are valued at
the last available bid price in the OTC 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>
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
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 their income dividends or
capital gains distributions, or both, in cash, in which event payment will be
mailed on or about the payment date.
28
<PAGE>
Shareholders may, at any time, notify Merrill Lynch in writing if their
account is maintained with Merrill Lynch or notify the Transfer Agent in
writing or by telephone (1-800-MER-FUND) if their account is maintained with
the Transfer Agent, 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
A shareholder may elect to make systematic withdrawals from an Investment
Account of Class A, Class B, Class C or Class D shares on either a monthly or
quarterly basis as provided below. Quarterly withdrawals are available for
shareholders who have acquired 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 shares having a value of $10,000 or more.
At the time of each withdrawal payment, sufficient 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 the dollar
amount and class of shares to be redeemed. 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 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 shares in
the Investment Account are reinvested automatically in Fund shares. 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.
With respect to redemptions of Class B and Class C shares pursuant to a
systematic withdrawal plan, the maximum number of Class B or Class C shares
that can be redeemed from an account annually shall not exceed 10% of the
value of shares of such Class in that account at the time the election to join
the systematic withdrawal plan was made. Any CDSC that otherwise might be due
on such redemption of Class B or Class C shares will be waived. Shares
redeemed pursuant to a systematic withdrawal plan will be redeemed in the same
order as Class B or Class C shares are otherwise redeemed. See "Purchase of
Shares--Deferred Sales Charge Alternatives--Class B and Class C Shares--
Contingent Deferred Sales Charges--Class B Shares" and "--Contingent Deferred
Sales Charges--Class C Shares" in the Prospectus. Where the systematic
withdrawal plan is applied to Class B shares, upon conversion of the last
Class B shares in an account to Class D shares, the systematic withdrawal plan
will automatically be applied thereafter to Class D shares. See "Purchase of
Shares--Deferred Sales Charge Alternatives--Class B and C Shares--Conversion
of Class B Shares to Class D Shares" in the Prospectus; if an investor wishes
to change the amount being withdrawn in a systematic withdrawal plan the
investor should contact his or her Financial Consultant.
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 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 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
29
<PAGE>
investments may not be made into an Investment Account in which the
shareholder has elected to make systematic withdrawals.
Alternatively, a 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 $50. The proceeds of
systematic redemptions will be posted to the shareholder's account three
business days after the date the shares are redeemed. All redemptions are made
at net asset value. A shareholder may elect to have his or her shares redeemed
on the first, second, third or fourth Monday of each month, in the case of
monthly redemptions, or of every other month, in the case of bimonthly
redemptions. For quarterly, semiannual or annual redemptions, the shareholder
may select the month in which the shares are to be redeemed and may designate
whether the redemption is to be made on the first, second, third or fourth
Monday of the month. If the Monday selected is not a business day, the
redemption will be processed at net asset value on the next business day. The
CMA(R) or CBA(R) Systematic Redemption 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 Financial Consultant.
EXCHANGE PRIVILEGE
U.S. 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 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. 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 at least 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
30
<PAGE>
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 with a reduced or without a
sales charge.
In addition, each of the funds with Class B and Class C shares outstanding
("outstanding Class B or Class C shares") offers to exchange its outstanding
Class B or Class C shares for Class B or Class C shares, respectively, 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
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 that 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
31
<PAGE>
of such redemption the shareholder exchanged such shares for Class B shares of
a fund that 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 MLAM-advised funds
with shares for which certificates have not been issued, may exercise the
exchange privilege by wire through their securities dealers. The Fund reserves
the right to require a properly completed Exchange Application. This exchange
privilege may be modified or terminated in accordance with the rules of the
Commission. The Fund reserves the right to limit the number of times an
investor may exercise the exchange privilege. Certain funds may suspend the
continuous offering of their shares to the general public at any time and may
thereafter resume such offering from time to time. The exchange privilege is
available only to U.S. shareholders in states where the exchange legally may
be made.
DISTRIBUTIONS AND TAXES
The Trust intends to continue to qualify the Fund for the special tax
treatment afforded regulated investment companies ("RICs") under the Code. As
long as 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 that 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
32
<PAGE>
this purpose, the Fund will allocate interest from tax-exempt obligations (as
well as ordinary income, capital gains, including new categories of 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 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
advisors 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 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 that constitutes exempt-interest dividends and the portion that
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 of the Fund,
including exempt-interest dividends, may be subject to the California state
franchise tax if received by a corporation subject to such tax, and may be
subject to state taxes in states other than California and to local taxes in
other states. 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 that are taxed at ordinary income tax rates.
Recent legislation creates additional categories of capital gains taxable at
different rates. Not later than 60 days after the close of its taxable year,
the Fund will provide its shareholders with a written notice designating the
amounts of
33
<PAGE>
any exempt-interest dividends, ordinary income dividends or capital gain
dividends, as well as the amount of capital gain dividends in the different
categories of capital gain referred to above. 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 such dividend will be treated for tax purposes as
being paid by the Fund and received by its shareholders on December 31 of the
year in which such dividend was declared.
The Code subjects interest received on certain otherwise tax-exempt
securities to an alternative minimum tax. The alternative minimum tax applies
to interest received on "private activity bonds" issued after August 7, 1986.
Private activity bonds are bonds which, although tax-exempt, are used for
purposes other than those generally performed by governmental units 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.
34
<PAGE>
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.
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"). 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.
TAX TREATMENT OF OPTIONS AND FUTURES 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.
35
<PAGE>
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 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>
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 CLASS C SHARES CLASS D SHARES
-------------------------- -------------------------- -------------------------- --------------------------
REDEEMABLE REDEEMABLE REDEEMABLE REDEEMABLE
EXPRESSED AS VALUE OF A EXPRESSED AS VALUE OF A EXPRESSED AS VALUE OF A EXPRESSED AS VALUE OF A
A PERCENTAGE HYPOTHETICAL A PERCENTAGE HYPOTHETICAL A PERCENTAGE HYPOTHETICAL A PERCENTAGE HYPOTHETICAL
BASED ON A $1,000 BASED ON A $1,000 BASED ON A $1,000 BASED ON A $1,000
HYPOTHETICAL INVESTMENT HYPOTHETICAL INVESTMENT HYPOTHETICAL INVESTMENT HYPOTHETICAL INVESTMENT
$1,000 AT THE END OF $1,000 AT THE END OF $1,000 AT THE END OF $1,000 AT THE END OF
INVESTMENT THE PERIOD INVESTMENT THE PERIOD INVESTMENT THE PERIOD INVESTMENT THE PERIOD
------------ ------------- ------------ ------------- ------------ ------------- ------------ ------------- ---
AVERAGE ANNUAL TOTAL RETURN
(including maximum applicable sales charges)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
One Year Ended
August 31,
1997............ 4.21% $1,042.10 4.09% $1,040.90 6.98% $1,069.80 4.19% $1,041.90
Five Years Ended
August 31,
1997............ 5.85% $1,328.90 6.19% $1,350.40 -- -- -- --
Ten Years Ended
August 31,
1997............ -- -- 7.14% $1,992.60 -- -- -- --
Inception
(October 25,
1988) to August
31, 1997........ 7.15% $1,842.60 -- -- -- -- -- --
Inception
(October 21,
1994) to August
31, 1997........ -- -- -- -- 7.97% $1,245.30 6.98% $1,213.00
<CAPTION>
ANNUAL TOTAL RETURN
(excluding maximum applicable sales charges)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Year Ended August
31,
1997............ 8.55% $1,085.50 8.09% $1,080.90 7.98% $1,079.80 8.53% $1,085.30
1996............ 6.53% $1,065.30 5.99% $1,059.90 5.88% $1,058.80 6.43% $1,064.30
1995............ 6.75% $1,067.50 6.25% $1,062.50 -- -- -- --
Inception
(October 21,
1994) to August
31, 1995........ -- -- -- -- 8.91% $1,089.10 9.39% $1,093.90
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 -- -- -- --
Inception
(October 25,
1988) to August
31, 1989........ 7.96% $1,079.60 -- -- -- -- -- --
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 -- -- -- --
<CAPTION>
AGGREGATE TOTAL RETURN
(including maximum applicable sales charges)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Inception
(September 30,
1985) to August
31, 1997........ -- -- 149.18% $2,491.80 -- -- -- --
Inception
(October 25,
1988) to August
31, 1997........ 84.26% $1,842.60 -- -- -- -- -- --
Inception
(October 21,
1994) to August
31, 1997........ -- -- -- -- 24.53% $1,245.30 21.30% $1,213.00
<CAPTION>
YIELD
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
30 days ended on
August 31,
1997............ 4.26% -- 3.93% -- 3.82% -- 4.16% --
<CAPTION>
TAX-EQUIVALENT YIELD*
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
30 days ended on
August 31,
1997............ 5.92% -- 5.46% -- 5.30% -- 5.78% --
</TABLE>
- --------
* Based on a Federal income tax rate of 28%.
37
<PAGE>
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 may be 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 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 or
other 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, as appropriate, being borne solely by such
class. Each issued and outstanding share of a Series is entitled to one vote
and to participate equally in dividends and distributions with respect to that
Series and upon liquidation or dissolution of the Series, in the net assets of
such Series remaining after satisfaction of outstanding liabilities, except
that, as noted above, expenses relating to distribution and/or account
maintenance of the Class B, Class C and Class D shares are borne solely by the
respective 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
will be freely transferable. Holders of shares of any Series are entitled to
redeem their shares as set forth elsewhere herein and
38
<PAGE>
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, other than
amendments necessary to commence the Declaration to certain laws or
regulations, to change the name of the Trust, or to make certain non-material
changes, without the affirmative vote of a majority of the outstanding shares
of the Trust or of the affected Series or Class as applicable.
Under Massachusetts law, shareholders of a business trust may, under certain
circumstances, be held personally liable as partners for the trust's
obligations. However, the risk of a shareholder incurring financial loss on
account of shareholder liability is limited to circumstances in which both
inadequate insurance existed and the trust itself was unable to meet its
obligations.
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, 1997, is set
forth below.
<TABLE>
<CAPTION>
CLASS A CLASS B CLASS C CLASS D
----------- ------------ ----------- ------------
<S> <C> <C> <C> <C>
Net Assets................... $44,652,364 $376,018,231 $10,903,527 $185,300,250
=========== ============ =========== ============
Number of Shares
Outstanding................. 3,779,839 31,819,804 922,838 15,682,302
=========== ============ =========== ============
Net Asset Value Per Share
(net assets divided by
number of shares
outstanding)................ $ 11.81 $ 11.82 $ 11.82 $ 11.82
Sales Charge (for Class A and
Class D shares: 4.00% of
offering price; 4.17% of net
asset value per share)*..... .49 ** ** .49
----------- ------------ ----------- ------------
Offering Price............... $ 12.30 $ 11.82 $ 11.82 $ 12.31
=========== ============ =========== ============
</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 selection of
independent auditors is subject to approval by the independent Trustees of the
Trust. The independent auditors are responsible for auditing the annual
financial statements of the Fund.
39
<PAGE>
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.
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 October 31, 1997.
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APPENDIX I
ECONOMIC AND OTHER CONDITIONS IN CALIFORNIA
The following information is a brief summary of factors affecting the
economy of the State of California ("California" or the "State") and does not
purport to be a complete description of such factors. Other factors will
affect State 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
Fund has not independently verified the information.
GENERAL ECONOMIC CONDITIONS
The economy of the State of California is the largest among the 50 states
and one of the largest in the world and has major components in agriculture,
manufacturing, high technology, trade, entertainment, tourism, construction
and services. Total State gross domestic product is expected to exceed $1
trillion in 1997. On a stand-alone basis, California's economy is larger than
all but six nations in the world.
California's July 1, 1996 population of over 32 million represented over 12%
of the total United States population. As of July 1, 1990 the population of
29,944,000 represented an increase of over 6 million persons, or 26%, during
the decade of the 1980's.
California's population is concentrated in metropolitan areas. As of the
April 1, 1990 Census, 96% of the citizens resided in the 23 Metropolitan
Statistical Areas in the State. As of July 1, 1995, the 5-county Los Angeles
area accounted for 49%, with 15.7 million residents. The 10-county San
Francisco Bay Area represented 21% with a population of 6.7 million.
From 1990-1993, the State suffered through a severe recession, the worst
since the 1930's, heavily influenced by large cutbacks in defense/aerospace
industries and military base closures and by a major drop in real estate
construction. California's economy has been recovering and growing steadily
since the start of 1994; currently the State's economic growth is outpacing
the rest of the nation. More than 300,000 nonfarm jobs were added in the State
in 1996, while personal income grew by more than $55 billion. Another 380,000
jobs are expected to be created in 1997. The unemployment rate, while still
higher than the national average, fell to the low 6% range in mid-1997,
compared to over 10% at the worst of the recession.
California's economic expansion is being fueled by growth in high-technology
industries, including computer software, electronics manufacturing and motion
picture/television production; growth is also strong in business services,
export trade, and manufacturing, with even the aerospace sector now showing
increased employment. The State's economy is now more diversified than it was
during the 1980's. Nonresidential real estate construction has grown rapidly
in response to the growth in the economy. Residential construction has been
growing slowly since the depths of the recession, but remains much lower (as
measured by annual new unit permits) than the late 1980's.
THE STATE
Fiscal Years Prior to 1995-96. The State's budget problems in recent years
were caused by a combination of external economic conditions and a structural
imbalance in that the largest general fund programs--K-14 education, health,
welfare and corrections--were increasing faster than the revenue base, driven
by the State's rapid population growth. These pressures are expected to
continue as population trends maintain strong demand
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for health and welfare services, as the school age population continues to
grow, and as the State's corrections program responds to a "Three Strikes" law
enacted in 1994, which requires mandatory life prison terms for certain third-
time felony offenders.
As a result of these factors and others, and especially because a severe
recession between 1990-94 reduced revenues and increased expenditures for
social welfare programs, from the late 1980's until 1992-93, the State had a
period of budget imbalance. During this period, expenditures exceeded revenues
in four out of six years, and the State accumulated and sustained a budget
deficit in its budget reserve, the Special Fund for Economic Uncertainties
("SFEU") approaching $2.8 billion at its peak at June 30, 1993. Starting in
the 1990-91 Fiscal Year and for each fiscal year thereafter, each budget
required multibillion dollar actions to bring projected revenues and
expenditures into balance. The State Legislature and Governor agreed on the
following principal steps to produce Budget Acts in the years 1991-92 to 1994-
95, although not all these actions were taken in each year.
. significant cuts in health and welfare program expenditures;
. transfers of program responsibilities and funding from the State to
local governments (referred to as "realignment"), coupled with some
reduction in mandates on local government;
. transfer of about $3.6 billion in local property tax revenues from
cities, counties, redevelopment agencies and some other districts to
local school districts, thereby reducing State funding for schools under
Proposition 98 (discussed below);
. reduction in growth of support for higher education programs, coupled
with increases in student fees, through the 1994-95 Fiscal Year;
. maintenance of the minimum Proposition 98 funding guarantee for K-14
schools, and the disbursement of additional funds to keep a constant
level of about $4,200 per K-12 pupils through the 1993-94 Fiscal Year;
. revenue increases (particularly in the 1991-92 Fiscal Year budget), most
of which were for a short duration;
. increased reliance on aid from the federal government to offset the
costs of incarcerating, educating and providing health and welfare
services to illegal immigrants, although during this time frame, most of
the additional aid requested by the Administration was not received; and
. various one-time adjustments and accounting changes.
Despite these budget actions, as noted, 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, again using the cross-fiscal
year revenue anticipation warrants to partly finance the deficit into the
1995-96 fiscal year.
Another consequence of the accumulated budget deficits, together with other
factors such as disbursement of funds to local school districts "borrowed"
from future fiscal years and hence not shown in the annual budget, was to
significantly reduce the State's cash resources available to pay its ongoing
obligations. When the Legislature and the Governor failed to adopt a budget
for the 1992-93 Fiscal Year by July 1, 1992, which would
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have allowed the State to carry out its normal annual cash flow borrowing to
replenish its cash reserves, the State Controller issued registered warrants
to pay a variety of obligations representing prior years' or continuing
appropriations, and mandates from court order. Available funds were used to
make constitutionally-mandated payments, such as debt service on bonds and
warrants. Between July 1 and September 4, 1992, when the budget was adopted,
the State Controller issued a total of approximately $3.8 billion of
registered warrants.
During the past several fiscal years, the State was forced to rely
increasingly on external debt markets to meet its cash needs, as a succession
of notes and revenue anticipation warrants were issued in the period from June
1992 to July 1994, often needed to pay previously maturing notes or warrants.
These borrowings were used also in part to spread out the repayment of the
accumulated budget deficit over the end of a fiscal year, as noted earlier.
The last and largest of these borrowings was $4.0 billion of revenue
anticipation warrants which were issued in July 1994 and matured on April 25,
1996.
1995-96 Fiscal Year. The 1995-96 Budget Act was signed by the Governor on
August 3, 1995, 34 days after the start of the fiscal year. The Budget Act
projected general fund revenues and transfers of $44.1 billion, a 3.5%
increase from the prior year. Expenditures were budgeted at $43.4 billion, a 4
percent increase. The Budget Act also projected Special Fund revenues of $12.7
billion and appropriated Special Fund expenditures of $13.0 billion.
Final data for the 1995-96 Fiscal Year showed revenues and transfers of
$46.1 billion, some $2 billion over the original fiscal year estimate, which
was attributed to the strong economic recovery. Expenditures also increased,
to an estimated $45.4 billion, as a result of the requirement to expend
revenues for schools under Proposition 98, and, among other things, failure of
the federal government to enact welfare reform during the fiscal year and to
budget new aid for illegal immigrant costs, both of which had been counted on
to allow reductions in State costs. SFEU had a small negative balance of about
$87 million at June 30, 1996, all but eliminating the accumulated budget
deficit from the early 1990's. Available internal borrowable resources
(available cash, after payment of all obligations due) on June 30, 1996 was
about $3.8 billion, representing a significant improvement in the State's cash
position, and ending the need for deficit borrowing over the end of the fiscal
year. The State's improved cash position allowed it to repay the $4.0 billion
Revenue Anticipation Warrant issue on April 25, 1996, and to issue only $2.0
billion of revenue anticipation notes during the fiscal year, which matured on
June 28, 1996.
The 1995-96 Budget Act included substantial additional funding under
Proposition 98 for schools and community colleges (about $1.0 billion general
fund and $1.2 billion total above 1994-95 levels). Because of higher than
projected revenues in 1994-95, an additional $561 million ($92 per K-12 pupil
(also called per ADA, or average daily attendance)) was appropriated to the
1994-95 Proposition 98 entitlement. A large part of this was a block grant of
about $50 per pupil for any one-time purpose. For the first time in several
years, a full 2.7 percent cost of living allowance was funded. The budget was
based on the settlement of the CTA v. Gould litigation. Cuts in health and
welfare costs totaled about $220 million, almost $700 million less than had
been anticipated, because of the failure by the federal government to approve
certain of these actions in a timely manner. The federal government also
failed to appropriate all but $31 million of an anticipated $500 million in
new federal aid for incarceration and health care costs of illegal immigrants.
Funding from the general fund for the University of California was increased
by $106 million and for the California State University system by $97 million,
with no increase in student fees.
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1996-97 Fiscal Year. The 1996-97 Budget Act was signed by the Governor on
July 15, 1996, along with various implementing bills. The Governor vetoed
about $82 million of appropriations (both general fund and Special Fund). With
the signing of the Budget Act, the State implemented its regular cash flow
borrowing program with the issuance of $3.0 billion of Revenue Anticipation
Notes to mature on June 30, 1997. The Budget Act appropriated a modest budget
reserve in the SFEU of $305 million, as of June 30, 1997. The Department of
Finance projected that, on June 30, 1997, the State's available internal
borrowing (cash) resources will be $2.9 billion, after payment of all
obligations due by that date, so that no cross-fiscal year borrowing will be
needed.
Revenues. The Legislature rejected the Governor's proposed 15% cut in
personal income taxes (to be phased in over three years), but did approve a 5%
cut in bank and corporation taxes, to be effective for income years starting
on January 1, 1997. As a result, revenues for the Fiscal Year were estimated
to total $47.643 billion, a 3.3% increase over the final estimated 1995-96
revenues. Special Fund revenues were estimated to be $13.3 billion.
Expenditures. The Budget Act contained general fund appropriations totaling
$47.251 billion, a 4.0% increase over the final estimated 1995-96
expenditures. Special Fund expenditures were budgeted at $12.6 billion.
The following are principal features of the 1996-97 Budget Act:
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%) was funded.
The Proposition 98 increases have brought K-12 expenditures to almost
$4,800 per ADA, 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 were allocated to each school site.
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.
A 4.9% 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.
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 projections,
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the State Department of Finance expects $540 million of this amount to be
received during the 1996-97 fiscal year.)
General fund support for the State Department of Corrections was
increased by about 7% over the prior year, reflecting estimates of
increased prison population.
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.
Subsequent Events. On January 9, 1997, the Governor released his proposed
budget for the 1997-98 Fiscal Year (the "Proposed Budget"). The Proposed
Budget estimated general fund revenues and transfers in 1997-98 of $50.7
billion, a 4.6% increase from revised 1996-97 figures. The Governor proposes
expenditures of $50.3 billion, a 3.9% increase from 1996-97. The Proposed
Budget projected a balance in the SFEU of $553 million on June 30, 1998.
At the time of the May Revision, released on May 14, 1997, the Department of
Finance increased its revenue estimate for the upcoming fiscal year by $1.3
billion, in response to the continued strong growth in the State's economy.
Budget negotiations continued into the summer, with major issues to be
resolved including final agreement on State welfare reform, increase in State
employee salaries and consideration of a tax cut proposed by the Governor.
In May 1997, action was taken by the California Supreme Court in an ongoing
lawsuit, PERS v. Wilson, which made final a judgment against the State
requiring an immediate payment from the General Fund to the Public Employees
Retirement Fund ("PERF") to make up certain deferrals in annual retirement
fund contributions which had been legislated in earlier years for budget
savings, and which the courts found to be unconstitutional. On July 30, 1997,
following a direction from the Governor, the Controller transferred $1.235
billion from the General Fund to the PERF in satisfaction of the judgment,
representing the principal amount of the improperly deferred payments from
1995-96 and 1996-97.
1997-98 Fiscal Year. Once the pension payment eliminated essentially all the
"increased" revenue in the budget, final agreement was reached within a few
weeks on the welfare package and the remainder of the budget. The Legislature
passed the Budget Bill on August 11, 1997, along with numerous related bills
to implement its provisions. Agreement was not finally reached, however, on
one aspect of the budget plan, concerning the Governor's proposal for a
comprehensive educational testing program.
On August 18, 1997, the Governor signed the Budget Act, but vetoed about
$314 million of specific spending items, primarily in health and welfare and
education areas from both the General Fund and Special Funds. The Governor
announced that he was prepared to restore about $200 million of education
spending upon satisfactory completion of legislation on the education testing
program.
The Budget Act anticipates General Fund revenues and transfers of $52.5
billion (a 6.8 percent increase over the final 1996-97 amount), and
expenditures of $52.8 billion (an 8.0 percent increase from the 1996-97
levels). On a budgetary basis, the budget reserve (SFEU) is projected to
decrease from $408 million at June 30, 1997 to $112 million at June 30, 1998.
(The expenditure figure assumes restoration of $200 million of vetoed
funding.) The Budget Act also includes Special Fund expenditures of $14.4
billion (as against estimated Special Fund revenues of $14.0 billion), and
$2.1 billion of expenditures from various Bond Funds. The State has
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implemented its normal annual cash flow borrowing program, issuing $3 billion
of notes which mature on June 30, 1998.
The following are major features of the 1997-98 Budget Act:
1. For the second year in a row, the Budget contains a large increase in
funding for K-14 education under Proposition 98, reflecting strong revenues
which have exceeded initial budgeted amounts. Part of the nearly $1.75
billion in increased spending is allocated to prior fiscal years. Funds are
provided to fully pay for the cost-of-living increase component of
Proposition 98, and to extend class size reduction and reading initiatives.
2. The Budget Act reflects the $1.235 billion pension case judgment
payment, and brings funding of the State's pension contribution back to the
quarterly basis which existed prior to the deferral actions which were
invalidated by the courts. There is no provision for any additional
payments relating to this court case.
3. Continuing the third year of a four-year "compact" which the
Administration has made with higher education units, funding from the
General Fund for the University of California and California State
University has increased by about 6 percent ($121 million and $107 million,
respectively), and there was no increase in student fees.
4. Because of the effect of the pension payment, most other State
programs were continued at 1996-97 levels.
5. Health and welfare costs are contained, continuing generally the grant
levels from prior years, as part of the initial implementation of the new
CalWORKs program.
6. Unlike prior years, this Budget Act does not depend on federal budget
actions. About $300 million in federal funds, already included in the
federal FY 1997 and 1998 budgets, are included in the Budget Act, to offset
incarceration costs for illegal aliens.
7. The Budget Act contains no tax increases, and no tax reductions. The
Renters Tax Credit was suspended for another year, saving approximately
$500 million.
Federal Welfare Reform. Congress passed and the President signed (on August
22, 1996) the Personal Responsibility and Work Opportunity Act of 1996 (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.
As part of the 1997-98 Budget Act legislative package, the State Legislature
and Governor agreed on a comprehensive reform of the State's public assistance
programs to implement the new federal Law. The new basic State welfare program
is called California Work Opportunity and Responsibility to Kids Act
("CalWORKs"), which replaces the former Aid to Families with Dependent
Children (AFDC) and Greater Avenues to Independence (GAIN) programs effective
January 1, 1998. Consistent with the federal Law, CalWORKs contains new time
limits on receipt of welfare aid, both lifetime as well as for any current
time on aid. The centerpiece of CalWORKs is the linkage of eligibility to work
participation requirements.
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Administration of the new Welfare-to-Work programs will be largely at the
county level, and counties are given financial incentives for success in this
program.
Although the longer-term impact of the new federal Law and CalWORKs cannot
be determined until there has been some experience, the State does not
presently anticipate that these new programs will have any adverse financial
impact on the General Fund. Overall TANF grants from the federal government
are expected to equal or exceed the amounts the State would have received
under the old AFDC program.
LOCAL GOVERNMENTS
The primary units of local government in California are the counties,
ranging in population from 1,300 (Alpine) to over 9,000,000 (Los Angeles).
Counties are responsible for the provision of many basic services, including
indigent healthcare, welfare, courts, jails and public safety in
unincorporated areas. There are also about 480 incorporated cities and
thousands of other special districts formed for education, utility and other
services. The fiscal condition of local governments has been constrained since
the enactment of "Proposition 13" in 1978, which reduced and limited the
future growth of property taxes and limited the ability of local governments
to impose "special taxes" (those devoted to a specific purpose) without two-
thirds voter approval.
Counties, in particular, have had fewer options to raise revenues than many
other local government entities, and have been required to maintain many
services. The entire statewide welfare system has been changed in response to
the change in federal welfare law enacted in 1996 (see "Welfare Reform"
above). Under the CalWORKs program, counties are given flexibility to develop
their own plans, consistent with State law, to implement Welfare-to-Work and
to administer many of its elements. Counties are also given financial
incentives if, at the individual county level or statewide, the CalWORKs
program produces savings associated with specified Welfare-to-Work outcomes;
counties may also suffer penalties for failing to meet federal standards.
Under CalWORKs, counties will still be required to provide "general
assistance" aid to certain persons who cannot obtain welfare from other
programs. It is yet not known how the CalWORKs system will affect county
finances in the long run.
In the aftermath of Proposition 13, the State provided aid from the General
Fund to make up some of the loss of property tax moneys, including taking over
the principal responsibility for funding local K-12 schools and community
colleges. Under the pressure of the recent recession, the Legislature has
eliminated the remnants of this post-Proposition 13 aid to entities other than
K-14 education districts, although it has also provided additional funding
sources (such as sales taxes) and reduced mandates for local services. Many
counties continue to be under severe fiscal stress. While such stress has in
recent years most often been experienced by smaller, rural counties, larger
urban counties, such as Los Angeles, have also been affected. Orange County
implemented significant reductions in services and personnel, and continues to
face fiscal constraints in the aftermath of its bankruptcy, which had been
caused at least in part by large investment losses in its pooled investment
funds.
On November 5, 1996, voters approved Proposition 218, entitled the "Right to
Vote on Taxes Act," which incorporates new Articles XIIIC and XIIID into the
California Constitution. These new provisions enact limitations on the ability
of local government agencies to impose or raise various taxes, fees, charges
and assessments without voter approval. Certain "general taxes" imposed after
January 1, 1995 must be approved by voters in order to remain in effect. In
addition, Article XIIIC clarifies the right of local voters to reduce taxes,
fees, assessments or charges through local initiatives.
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Proposition 218 does not affect the State or its ability to levy or collect
taxes. There are a number of ambiguities concerning the Proposition and its
impact on local governments and their bonded debt which will require
interpretation by the courts or the State Legislature. The State Legislative
Analyst estimated that enactment of Proposition 218 would reduce local
government revenues statewide by over $100 million a year, and that over time,
annual revenues to local government would be reduced by several hundred
million dollars.
In May 1996, a taxpayer filed an action (the "Rider Case") against the City
of San Diego ("San Diego") and the San Diego Convention Center Expansion
Authority (the "Authority") challenging the validity of a lease revenue
financing involving a lease having features similar to the leases commonly
used in California lease-based financings such as certificates of
participation. In the Rider Case, the plaintiffs maintain that voter approval
is required for the San Diego lease (a) since the lease constituted
indebtedness prohibited by Article XVI, Section 18 of the California
Constitution without a two-thirds vote of the electorate, and (b) since San
Diego was prohibited under its charter from issuing bonds without a two-thirds
vote of the electorate, and the power of the Authority, a joint powers'
authority, one of the members of which is San Diego, to issue bonds is no
greater than the power of San Diego. In response to San Diego's motion for
summary judgment, the trial court rejected the plaintiffs' arguments and ruled
that the lease was constitutionally valid and that the Authority's related
lease revenue bonds did not require voter approval. The plaintiffs appealed
the matter to the Court of Appeals for the Fourth District, which likewise
affirmed the validity of the lease and of the lease revenue bond financing
arrangements. The plaintiffs then filed a petition for review with the
California State Supreme Court, and, on April 2, 1997, the California Supreme
Court granted the plaintiffs' petition for review. No decision from the State
Supreme Court is expected until sometime during the 1998 calendar year.
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% 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%
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%) 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.
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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. 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. The settlement
of this case, finalized in July 1996, 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 an
appropriation 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.
Substantially increased general fund revenues, above initial budget
projections, in the 1994-95, 1995-96 and 1996-97 fiscal years have resulted or
will result in retroactive increases in Proposition 98 appropriations from
subsequent fiscal years' budgets.
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,
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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 stuck down the cental 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 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 involved in a lawsuit, Thomas Hayes v. Commission on State
Mandates, related to state-mandated costs. The action involves an appeal by
the Director of Finance from a 1984 decision by the State Board of Control
(now succeeded by the Commission on State Mandates ("Commission")). The Board
of Control decided in favor of local school districts' claims for
reimbursement for special education programs for handicapped students. The
case was then brought to the trial court by the State and later remanded to
the Commission for redetermination. The Commission has since expanded the
claim to include supplemental claims filed by seven other educational
institutions; the issuance of a final consolidated decision is anticipated
sometime in early 1997. To date, the Legislature has not appropriated funds.
The liability of the State, if all potentially eligible school districts
pursue timely claims, has been estimated by the Department of Finance at more
than $1 billion.
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The State is involved in a lawsuit related to contamination at the
Stringfellow toxic waste site. In United States, People of the State of
California v. J.B. Stringfellow, Jr., et al., the State is seeking recovery
for post costs of cleanup of the site, a declaration that the defendants are
jointly and severally liable for future costs, and an injunction ordering
completion of the cleanup. However, the defendants have filed a counterclaim
against the State for alleged negligent acts. Because the State is the present
owner of the site, the State may be found liable. Present estimates of the
cleanup range from $200 million to $800 million.
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. An appeal has been filed.
In Professional Engineers in California Government v. Wilson, the
petitioners are challenging several appropriations in the 1993, 1994, and 1995
Budget Acts. The appropriations mandate the transfer of approximately $262
million from the State Highway Account and $113 million from the Motor Vehicle
Account to the general fund and appropriate approximately $6 million from the
State Highway Account to fund a highway-grade crossing program administered by
the Public Utilities Commission. Petitioners contend that the transfers
violate several constitutional provisions and request that the moneys be
returned to the State Highway Account and Motor Vehicle Account.
The State is a defendant in Just Say No To Tobacco Dough Campaign v. State
of California, where the petitioners challenge the appropriation of
approximately $166 million of Proposition 99 funds in the Cigarette and
Tobacco Products Surtax Fund for years ended June 30, 1990, through June 30,
1995 for programs which were allegedly not health education or tobacco-related
disease research. If the State loses, the general fund and funds from other
sources would be used to reimburse the Cigarette and Tobacco Products Surtax
Fund for approximately $166 million.
The State is a defendant in the case of Kurt Hathaway, et al. v. Wilson, et
al., where the plaintiffs are challenging the legality of various budget
action transfers and appropriations from particular special funds for years
ended June 30, 1995, and June 30, 1996. The plaintiffs allege that the
transfers and appropriations are contrary to the substantive law establishing
the funds and providing for interest accruals to the funds, violate the single
subject requirement of the State Constitution, and is an invalid "special
law." Plaintiffs seek to have monies totaling approximately $335 million
returned to the special funds.
The State is a defendant in two related cases, Beno v. Sullivan ("Beno") and
Welch v. Anderson ("Welch"), concerning reductions in Aid to Families with
Dependent Children ("AFDC") grant payments. In the Beno case, plaintiffs seek
to invalidate AFDC grant reductions and in the Welch case, plaintiffs contend
that AFDC grant reductions are not authorized by state law. The Beno case
concerns the total grant reductions while the Welch case concerns the period
of time the State did not have a waiver for those reductions. The State's
potential liability for retroactive AFDC grant reductions is estimated at $831
million if the plaintiffs are awarded the full amount in both cases.
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
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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 contributions that were unpaid to date. On February 19, 1997, the State
Court of Appeals affirmed the decision of the Superior Court, and the Supreme
Court subsequently refused to hear the case, making the Court of Appeals'
ruling final. On July 30, 1997, the Controller transferred $1.235 billion from
the General Fund to PERS in repayment of the principal amount determined to
have been improperly deferred. Subsequent State payments to PERS will be made
on a quarterly basis. No prejudgment interest has been paid in accordance with
the trial court ruling that there was insufficient evidence that money for
that purpose had been appropriated and was available. No post-judgment
interest was ordered.
STATE GENERAL OBLIGATION BOND RATINGS
As of the date of this Statement of Additional Information, the State's
general obligation bonds are rated A1 by Moody's Investors Services, Inc., A+
by Standard & Poor's Ratings Services, and AA- by Fitch Investors Service,
Inc.
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APPENDIX II
RATINGS OF MUNICIPAL BONDS
DESCRIPTION OF MUNICIPAL BOND RATINGS OF MOODY'S INVESTORS SERVICE, INC.
("MOODY'S")
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.
Note: Those bonds in the Aa, A, Baa, Ba and B groups which Moody's believes
possess the strongest investment attributes are designated by the symbols Aa1,
A1, Baa1, Ba1 and B1.
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Short-term Notes: The four ratings of Moody's for short-term notes are MIG
1/VMIG1, MIG 2/VMIG2, MIG 3/VMIG3 and MIG 4/VMIG4; MIG 1/VMIG1 denotes "best
quality ... strong protection by established cash flows"; MIG 2/VMIG2 denotes
"high quality" with ample margins of protection; MIG 3/VMIG3 notes are of
"favorable quality ... but ... lacking the undeniable strength of the
preceding grades"; MIG 4/VMIG4 notes are of "adequate quality ... [p]rotection
commonly regarded as required of an investment security is present ... there
is specific risk."
DESCRIPTION OF MOODY'S 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 ability of
rated issuers:
Issuers rated Prime-1 (or supporting institutions) have a superior ability
for repayment of short-term promissory obligations. Prime-1 repayment ability
will often be evidenced by many of the following characteristics: leading
market positions in well-established industries; high rates of return on funds
employed; conservative capitalization structure 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 supporting institutions) have a strong ability 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, may 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 supporting institutions) have an acceptable
ability for repayment of short-term promissory obligations. The effect of
industry characteristics and market compositions may be more pronounced.
Variability in earnings and profitability may result in changes in the level
of debt protection measurements and may require 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 STANDARD & POOR'S RATINGS SERVICES ("STANDARD & POOR'S")
MUNICIPAL DEBT RATINGS
A Standard & Poor's municipal debt rating is a current opinion of the
creditworthiness of an obligor with respect to a specific financial
obligation, a specific class of financial obligations or a specific financial
program. It takes into consideration the creditworthiness of guarantors,
insurers, or other forms of credit enhancement on the obligation.
The debt rating is not a recommendation to purchase, sell or hold a
financial obligation, inasmuch as it does not comment as to market price or
suitability for a particular investor.
The ratings are based on current information furnished by the obligors or
obtained by Standard & Poor's from other sources it 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 based on other circumstances.
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The ratings are based, in varying degrees, on the following considerations:
I.Likelihood of payment--capacity and willingness of the obligor to meet
its financial commitment on an obligation in accordance with the terms of
the obligation;
II.Nature of and provisions of the obligation; and
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 meet its financial commitment on the obligation is extremely
strong.
AA Debt rated "AA" differs from the highest rated obligations only in small
degree. The obligor's capacity to meet its financial commitment on the
obligation is very strong.
A Debt rated "A" is somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than debt in higher-
rated categories. However, the obligor's capacity to meet its financial
commitment on the obligation is still strong.
BBB Debt rated "BBB" exhibits adequate protection parameters. However,
adverse economic conditions or changing circumstances are more likely to
lead to a weakened capacity of the obligor to meet its financial
commitment on the obligation.
BB B CCC CC C
Debt rated "BB," "B," "CCC," "CC" and "C" are regarded as having
significant speculative characteristics. "BB" indicates the least degree
of speculation and "C" the highest degree of speculation. While such
debt will likely have some quality and protective characteristics, these
may be outweighed by large uncertainties or major exposures to adverse
conditions.
D Debt rated "D" is in payment default. The "D" rating category is used
when payments on an obligation 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 or
the taking of a similar action payments on an obligation are
jeopardized.
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.
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"
for the highest quality obligations to "D" for the lowest. These categories
are as follows:
A-1
This designation indicates that the degree of safety regarding timely
payment is strong. Those issues determined to possess extremely strong
safety characteristics are denoted with a plus sign (+) designation.
A-2
Capacity for timely payment on issues with this designation is
satisfactory. However, the relative degree of safety is not as high as
for issues designated "A-1."
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A-3 Issues carrying this designation have an adequate capacity for timely
payment. They are, however, 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
Standard & Poor's believes that such payments will be made during such
grace period.
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.
DESCRIPTION OF STANDARD & POOR'S SHORT-TERM ISSUE CREDIT RATINGS
A Standard & Poor's note rating reflects the liquidity factors 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
Strong capacity to pay principal and interest. An issue determined to
possess a very strong capacity to pay debt service is given a plus (+)
designation.
SP-2
Satisfactory capacity to pay principal and interest with some
vulnerability to adverse financial and economic changes over the term of
the notes.
SP-3
Speculative capacity to pay principal and interest.
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.
Fitch ratings do not reflect any credit enhancement that may be provided by
insurance policies or financial guaranties unless otherwise indicated.
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Bonds carrying 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.
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.
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.
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.
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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.
Ratings Outlook: An outlook is used to describe the most likely direction of
any rating change over the intermediate term. It is described as "Positive" or
"Negative." The absence of a designation indicates a stable outlook.
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.
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.
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 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.
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.
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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.
Fitch short-term ratings are as follows:
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.
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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,
1997, 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, 1997 by correspondence with the custodian and brokers. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, such financial statements and financial highlights present
fairly, in all material respects, the financial position of Merrill Lynch
California Municipal Bond Fund of Merrill Lynch California Municipal Series
Trust as of August 31, 1997, 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 8, 1997
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<TABLE>
<CAPTION>
Merrill Lynch California Municipal Bond Fund August 31, 1997
SCHEDULE OF INVESTMENTS (in Thousands)
S&P Moody's Face Value
Ratings Ratings Amount Issue (Note 1a)
California -- 100.6%
<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 $4,034
AAA Aaa 3,000 Anaheim, California, Public Financing Authority, Tax Allocation Revenue Bonds,
RITES, 9.12% due 12/28/2018 (c)(j) 3,536
Antioch, California, Improvement Bonds (1915 Assessment District No. 27 -- Lone Tree):
NR* NR* 655 Series D, 6.40% due 9/02/2003 681
NR* NR* 4,955 Series D, 7.30% due 9/02/2013 5,142
NR* NR* 3,995 Series E, 7.125% due 9/02/2016 4,139
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) 3,438
AAA Aaa 2,025 Brentwood, California, GO, Unified School District, 6.85% due 2/01/1999 (a)(d) 2,149
California HFA, Home Mortgage Revenue Bonds:
AA- Aa 3,620 AMT, Series A, 7.70% due 8/01/2030 3,802
AA- Aa 445 AMT, Series B, 8% due 8/01/2029 465
AA- Aa 10,115 AMT, Series F-1, 7% due 8/01/2026 10,819
AA- Aa 655 AMT, Series G, 8.15% due 8/01/2019 677
AA- Aa 2,035 Series A, 8.125% due 8/01/2019 2,113
AA- Aa 1,720 Series D, 7.25% due 8/01/2017 1,814
California HFA, Revenue Bonds, AMT:
AA- Aa 4,050 RIB, 8.945% due 8/01/2023 (j) 4,430
AAA Aaa 980 Series A, 7.20% due 2/01/2026 (c) 1,037
California Health Facilities Financing Authority Revenue Bonds, Series A:
AAA Aaa 4,350 (Kaiser Permanente), 7% due 10/01/2018 (c)(k) 4,652
BB Aaa 5,150 Refunding (Good Samaritan Health System), 7.50% due 5/01/2000 (a) 5,681
AAA Aaa 4,000 Refunding (Sutter Health), 5.25% due 8/15/2027 (f) 3,843
NR* A 5,780 (Scripps Research Institute), 6.625% due 7/01/2014 6,323
NR* NR* 5,000 California Pollution Control Financing Authority, PCR, Refunding (Laidlaw
Environmental), AMT, Series A, 6.70% due 7/01/2007 5,092
</TABLE>
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.
PORTFOLIO ABBREVIATIONS
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>
<TABLE>
<CAPTION>
Merrill Lynch California Municipal Bond Fund August 31, 1997
SCHEDULE OF INVESTMENTS (continued) (in Thousands)
S&P Moody's Face Value
Ratings Ratings Amount Issue (Note 1a)
Califonia -- 100.6%
<S> <C> <C> <C> <C>
California Pollution Control Financing Authority, Resource Recovery Revenue
Bonds, VRDN, AMT (b):
A1 VMIG1+ 3,000 (Atlantic Richfield Company Project), Series A, 3.55% due 12/01/2024 3,000
NR* Aa1 1,500 (Delano Project), 3.55% due 8/01/2019 1,500
NR* P1 1,400 Refunding (Ultra Power Rocklin Project), Series A, 3.55% due 6/01/2017 1,400
NR* P1 1,000 Refunding (Ultra Power Rocklin Project), Series B, 3.55% due 6/01/2017 1,000
A1+ VMIG1+ 2,200 California Pollution Control Financing Authority, Solid Waste Disposal Revenue
Bonds (Shell Oil Co. -- Martinez Project), VRDN, AMT, Series A, 3.45% due 10/01/2024 (b) 2,200
AA Aa2 10,000 California State Department of Water Resources, Water System Revenue Bonds
(Central Valley Project), Series O, 5% due 12/01/2022 9,425
A+ A1 5,000 California State, GO, Refunding, 6.75% due 6/01/2006 5,767
California State Public Works Board, Lease Revenue Bonds:
A Aaa 10,675 (Department of Corrections -- Monterey County Soledad II), Series A,
7% due 11/01/2004 (a) 12,515
A A 3,555 High Technology Facilities (San Jose Facilities), Series A, 7.75% due 8/01/2006 4,078
A Aaa 7,000 (Various Community College Projects), Series B, 7% due 3/01/2004 (a) 8,160
California State, Veterans' Bonds, AMT, UT:
A+ A1 16,300 Series AW, 7.70% due 4/01/2009 16,946
AAA Aaa 7,500 Series BD, BE and BF, 6.375% due 2/01/2027 (d) 7,711
AA Aa 4,750 California Statewide Communities Development Authority Revenue Bonds
(Saint Joseph Health System Group), COP, 6.625% due 7/01/2021 5,231
NR* Aa2 5,500 California Statewide Communities Development Authority, Solid Waste Facilities
Revenue Bonds (Chevron U.S.A. Inc. Project), VRDN, AMT, 3.50% due 12/15/2024 (b) 5,500
Central Coast, California, Water Authority Revenue Bonds (State Water Project
Regional Facilities) (d):
AAA Aaa 5,000 6.60% due 10/01/2002 (a) 5,616
AAA Aaa 3,000 Refunding, Series A, 5% due 10/01/2022 2,824
AAA Aaa 6,420 Series A, 5% due 10/01/2016 6,146
BBB NR* 1,000 Contra Costa County, California, Public Financing Authority, Tax Allocation
Revenue Refunding Bonds, Series A, 7.10% due 8/01/2022 1,088
Corona, California, COP (Corona Community):
AAA Aaa 1,915 8% due 3/01/2009 (a) 2,430
AAA Aaa 2,065 8% due 3/01/2010 (a) 2,636
AAA Aaa 2,230 8% due 3/01/2011 (a) 2,863
AAA Aaa 2,410 8% due 3/01/2012 (a) 3,106
AAA Aaa 2,605 8% due 3/01/2013 (a) 3,368
AAA Aaa 2,810 8% due 3/01/2014 (a) 3,649
AAA Aaa 3,035 8% due 3/01/2015 (i) 3,958
AAA Aaa 5,000 East Bay, California, Municipal Utility District, Water System Subordinated,
Revenue Refunding Bonds, 5% due 6/01/2026 (e) 4,675
AAA Aaa 5,000 El Cajon, California, Redevelopment Agency, Tax Allocation Bonds (El Cajon
Redevelopment Project), 6.60% due 10/01/2022 (d) 5,461
AAA Aaa 5,000 El Dorado County, California, Public Agency Financing Authority, Revenue
Refunding Bonds, 5.50% due 2/15/2021 (e) 4,980
AAA Aaa 2,230 Irvine, California, Unified School District, Special Tax Community Facilities Bonds
(District No. 86-1), Series A, 8.10% due 11/15/1998 (a)(c) 2,383
</TABLE>
62
<PAGE>
<TABLE>
Merrill Lynch California Municipal Bond Fund August 31, 1997
SCHEDULE OF INVESTMENTS (continued) (in Thousands)
S&P Moody's Face Value
Ratings Ratings Amount Issue (Note 1a)
Califonia -- 100.6%
<S> <C> <C> <C> <C>
Long Beach, California, Improvement Bonds (1915 Assessment District 90-2):
NR* NR* 465 7% due 9/02/2001 485
NR* NR* 495 7.05% due 9/02/2002 516
NR* NR* 530 7.10% due 9/02/2003 553
NR* NR* 570 7.15% due 9/02/2004 590
NR* NR* 610 7.20% due 9/02/2005 632
NR* NR* 655 7.25% due 9/02/2006 678
NR* NR* 4,065 7.50% due 9/02/2011 4,234
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 (l) 3,702
NR* NR* 4,545 Long Beach, California, Special Tax Community Facilities Bonds (District No. 3 -- Pine
Avenue), 6.375% due 9/01/2023 4,653
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) 5,694
AAA Aaa 17,050 Los Angeles, California, Convention and Exhibition Center Authority, COP,
9% due 12/01/2005 (a) 22,276
AAA Aaa 10,000 Los Angeles, California, Convention and Exhibition Center Authority, Lease
Revenue Refunding Bonds, Series A, 5.125% due 8/15/2021 (c) 9,478
A+ Aa3 20,000 Los Angeles, California, Department of Water and Power, Electric Plant Revenue
Refunding Bonds, 6.375% due 2/01/2020 21,383
AAA Aaa 5,000 Los Angeles, California, Department of Water and Power, Waterworks Revenue
Bonds, 6.30% due 7/01/2024 (c) 5,398
Los Angeles, California, Harbor Department Revenue Bonds:
AAA NR* 10,000 7.60% due 10/01/2018 (i) 12,472
AAA Aaa 5,000 AMT, RITR, Series 7, 8.795% due 11/01/2026 (c)(j) 5,938
Los Angeles, California, Wastewater System Revenue Bonds, Series D (c):
AAA Aaa 8,000 6.70% due 12/01/2000 (a) 8,773
AAA Aaa 7,890 6.625% due 12/01/2012 8,543
Los Angeles County, California, Metropolitan Transportation Authority, Sales Tax
Revenue Bonds:
AAA Aaa 18,000 (Proposition C), Second Series A, 5% due 7/01/2025 (d) 16,772
AAA Aaa 10,000 Refunding (Proposition A), Series A, 5% due 7/01/2021 (e) 9,352
AAA Aaa 6,250 Marysville, California, Hospital Revenue Bonds (Fremont -- Rideout Health Group),
Series A, 6.30% due 1/01/2022 (d) 6,680
Metropolitan Water District, Southern California, Waterworks Revenue Bonds:
AA Aa 11,650 RIB, 7.682% due 8/05/2022 (j) 12,451
AA Aa 5,500 Series C, 5% due 7/01/2027 5,144
AAA Aaa 5,635 Ontario, California, Redevelopment Financing Authority Revenue Bonds
(Cimarron Project No. 1 -- Center City), 6.375% due 8/01/2020 (c) 6,090
A NR* 2,500 Palmdale, California, Civic Authority, Revenue Refunding Bonds (Merged
Redevelopment Project), Series A, 6.60% due 9/01/2034 2,816
AAA Aaa 11,620 Pittsburg, California, Redevelopment Agency, Residential Mortgage Revenue
Bonds, 9.60% due 6/01/2016 (i) 16,634
NR* NR* 8,315 Pleasanton, California, Joint Powers Financing Authority, Revenue Reassessment
Bonds, Sub-Series B, 6.75% due 9/02/2017 8,839
</TABLE>
63
<PAGE>
<TABLE>
Merrill Lynch California Municipal Bond Fund August 31, 1997
SCHEDULE OF INVESTMENTS (continued) (in Thousands)
S&P Moody's Face Value
Ratings Ratings Amount Issue (Note 1a)
Califonia -- 100.6%
<S> <C> <C> <C> <C>
AAA Aaa 3,450 Rancho, California, Water District Financing Authority Revenue Bonds, RITES,
8.974% 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) 1,628
A- NR* 2,500 Series B, 7.25% due 7/15/2001 (a) 2,816
BBB NR* 2,430 Riverside County, California, Redevelopment Agency Bonds (Tax Allocation
Redevelopment Project No. 4), Series A, 7.50% due 10/01/2026 2,645
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) 3,220
Sacramento, California, Municipal Utility District, Electric Revenue Bonds:
AAA Aaa 7,000 INFLOS, 8.868% due 8/15/2018 (e)(j) 8,076
AAA Aaa 5,000 Series B, 6.375% due 8/15/2002 (a)(c) 5,554
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 2,245 San Diego, California, Public Facilities Financing Authority, Sewer Revenue Bonds,
5% due 5/15/2020 (e) 2,106
San Francisco, California, City and County Airport Commission, International
Airport Revenue Bonds, Second Series:
AAA Aaa 3,240 AMT, Issue 6, 6.50% due 5/01/2018 (d) 3,513
AAA Aaa 8,000 AMT, Issue 6, 6.60% due 5/01/2020 (d) 8,719
AAA Aaa 2,000 AMT, Issue 10A, 5.70% due 5/01/2026 (c) 2,016
A+ A1 6,000 AMT, Issue 12A, 5.80% due 5/01/2021 6,066
AAA Aaa 8,500 Refunding, Issue 1, 6.30% due 5/01/2011 (d) 9,186
San Francisco, California, City and County, Public Utilities Commission, Water
Revenue Refunding Bonds, Series A:
AA- Aa 8,870 5% due 11/01/2021 8,394
AA- Aa 6,990 5% due 11/01/2026 6,581
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 1,346
AAA Aaa 5,000 San Francisco, California, State Building Authority, Lease Revenue Bonds (San
Francisco Civic Center Complex), Series A, 5.25% due 12/01/2021 (d) 4,833
AAA Aaa 4,150 Santa Clara, California, Electric Revenue Bonds, Series A, 6.50% due 7/01/2021 (c) 4,502
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) 11,285
AA A1 1,000 Santa Clara County, California, Transportation District, Sales Tax Revenue Bonds,
Series A, 6.75% due 6/01/2011 1,090
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) 2,178
AAA Aaa 10,000 Santa Rosa, California, Wastewater Revenue Refunding Bonds (Subregional
Wastewater Project), 5% due 9/01/2022 (e) 9,390
</TABLE>
64
<PAGE>
<TABLE>
Merrill Lynch California Municipal Bond Fund August 31, 1997
SCHEDULE OF INVESTMENTS (concluded) (in Thousands)
S&P Moody's Face Value
Ratings Ratings Amount Issue (Note 1a)
Califonia -- 100.6%
<S> <C> <C> <C> <C>
Southern California Home Financing Authority, S/F Mortgage Revenue Bonds, AMT (h):
AAA NR* 3,425 (Mortgage-Backed Security), Series A, 7.625% due 10/01/2023 3,612
AAA NR* 2,450 (Mortgage-Backed Security), Series A, 7.35% due 9/01/2024 (g) 2,591
AAA NR* 1,025 Series B, 7.75% due 3/01/2024 (g) 1,085
BBB+ NR* 19,300 Stanislaus, California, Waste-to-Energy Financing Agency, Solid Waste Facility
Revenue Refunding Bonds (Ogden Martin System Inc. Project), 7.625% due 1/01/2010 20,698
AAA Aaa 6,500 Stockton, California, Revenue Bonds (Wastewater Treatment Plant Expansion),
COP, Series A, 6.80% due 9/01/2024 (e) 7,268
AAA Aaa 4,000 Tri-City, California, Hospital District Revenue Bonds (Tri-City Hospital),
7.50% due 2/01/2002 (a)(c) 4,584
University of California Revenue Bonds (Multiple Purpose Projects):
A- NR* 14,700 Refunding, Series A, 6.875% due 9/01/2002 (a) 16,633
AAA Aaa 8,000 Series D, 6.25% due 9/01/2012 (c) 8,659
AAA Aaa 11,845 Series D, 6.375% due 9/01/2024 (c) 12,886
AAA Aaa 2,940 University of California Revenue Bonds, RITR, Series 13, 9.17% due 9/01/2019 (c)(j) 3,429
A A2 6,000 West Covina, California, COP (Queen of the Valley Hospital), 6.95% due 8/15/2023 6,720
AAA Aaa 6,000 West Sacramento, California, Redevelopment Agency, Tax Allocation Bonds
(West Sacramento Redevelopment Project), 6.25% due 9/01/2010 (c) 6,447
Puerto Rico -- 0.9%
A Baa1 5,000 Puerto Rico Commonwealth, GO, UT, 6.45% due 7/01/2017 5,481
Total Investments (Cost -- $580,294) -- 101.5% 626,373
Variation Margin on Financial Futures Contracts** -- 0.0% (45)
Liabilities in Excess of Other Assets -- (1.5%) (9,454)
---------
Net Assets -- 100.0% $616,874
=========
(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, 1997.
(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, 1997.
(k) All or portion of security held as collateral in connection with open financial futures contracts.
(l) Non-income producing security.
* Not Rated.
** Financial futures contracts purchased as of August 31, 1997
were as follows: (in Thousands)
Value
Number of Expiration (Notes
Contracts Issue Date 1a & 1b)
100 Municipal Bond Index December 1997 $11,781
Total Financial Futures Contracts Purchased
(Total Contract Price -- $11,826) $11,781
========
+ Highest short-term rating by Moody's Investors Service, Inc.
Ratings of issues shown have not been audited by Deloitte & Touche LLP.
</TABLE>
See Notes to Financial Statements.
65
<PAGE>
<TABLE>
<CAPTION>
FINANCIAL INFORMATION
Statement of Assets and Liabilities as of August 31, 1997
<S> <C> <C> <C>
Assets: Investments, at value (identified cost -- $580,294,043) (Note 1a) $626,372,705
Cash 82,178
Receivables:
Interest $10,463,792
Securities sold 9,247,508
Beneficial interest sold 422,185 20,133,485
-----------
Prepaid registration fees and other assets (Note 1e) 114,190
------------
Total assets 646,702,558
------------
Liabilities: Payables:
Securities purchased 27,657,449
Beneficial interest redeemed 899,044
Dividends to shareholders (Note 1f) 590,865
Investment adviser (Note 2) 296,202
Distributor (Note 2) 188,018
Variation margin (Note 1b) 45,094 29,676,672
-----------
Accrued expenses and other liabilities 151,514
------------
Total liabilities 29,828,186
------------
Net Assets: Net assets $616,874,372
============
Net Assets Class A Shares of beneficial interest, $.10 par value, unlimited number of
Consist of: shares authorized $377,984
Class B Shares of beneficial interest, $.10 par value, unlimited number of
shares authorized 3,181,980
Class C Shares of beneficial interest, $.10 par value, unlimited number of
shares authorized 92,284
Class D Shares of beneficial interest, $.10 par value, unlimited number of
shares authorized 1,568,230
Paid-in capital in excess of par 577,532,952
Accumulated realized capital losses on investments -- net (Note 5) (11,912,626)
Unrealized appreciation on investments -- net 46,033,568
------------
Net assets $616,874,372
============
Net Asset Value: Class A -- Based on net assets of $44,652,364 and 3,779,839 shares of
beneficial interest outstanding $11.81
============
Class B -- Based on net assets of $376,018,231 and 31,819,804 shares of
beneficial interest outstanding $11.82
============
Class C -- Based on net assets of $10,903,527 and 922,838 shares of
beneficial interest outstanding $11.82
============
Class D -- Based on net assets of $185,300,250 and 15,682,302 shares of
beneficial interest outstanding $11.82
============
See Notes to Financial Statements.
</TABLE>
66
<PAGE>
<TABLE>
<CAPTION>
FINANCIAL INFORMATION (continued)
Statement of Operations
For the Year Ended August 31, 1997
<S> <C> <C> <C>
Investment Income Interest and amortization of premium and discount earned $38,438,745
(Note 1d):
Expenses: Investment advisory fees (Note 2) $3,422,246
Account maintenance and distribution fees -- Class B (Note 2) 2,104,015
Transfer agent fees -- Class B (Note 2) 159,145
Account maintenance fees -- Class D (Note 2) 155,124
Registration fees (Note 1e) 90,645
Professional fees 69,545
Accounting services (Note 2) 64,769
Custodian fees 62,832
Account maintenance and distribution fees -- Class C (Note 2) 54,528
Transfer agent fees -- Class D (Note 2) 47,820
Trustees' fees and expenses 39,267
Printing and shareholder reports 25,413
Transfer agent fees -- Class A (Note 2) 13,348
Transfer agent fees -- Class C (Note 2) 3,680
Pricing fees 3,663
-----------
Total expenses 6,316,040
------------
Investment income -- net 32,122,705
------------
Realized & Realized gain on investments -- net 7,326,062
Unrealized Gain on Change in unrealized appreciation on investments -- net 10,038,184
Investments -- Net ------------
(Notes 1b, 1d & 3): Net Increase in Net Assets Resulting from Operations $49,486,951
============
See Notes to Financial Statements.
</TABLE>
<TABLE>
<CAPTION>
Statements of Changes in Net Assets
For the Year Ended August 31,
Increase (Decrease) in Net Assets: 1997 1996
<S> <C> <C> <C>
Operations: Investment income -- net $32,122,705 $33,842,706
Realized gain on investments -- net 7,326,062 4,306,220
Change in unrealized appreciation on investments -- net 10,038,184 1,206,892
------------ ------------
Net increase in net assets resulting from operations 49,486,951 39,355,818
------------ ------------
Dividends to Investment income -- net:
Shareholders Class A (2,365,153) (2,457,264)
(Note 1f): Class B (20,956,944) (27,350,656)
Class C (442,724) (287,834)
Class D (8,357,884) (3,746,952)
------------ ------------
Net decrease in net assets resulting from dividends to shareholders (32,122,705) (33,842,706)
------------ ------------
Beneficial Interest Net decrease in net assets derived from beneficial interest transactions (43,754,648) (29,652,521)
Transactions ------------ ------------
(Note 4):
Net Assets: Total decrease in net assets (26,390,402) (24,139,409)
Beginning of year 643,264,774 667,404,183
------------ ------------
End of year $616,874,372 $643,264,774
============ ============
See Notes to Financial Statements.
</TABLE>
67
<PAGE>
<TABLE>
<CAPTION>
FINANCIAL INFORMATION (continued)
Financial Highlights
Class A
The following per share data and ratios have been derived
from information provided in the financial statements. For the Year Ended August 31,
Increase (Decrease) in Net Asset Value: 1997 1996 1995 1994 1993
<S> <C> <C> <C> <C> <C> <C>
Per Share Net asset value, beginning of year $11.49 $11.40 $11.32 $12.38 $11.80
Operating -------- -------- -------- -------- --------
Performance: Investment income -- net .64 .64 .64 .68 .70
Realized and unrealized gain (loss) on
Investments -- net .32 .09 .08 (.78) .78
-------- -------- -------- -------- --------
Total from investment operations .96 .73 .72 (.10) 1.48
-------- -------- -------- -------- --------
Less dividends and distributions:
Investment income -- net (.64) (.64) (.64) (.68) (.70)
Realized gain on investments -- net -- -- -- (.19) (.20)
In excess of realized gain on
investments -- net -- -- -- (.09) --
-------- -------- -------- -------- --------
Total dividends and distributions (.64) (.64) (.64) (.96) (.90)
-------- -------- -------- -------- --------
Net asset value, end of year $11.81 $11.49 $11.40 $11.32 $12.38
======== ======== ======== ======== ========
Total Investment Based on net asset value per share 8.55% 6.53% 6.75% (.92%) 13.19%
Return:* ======== ======== ======== ======== ========
Ratios to Average Expenses .63% .65% .65% .62% .63%
Net Assets: ======== ======== ======== ======== ========
Investment income -- net 5.49% 5.51% 5.83% 5.65% 5.87%
======== ======== ======== ======== ========
Supplemental Net assets, end of year (in thousands) $44,652 $42,668 $44,228 $60,017 $64,526
Data: ======== ======== ======== ======== ========
Portfolio turnover 73.60% 53.79% 53.40% 75.66% 61.24%
======== ======== ======== ======== ========
</TABLE>
<TABLE>
<CAPTION>
Class B
The following per share data and ratios have been derived
from information provided in the financial statements. For the Year Ended August 31,
Increase (Decrease) in Net Asset Value: 1997 1996 1995 1994 1993
<S> <C> <C> <C> <C> <C> <C>
Per Share Net asset value, beginning of year $11.49 $11.40 $11.32 $12.38 $11.80
Operating -------- -------- -------- -------- --------
Performance: Investment income -- net .58 .58 .59 .61 .64
Realized and unrealized gain (loss) on
Investments -- net .33 .09 .08 (.78) .78
-------- -------- -------- -------- --------
Total from investment operations .91 .67 .67 (.17) 1.42
-------- -------- -------- -------- --------
Less dividends and distributions:
Investment income -- net (.58) (.58) (.59) (.61) (.64)
Realized gain on investments -- net -- -- -- (.19) (.20)
In excess of realized gain on
investments -- net -- -- -- (.09) --
-------- -------- -------- -------- --------
Total dividends and distributions (.58) (.58) (.59) (.89) (.84)
-------- -------- -------- -------- --------
Net asset value, end of year $11.82 $11.49 $11.40 $11.32 $12.38
======== ======== ======== ======== ========
Total Investment Based on net asset value per share 8.09% 5.99% 6.25% (1.50%) 12.62%
Return:* ======== ======== ======== ======== ========
Ratios to Average Expenses 1.14% 1.16% 1.16% 1.13% 1.13%
Net Assets: ======== ======== ======== ======== ========
Investment income -- net 4.98% 5.01% 5.32% 5.15% 5.38%
======== ======== ======== ======== ========
Supplemental Net assets, end of year (in thousands) $376,018 $480,668 $616,199 $726,888 $821,220
Data: ======== ======== ======== ======== ========
Portfolio turnover 73.60% 53.79% 53.40% 75.66% 61.24%
======== ======== ======== ======== ========
* Total investment returns exclude the effects of sales loads.
See Notes to Financial Statements.
</TABLE>
68
<PAGE>
<TABLE>
<CAPTION>
FINANCIAL INFORMATION (concluded)
Class C Class D
For the For the
Period Period
Oct. 21, Oct. 21,
The following per share data and ratios have been derived For the Year Ended 1994+ to For the Year Ended 1994+ to
from information provided in the financial statements. August 31, Aug. 31, August 31, Aug. 31,
Increase (Decrease) in Net Asset Value: 1997 1996 1995 1997 1996 1995
<S> <C> <C> <C> <C> <C> <C> <C>
Per Share Net asset value, beginning of period $11.49 $11.40 $10.94 $11.49 $11.40 $10.94
Operating ------- ------- ------- -------- -------- -------
Performance: Investment income -- net .57 .57 .49 .63 .63 .54
Realized and unrealized gain on
investments -- net .33 .09 .46 .33 .09 .46
------- ------- ------- -------- -------- -------
Total from investment operations .90 .66 .95 .96 .72 1.00
------- ------- ------- -------- -------- -------
Less dividends from investment
income -- net (.57) (.57) (.49) (.63) (.63) (.54)
------- ------- ------- -------- -------- -------
Net asset value, end of period $11.82 $11.49 $11.40 $11.82 $11.49 $11.40
======= ======= ======= ======== ======== =======
Total Investment Based on net asset value per share 7.98% 5.88% 8.91%++++ 8.53% 6.43% 9.39%++++
Return:** ======= ======= ======= ======== ======== =======
Ratios to Average Expenses 1.24% 1.26% 1.27%* .73% .75% .76%*
Net Assets: ======= ======= ======= ======== ======== =======
Investment income -- net 4.87% 4.91% 5.04%* 5.39% 5.42% 5.59%*
======= ======= ======= ======== ======== =======
Supplemental Net assets, end of period
Data: (in thousands) $10,904 $8,112 $3,131 $185,300 $111,817 $3,846
======= ======= ======= ======== ======== =======
Portfolio turnover 73.60% 53.79% 53.40% 73.60% 53.79% 53.40%
======= ======= ======= ======== ======== =======
* Annualized.
** Total investment returns exclude the effects of sales loads.
+ Commencement of Operations.
++++ Aggregate total investment return.
</TABLE>
See Notes to Financial Statements.
69
<PAGE>
Merrill Lynch California Municipal Bond Fund August 31, 1997
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 PricingSM
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.
[bullet] 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.
70
<PAGE>
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.
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 Incorporated ("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, 1997, 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 $1,003 $10,677
Class D $4,949 $45,618
For the year ended August 31, 1997, MLPF&S received contingent
deferred sales charges of $367,638 and $5,077 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, MLFDS, MLFD, and/or ML & Co.
3. Investments:
Purchases and sales of investments, excluding short-term securities,
for the year ended August 31, 1997 were $446,440,270 and $466,703,274,
respectively.
Net realized and unrealized gains (losses) as of August 31, 1997 were
as follows:
Realized Unrealized
Gains Gains
(Losses) (Losses)
Long-term investments $9,399,671 $46,078,662
Short-term investments (3,046) --
Financial futures contracts (2,070,563) (45,094)
---------- -----------
Total $7,326,062 $46,033,568
========== ===========
As of August 31, 1997, net unrealized appreciation for Federal income
tax purposes aggregated $45,973,320, of which $48,037,058 related to
appreciated securities and $2,063,738 related to depreciated
securities. The aggregate cost of investments at August 31, 1997 for
Federal income tax purposes was $580,399,385.
4. Beneficial Interest Transactions:
Net decrease in net assets derived from beneficial interest
transactions was $43,754,648 and
71
<PAGE>
NOTES TO FINANCIAL STATEMENTS (concluded)
$29,652,521 for the years ended August 31, 1997 and August 31, 1996,
respectively.
Transactions in shares of beneficial interest for each class were as
follows:
Class A Shares for the Year Dollar
Ended August 31, 1997 Shares Amount
Shares sold 784,082 $9,128,183
Shares issued to shareholders
in reinvestment of dividends 90,013 1,049,006
---------- -------------
Total issued 874,095 10,177,189
Shares redeemed (807,960) (9,396,731)
---------- -------------
Net increase 66,135 $780,458
=========== =============
Class A Shares for the Year Dollar
Ended August 31, 1996 Shares Amount
Shares sold 343,484 $3,993,921
Shares issued to shareholders
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 B Shares for the Year Dollar
Ended August 31, 1997 Shares Amount
Shares sold 3,032,901 $35,356,868
Shares issued to shareholders
in reinvestment of dividends 801,637 9,343,192
---------- -------------
Total issued 3,834,538 44,700,060
Automatic conversion
of shares (6,809,790) (79,213,998)
Shares redeemed (7,027,468) (81,817,493)
---------- -------------
Net decrease (10,002,720) $(116,331,431)
=========== =============
Class B Shares for the Year Dollar
Ended August 31, 1996 Shares Amount
Shares sold 3,684,831 $42,602,905
Shares issued to shareholders
in reinvestment of dividends 1,050,882 12,150,317
---------- -------------
Total issued 4,735,713 54,753,222
Automatic conversion
of shares (9,424,309) (109,009,248)
Shares redeemed (7,544,434) (87,132,865)
---------- -------------
Net decrease (12,233,030) $(141,388,891)
=========== =============
Class C Shares for the Year Dollar
Ended August 31, 1997 Shares Amount
Shares sold 528,637 $6,169,836
Shares issued to shareholders
in reinvestment of dividends 21,632 252,331
---------- -------------
Total issued 550,269 6,422,167
Shares redeemed (333,381) (3,882,185)
---------- -------------
Net increase 216,888 $2,539,982
=========== =============
Class C Shares for the Year Dollar
Ended August 31, 1996 Shares Amount
Shares sold 544,866 $6,303,679
Shares issued to shareholders
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 D Shares for the Year Dollar
Ended August 31, 1997 Shares Amount
Shares sold 788,405 $9,195,140
Automatic conversion of shares 6,809,790 79,213,998
Shares issued to shareholders
in reinvestment of dividends 310,139 3,617,224
---------- -------------
Total issued 7,908,334 92,026,362
Shares redeemed (1,956,003) (22,770,019)
---------- -------------
Net increase 5,952,331 $69,256,343
=========== =============
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 shareholders
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
=========== =============
5. Capital Loss Carryforward:
At August 31, 1997, the Fund had a net capital loss carryforward of
approximately $9,723,000, of which $2,578,000 expires in 2003 and
$7,145,000 expires in 2004. This amount will be available to offset
like amounts of any future taxable gains.
72
<PAGE>
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<PAGE>
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<PAGE>
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<PAGE>
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............................... 8
Investment Restrictions.................................................... 13
Management of the Trust.................................................... 15
Trustees and Officers.................................................... 15
Compensation of Trustees................................................. 16
Management and Advisory Arrangements..................................... 17
Purchase of Shares......................................................... 18
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..................... 23
Redemption of Shares....................................................... 24
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.............................................. 29
Exchange Privilege....................................................... 30
Distributions and Taxes.................................................... 32
Tax Treatment of Options and Futures Transactions........................ 35
Performance Data........................................................... 36
General Information........................................................ 38
Description of Shares.................................................... 38
Computation of Offering Price Per Share.................................. 39
Independent Auditors..................................................... 39
Custodian................................................................ 40
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............................................... 53
Independent Auditors' Report............................................... 60
Financial Statements....................................................... 61
</TABLE>
Code #10328-1197
[LOGO] MERRILL LYNCH
Merrill Lynch
California Municipal
Bond Fund
Merrill Lynch California
Municipal Series Trust
[Art]
STATEMENT OF
ADDITIONAL
INFORMATION
November 26, 1997
Distributor:
Merrill Lynch
Funds Distributor, Inc.
<PAGE>
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, 1997.
Contained in Part B:
Schedule of Investments as of August 31, 1997.
Statement of Assets and Liabilities as of August 31, 1997.
Statement of Operations for the year ended August 31, 1997.
Statements of Changes in Net Assets for each of the years in the
two-year period ended August 31, 1997.
Financial Highlights for each of the years in the five-year period
ended August 31, 1997.
(B) EXHIBITS:
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
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 --None.
11 --Consent of Deloitte & Touche LLP, independent auditors for the
Registrant.
12 --None.
</TABLE>
C-1
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
13 --Certificate of Fund Asset Management, Inc.(a)
14 --None.
15(a) --Amended and Restated Class B Distribution Plan and Class B
Distribution Plan Sub-Agreement.(c)
(b) --Form of Class C Distribution Plan and Class C Distribution Plan
Sub-Agreement of the Registrant.(d)
(c) --Form of Class D Distribution Plan and Class D 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 PricingSM 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 OCTOBER 31, 1997
-------------- ----------------
<S> <C>
Class A shares of beneficial interest, par value $0.10
per share............................................ 1,209
Class B shares of beneficial interest, par value $0.10
per share............................................ 7,882
Class C shares of beneficial interest, par value $0.10
per share............................................ 275
Class D shares of beneficial interest, par value $0.10
per share............................................ 4,665
</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>
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
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.
C-3
<PAGE>
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 registered 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
registered investment companies: Apex Municipal Fund, Inc., Corporate High
Yield Fund, Inc., Corporate High Yield Fund II, Inc., Debt Strategies Fund,
Inc., Income Opportunities Fund 1999, Inc., Income Opportunities Fund 2000,
Inc., Merrill Lynch Municipal Strategy Fund, Inc., MuniAssets Fund Inc.,
MuniEnhanced Fund, Inc., MuniHoldings California Insured Fund, Inc.,
MuniHoldings Florida Insured Fund, MuniHoldings Fund, Inc., MuniHoldings New
York Insured Fund, Inc., MuniInsured Fund, Inc., MuniVest Fund, Inc., MuniVest
Fund II, Inc., MuniVest Florida Fund, MuniVest Michigan Insured Fund, Inc.,
MuniVest New Jersey 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 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 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 registered
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 Convertible 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 Intermediate Government Bond 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., Merrill
Lynch Variable Series Funds, Inc. and Hotchkis and Wiley Funds (advised by
Hotchkis and Wiley, a division of MLAM); and the following closed-end
registered investment companies: Convertible Holdings, Inc., Merrill Lynch
High Income Municipal Bond Fund, Inc. and Merrill Lynch Senior Floating Rate
Fund, Inc. MLAM also acts as sub-adviser to Merrill Lynch World Strategy
Portfolio and Merrill Lynch Basic Value Equity Portfolio, two investment
portfolios of EQ Advisory Trust.
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 Intermediate Government Bond
Fund is One Financial Center, 23rd 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>
("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, 1995 for his, her 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, 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
POSITION(S) WITH BUSINESS, PROFESSION,
NAME MANAGER 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 Di-
rector of Princeton Services; Execu-
tive Vice President of ML & Co.
Terry K. Glenn.......... Executive Vice President Executive Vice President of MLAM; Ex-
ecutive Vice President and Director
of
Princeton Services; President and
Director of MLFD; Director of MLFDS;
President of Princeton Administra-
tors, L.P.
Linda L. Federici....... Senior Vice President Senior Vice President of MLAM; Senior
Vice President of Princeton Services
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
Philip L. Kirstein...... Senior Vice President, Senior Vice President, General Coun-
General Counsel and sel and Secretary of MLAM; Senior
Secretary Vice President, General Counsel,
Secretary and
Director of Princeton Services
Ronald M. Kloss......... Senior Vice President Senior Vice President and Controller
and Controller of MLAM; Senior Vice President and
Controller of Princeton Services
Debra W. Landsman- Senior Vice President Senior Vice President of MLAM; Vice
Yaros.................. President of MLFD; Senior Vice Pres-
ident of Princeton Services
Stephen M. M. Miller.... Senior Vice President Executive Vice President of Princeton
Administrators, L.P.; Senior Vice
President of Princeton Services
</TABLE>
C-5
<PAGE>
<TABLE>
<CAPTION>
OTHER SUBSTANTIAL
POSITION(S) WITH BUSINESS, PROFESSION,
NAME MANAGER VOCATION OR EMPLOYMENT
---- ---------------- ----------------------
<S> <C> <C>
Joseph T. Monagle, Senior Vice President Senior Vice President of MLAM; Senior
Jr. ................... Vice President of Princeton Services
Michael L. Quinn........ Senior Vice President Senior Vice President of MLAM; Senior
Vice President of Princeton Servic-
es; Managing Director and First Vice
President of Merrill Lynch from 1989
to 1995
Richard L. Reller....... Senior Vice President First Vice President of MLAM; First
Vice President of Princeton Servic-
es; Director of MLFD
Gerald M. Richard....... Senior Vice President Senior Vice President and Treasurer
and Treasurer of MLAM; Senior Vice President and
Treasurer of Princeton Services;
Vice President and Treasurer of MLFD
Gregory Upah............ Senior Vice President Senior Vice President of MLAM; Vice
President of MLFD; Senior Vice Pres-
ident of Princeton Services
Ronald L. Welburn....... 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 02111-2665.
<TABLE>
<CAPTION>
POSITION(S) AND OFFICES POSITIONS AND OFFICES
NAME WITH MLFD WITH REGISTRANT
---- ----------------------- ---------------------
<S> <C> <C>
Terry K. Glenn.......... President and Director Executive Vice President
Richard L. Reller....... Director None
Thomas J. Verage........ Director None
William E. Aldrich...... Senior Vice President None
Robert W. Crook......... Senior Vice President None
Michael J. Brady........ Vice President None
William M. Breen........ Vice President None
Michael G. Clark........ Vice President None
James T. Fatseas........ Vice President None
Deborah W. Landsman-
Yaros.................. Vice President None
Michelle T. Lau......... Vice President None
Gerald M. Richard....... Vice President and Treasurer Treasurer
</TABLE>
C-6
<PAGE>
<TABLE>
<CAPTION>
POSITION(S) AND OFFICES POSITIONS AND OFFICES
NAME WITH MLFD WITH REGISTRANT
---- ----------------------- ---------------------
<S> <C> <C>
Salvatore Venezia....... Vice President None
William Wasel........... Vice President None
Robert Harris........... Secretary None
</TABLE>
(c) Not applicable.
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>
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 POST-EFFECTIVE AMENDMENT TO ITS 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
25TH DAY OF NOVEMBER, 1997.
Merrill Lynch California Municipal
Series Trust
(Registrant)
/s/ Gerald M. Richard
By_________________________________
Gerald M. Richard, Treasurer
Pursuant to the requirements of the Securities Act of 1933, this Post-
Effective Amendment to its Registration Statement has been signed below by the
following persons in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
Arthur Zeikel* President and
- ------------------------------------- Trustee (Principal
(Arthur Zeikel) Executive Officer)
/s/ Gerald M. Richard* Treasurer (Principal
- ------------------------------------- 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)
/s/ Gerald M. Richard
*By__________________________________ November 25,
(Gerald M. Richard 1997
Attorney-in-Fact)
C-8
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
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>
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.
DESCRIPTION OF OMITTED LOCATION OF GRAPHIC
GRAPHIC OR IMAGE OR IMAGE IN TEXT
- ---------------------- -------------------
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> <S> <C>
<PAGE>
<ARTICLE> 6
<SERIES>
<NUMBER> 001
<NAME> MERRILL LYNCH CALIFORNIA MUNICIPAL BOND FUND - CLASS A SHARES
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> AUG-31-1997
<PERIOD-START> SEP-01-1996
<PERIOD-END> AUG-31-1997
<INVESTMENTS-AT-COST> 580294043
<INVESTMENTS-AT-VALUE> 626372705
<RECEIVABLES> 20133485
<ASSETS-OTHER> 196368
<OTHER-ITEMS-ASSETS> 0
<TOTAL-ASSETS> 646702558
<PAYABLE-FOR-SECURITIES> 27657449
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 2170737
<TOTAL-LIABILITIES> 29828186
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 582753430
<SHARES-COMMON-STOCK> 3779839
<SHARES-COMMON-PRIOR> 3713704
<ACCUMULATED-NII-CURRENT> 0
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> (11912626)
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> 46033568
<NET-ASSETS> 44652364
<DIVIDEND-INCOME> 0
<INTEREST-INCOME> 38438745
<OTHER-INCOME> 0
<EXPENSES-NET> (6316040)
<NET-INVESTMENT-INCOME> 32122705
<REALIZED-GAINS-CURRENT> 7326062
<APPREC-INCREASE-CURRENT> 10038184
<NET-CHANGE-FROM-OPS> 49486951
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> (2365153)
<DISTRIBUTIONS-OF-GAINS> 0
<DISTRIBUTIONS-OTHER> 0
<NUMBER-OF-SHARES-SOLD> 784082
<NUMBER-OF-SHARES-REDEEMED> (807960)
<SHARES-REINVESTED> 90013
<NET-CHANGE-IN-ASSETS> (26390402)
<ACCUMULATED-NII-PRIOR> 0
<ACCUMULATED-GAINS-PRIOR> (16973057)
<OVERDISTRIB-NII-PRIOR> 0
<OVERDIST-NET-GAINS-PRIOR> (2265631)
<GROSS-ADVISORY-FEES> 3422246
<INTEREST-EXPENSE> 0
<GROSS-EXPENSE> 6316040
<AVERAGE-NET-ASSETS> 43215808
<PER-SHARE-NAV-BEGIN> 11.49
<PER-SHARE-NII> .64
<PER-SHARE-GAIN-APPREC> .32
<PER-SHARE-DIVIDEND> (.64)
<PER-SHARE-DISTRIBUTIONS> 0
<RETURNS-OF-CAPITAL> 0
<PER-SHARE-NAV-END> 11.81
<EXPENSE-RATIO> .63
<AVG-DEBT-OUTSTANDING> 0
<AVG-DEBT-PER-SHARE> 0
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 6
<SERIES>
<NUMBER> 002
<NAME> MERRILL LYNCH CALIFORNIA MUNICIPAL BOND FUND - CLASS B SHARES
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> AUG-31-1997
<PERIOD-START> SEP-01-1996
<PERIOD-END> AUG-31-1997
<INVESTMENTS-AT-COST> 580294043
<INVESTMENTS-AT-VALUE> 626372705
<RECEIVABLES> 20133485
<ASSETS-OTHER> 196368
<OTHER-ITEMS-ASSETS> 0
<TOTAL-ASSETS> 646702558
<PAYABLE-FOR-SECURITIES> 27657449
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 2170737
<TOTAL-LIABILITIES> 29828186
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 582753430
<SHARES-COMMON-STOCK> 31819804
<SHARES-COMMON-PRIOR> 41822524
<ACCUMULATED-NII-CURRENT> 0
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> (11912626)
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> 46033568
<NET-ASSETS> 376018231
<DIVIDEND-INCOME> 0
<INTEREST-INCOME> 38438745
<OTHER-INCOME> 0
<EXPENSES-NET> (6316040)
<NET-INVESTMENT-INCOME> 32122705
<REALIZED-GAINS-CURRENT> 7326062
<APPREC-INCREASE-CURRENT> 10038184
<NET-CHANGE-FROM-OPS> 49486951
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> (20956944)
<DISTRIBUTIONS-OF-GAINS> 0
<DISTRIBUTIONS-OTHER> 0
<NUMBER-OF-SHARES-SOLD> 3032901
<NUMBER-OF-SHARES-REDEEMED> (13837258)
<SHARES-REINVESTED> 801637
<NET-CHANGE-IN-ASSETS> (26390402)
<ACCUMULATED-NII-PRIOR> 0
<ACCUMULATED-GAINS-PRIOR> (16973057)
<OVERDISTRIB-NII-PRIOR> 0
<OVERDIST-NET-GAINS-PRIOR> (2265631)
<GROSS-ADVISORY-FEES> 3422246
<INTEREST-EXPENSE> 0
<GROSS-EXPENSE> 6316040
<AVERAGE-NET-ASSETS> 421959021
<PER-SHARE-NAV-BEGIN> 11.49
<PER-SHARE-NII> .58
<PER-SHARE-GAIN-APPREC> .33
<PER-SHARE-DIVIDEND> (.58)
<PER-SHARE-DISTRIBUTIONS> 0
<RETURNS-OF-CAPITAL> 0
<PER-SHARE-NAV-END> 11.82
<EXPENSE-RATIO> 1.14
<AVG-DEBT-OUTSTANDING> 0
<AVG-DEBT-PER-SHARE> 0
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 6
<SERIES>
<NUMBER> 003
<NAME> MERRILL LYNCH CALIFORNIA MUNICIPAL BOND FUND - CLASS C SHARES
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> AUG-31-1997
<PERIOD-START> SEP-01-1996
<PERIOD-END> AUG-31-1997
<INVESTMENTS-AT-COST> 580294043
<INVESTMENTS-AT-VALUE> 626372705
<RECEIVABLES> 20133485
<ASSETS-OTHER> 196368
<OTHER-ITEMS-ASSETS> 0
<TOTAL-ASSETS> 646702558
<PAYABLE-FOR-SECURITIES> 27657449
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 2170737
<TOTAL-LIABILITIES> 29828186
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 582753430
<SHARES-COMMON-STOCK> 922838
<SHARES-COMMON-PRIOR> 705950
<ACCUMULATED-NII-CURRENT> 0
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> (11912626)
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> 46033568
<NET-ASSETS> 10903527
<DIVIDEND-INCOME> 0
<INTEREST-INCOME> 38438745
<OTHER-INCOME> 0
<EXPENSES-NET> (6316040)
<NET-INVESTMENT-INCOME> 32122705
<REALIZED-GAINS-CURRENT> 7326062
<APPREC-INCREASE-CURRENT> 10038184
<NET-CHANGE-FROM-OPS> 49486951
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> (442724)
<DISTRIBUTIONS-OF-GAINS> 0
<DISTRIBUTIONS-OTHER> 0
<NUMBER-OF-SHARES-SOLD> 528637
<NUMBER-OF-SHARES-REDEEMED> (333381)
<SHARES-REINVESTED> 21632
<NET-CHANGE-IN-ASSETS> (26390402)
<ACCUMULATED-NII-PRIOR> 0
<ACCUMULATED-GAINS-PRIOR> (16973057)
<OVERDISTRIB-NII-PRIOR> 0
<OVERDIST-NET-GAINS-PRIOR> (2265631)
<GROSS-ADVISORY-FEES> 3422246
<INTEREST-EXPENSE> 0
<GROSS-EXPENSE> 6316040
<AVERAGE-NET-ASSETS> 9113048
<PER-SHARE-NAV-BEGIN> 11.49
<PER-SHARE-NII> .57
<PER-SHARE-GAIN-APPREC> .33
<PER-SHARE-DIVIDEND> (.57)
<PER-SHARE-DISTRIBUTIONS> 0
<RETURNS-OF-CAPITAL> 0
<PER-SHARE-NAV-END> 11.82
<EXPENSE-RATIO> 1.24
<AVG-DEBT-OUTSTANDING> 0
<AVG-DEBT-PER-SHARE> 0
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 6
<SERIES>
<NUMBER> 004
<NAME> MERRILL LYNCH CALIFORNIA MUNICIPAL BOND FUND - CLASS D SHARES
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> AUG-31-1997
<PERIOD-START> SEP-01-1996
<PERIOD-END> AUG-31-1997
<INVESTMENTS-AT-COST> 580294043
<INVESTMENTS-AT-VALUE> 626372705
<RECEIVABLES> 20133485
<ASSETS-OTHER> 196368
<OTHER-ITEMS-ASSETS> 0
<TOTAL-ASSETS> 646702558
<PAYABLE-FOR-SECURITIES> 27657449
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 2170737
<TOTAL-LIABILITIES> 29828186
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 582753430
<SHARES-COMMON-STOCK> 15682302
<SHARES-COMMON-PRIOR> 9729971
<ACCUMULATED-NII-CURRENT> 0
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> (11912626)
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> 46033568
<NET-ASSETS> 185300250
<DIVIDEND-INCOME> 0
<INTEREST-INCOME> 38438745
<OTHER-INCOME> 0
<EXPENSES-NET> (6316040)
<NET-INVESTMENT-INCOME> 32122705
<REALIZED-GAINS-CURRENT> 7326062
<APPREC-INCREASE-CURRENT> 10038184
<NET-CHANGE-FROM-OPS> 49486951
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> (8357884)
<DISTRIBUTIONS-OF-GAINS> 0
<DISTRIBUTIONS-OTHER> 0
<NUMBER-OF-SHARES-SOLD> 7598195
<NUMBER-OF-SHARES-REDEEMED> (1956003)
<SHARES-REINVESTED> 310139
<NET-CHANGE-IN-ASSETS> (26390402)
<ACCUMULATED-NII-PRIOR> 0
<ACCUMULATED-GAINS-PRIOR> (16973057)
<OVERDISTRIB-NII-PRIOR> 0
<OVERDIST-NET-GAINS-PRIOR> (2265631)
<GROSS-ADVISORY-FEES> 3422246
<INTEREST-EXPENSE> 0
<GROSS-EXPENSE> 6316040
<AVERAGE-NET-ASSETS> 155549854
<PER-SHARE-NAV-BEGIN> 11.49
<PER-SHARE-NII> .63
<PER-SHARE-GAIN-APPREC> .33
<PER-SHARE-DIVIDEND> (.63)
<PER-SHARE-DISTRIBUTIONS> 0
<RETURNS-OF-CAPITAL> 0
<PER-SHARE-NAV-END> 11.82
<EXPENSE-RATIO> .73
<AVG-DEBT-OUTSTANDING> 0
<AVG-DEBT-PER-SHARE> 0
</TABLE>
<PAGE>
EXHIBIT 99.11
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. 13 to Registration
Statement No. 2-96581 of our report dated October 8, 1997 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.
/s/ Deloitte & Touche LLP
Deloitte & Touche LLP
Princeton, New Jersey
November 25, 1997
