<PAGE>
As filed with the Securities and Exchange Commission on December 3, 1999
Securities Act File No. 2-96581
Investment Company Act File No. 811-4264
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- -------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------
FORM N-1A
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 [X]
Pre-Effective Amendment No. [_]
Post-Effective Amendment No. 16 [X]
and/or
REGISTRATION STATEMENT UNDER THE
INVESTMENT COMPANY ACT OF 1940 [X]
Amendment No. 27 [X]
(Check appropriate box or boxes)
----------------
MERRILL LYNCH CALIFORNIA
MUNICIPAL BOND FUND
of Merrill Lynch California Municipal Series Trust
(Exact Name of Registrant as Specified in Charter)
800 Scudders Mill Road, Plainsboro, New Jersey 08536
(Address of Principal Executive Offices)
Registrant's telephone number, including Area Code: (609) 282-2800
TERRY K. GLENN
Merrill Lynch California Municipal Series Trust
800 Scudders Mill Road
Plainsboro, New Jersey
Mailing Address: P.O. Box 9011, Princeton, New Jersey 08543-9011
(Name and Address of Agent for Service)
Copies to:
<TABLE>
<S> <C>
Counsel for the Trust: Michael J. Hennewinkel, Esq.
BROWN & WOOD LLP MERRILL LYNCH ASSET
One World Trade Center MANAGEMENT
New York, New York 10048-0557 P.O. Box 9011
Attention: Thomas R. Smith, Jr., Esq. Princeton, New Jersey 08543-9011
</TABLE>
----------------
It is proposed that this filing will become effective (check appropriate box)
[X] immediately upon filing pursuant to paragraph (b)
[_] on (date) pursuant to paragraph (b)
[_] 60 days after filing pursuant to paragraph (a)(1)
[_] on (date) pursuant to paragraph (a)(1)
[_] 75 days after filing pursuant to paragraph (a)(2)
[_] on (date) pursuant to paragraph (a)(2) of Rule 485.
If appropriate, check the following box:
[_] This post-effective amendment designates a new effective date for a
previously filed post-effective amendment.
----------------
Title of Securities Being Registered: Shares of Beneficial Interest, par value
$.10 per share.
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<PAGE>
Prospectus
[LOGO] Merrill Lynch
Merrill Lynch California Municipal Bond Fund
of Merrill Lynch California Municipal Series Trust
[GRAPHIC]
December 3, 1999
This Prospectus contains information you should know
before investing, including information about risks.
Please read it before you invest and keep it for
future reference.
The Securities and Exchange Commission has not
approved or disapproved these securities or passed
upon the adequacy of this Prospectus. Any
representation to the contrary is a criminal offense.
<PAGE>
Table of Contents
<TABLE>
<CAPTION>
PAGE
[GRAPHIC]
KEY FACTS
<S> <C>
- -------------------------------------------------------------------------------
Merrill Lynch California Municipal Bond Fund at a Glance..................... 3
Risk/Return Bar Chart........................................................ 5
Fees and Expenses............................................................ 6
[GRAPHIC]
DETAILS ABOUT THE FUND
- -------------------------------------------------------------------------------
How the Fund Invests......................................................... 8
Investment Risks............................................................. 9
[GRAPHIC]
YOUR ACCOUNT
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Merrill Lynch Select Pricing SM System...................................... 14
How to Buy, Sell, Transfer and Exchange Shares...............................19
Participation in Merrill Lynch Fee-Based Programs........................... 23
[GRAPHIC]
MANAGEMENT OF THE FUND
- -------------------------------------------------------------------------------
Fund Asset Management....................................................... 26
Financial Highlights........................................................ 27
[GRAPHIC]
FOR MORE INFORMATION
- -------------------------------------------------------------------------------
Shareholder Reports................................................. Back Cover
Statement of Additional Information................................. Back Cover
</TABLE>
MERRILL LYNCH CALIFORNIA MUNICIPAL BOND FUND
<PAGE>
Key Facts [GRAPHIC]
In an effort to help you better understand the many concepts involved in making
an investment decision, we have defined the highlighted terms in this
prospectus in the sidebar.
Investment Grade -- any of the four highest debt obligation ratings by
recognized rating agencies, including Moody's Investors Service, Inc., Standard
& Poor's or Fitch IBCA, Inc.
California Municipal Bond -- a debt obligation issued by or on behalf of a
governmental entity in California or other qualifying issuer that pays interest
exempt from California income taxes as well as from Federal income tax.
MERRILL LYNCH CALIFORNIA MUNICIPAL BOND FUND AT A GLANCE
- --------------------------------------------------------------------------------
What is the Fund's investment objective?
The investment objective of the Fund is to provide shareholders with income
exempt from Federal and California income taxes.
What are the Fund's main investment strategies?
The Fund invests primarily in a portfolio of long term investment grade
California municipal bonds. These may be obligations of a variety of issuers
including governmental entities in California and issuers located in Puerto
Rico, the U.S. Virgin Islands and Guam. The Fund will invest at least 65% of
its total assets in California municipal bonds and at least 80% of its total
assets in California municipal bonds and other bonds that pay interest exempt
from Federal income tax but not California income tax. The Fund may invest up
to 20% of its assets in high yield bonds (also known as "junk" bonds). The Fund
also may invest in certain types of derivative securities. When choosing
investments, Fund management considers various factors, including the credit
quality of issuers, yield analysis, maturity analysis and the call features of
the obligations. Under normal circumstances, the Fund's weighted average
maturity will be more than ten years. The Fund cannot guarantee that it will
achieve its objective.
What are the main risks of investing in the Fund?
As with any mutual fund, the value of the Fund's investments -- and therefore
the value of Fund shares -- may go up or down. These changes may occur in
response to interest rate changes or other factors that may affect a particular
issuer or obligation. Generally, when interest rates go up, the value of debt
instruments like municipal bonds goes down. If the value of the Fund's
investments goes down, you may lose money. Prices of longer term securities
generally change more in response to interest rate changes than prices of
shorter term securities.
In addition, since the Fund invests at least 65% of its assets in California
municipal bonds, it is more exposed to negative political or economic factors
in California than a fund that invests more widely. Derivatives and high yield
bonds may be volatile and subject to liquidity, leverage and credit risks.
MERRILL LYNCH CALIFORNIA MUNICIPAL BOND FUND
3
<PAGE>
[LOGO] Key Facts
MERRILL LYNCH CALIFORNIA MUNICIPAL BOND FUND
Who should invest?
The Fund may be an appropriate investment for you if you:
. Are looking for income that is exempt from Federal and California income
taxes
. Want a professionally managed portfolio without the administrative
burdens of direct investments in municipal bonds
. Are looking for liquidity
. Can tolerate the risk of loss caused by negative political or economic
developments in California, changes in interest rates or adverse changes
in the price of bonds in general
4
<PAGE>
RISK/RETURN BAR CHART
- --------------------------------------------------------------------------------
The bar chart and table shown below provide an indication of the risks of
investing in the Fund. The bar chart shows changes in the Fund's performance
for Class B shares for each of the past ten calendar years. Sales charges are
not reflected in the bar chart. If these amounts were reflected, returns would
be less than those shown. The table compares the average annual total returns
for each class of the Fund's shares for the periods shown with those of the
Lehman Brothers Municipal Bond Index. How the Fund performed in the past is not
necessarily an indication of how the Fund will perform in the future.
[BAR CHART]
1989 1990 1991 1992 1993 1994 1995 1996 1997 1998
----- ----- ------ ----- ------ ------ ------ ----- ----- -----
9.69% 5.51% 10.33% 7.94% 12.22% (7.50%) 17.07% 3.87% 8.21% 5.41%
During the ten-year period shown in the bar chart, the highest return for a
quarter was 7.50% (quarter ended March 31, 1995) and the lowest return for a
quarter was -6.25% (quarter ended March 31, 1994). The Fund's year-to-date
return as of September 30, 1999 was -3.75%.
<TABLE>
<CAPTION>
Average Annual Total Returns (as
of the Past Ten
calendar year ended) Past Past Years/Since
December 31, 1998 One Year Five Years Inception
- -----------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Merrill Lynch California
Municipal Bond Fund* A 1.79% 4.79% 7.20%
Lehman Brothers Municipal Bond Index** 6.48% 6.22% 8.21%
- -----------------------------------------------------------------------------
Merrill Lynch California
Municipal Bond Fund* B 1.47% 5.11% 7.09%
Lehman Brothers Municipal
Bond Index** 6.48% 6.22% 8.21%
- -----------------------------------------------------------------------------
Merrill Lynch California
Municipal Bond Fund* C 4.41% N/A 7.55%+
Lehman Brothers Municipal
Bond Index** 6.48% N/A 8.98%++
- -----------------------------------------------------------------------------
Merrill Lynch California
Municipal Bond Fund* D 1.69% N/A 7.05%+
Lehman Brothers Municipal
Bond Index** 6.48% N/A 8.98%++
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</TABLE>
* Includes sales charge.
** This unmanaged Index consists of long-term revenue bonds, prerefunded bonds,
general obligation bonds and insured bonds. Past performance is not
predictive of future performance.
+ Inception date is October 21, 1994.
++ Since October 31, 1994.
MERRILL LYNCH CALIFORNIA MUNICIPAL BOND FUND
5
<PAGE>
[GRAPHIC] Key Facts
UNDERSTANDING EXPENSES
Fund investors pay various fees and expenses, either directly or indirectly.
Listed below are some of the main types of expenses, which all mutual funds may
charge:
Expenses paid directly by the shareholder:
Shareholder Fees -- these include sales charges which you may pay when you buy
or sell shares of the Fund.
Expenses paid indirectly by the shareholder:
Annual Fund Operating Expenses -- expenses that cover the costs of operating
the Fund.
Management Fee -- a fee paid to the Manager for managing the Fund.
Distribution Fees -- fees used to support the Fund's marketing and distribution
efforts, such as compensating Financial Consultants, advertising and promotion.
Service (Account Maintenance) Fees -- fees used to compensate securities
dealers for account maintenance activities.
FEES AND EXPENSES
- --------------------------------------------------------------------------------
The Fund offers four different classes of shares. Although your money will be
invested the same way no matter which class of shares you buy, there are
differences among the fees and expenses associated with each class. Not
everyone is eligible to buy every class. After determining which classes you
are eligible to buy, decide which class best suits your needs. Your Merrill
Lynch Financial Consultant can help you with this decision.
This table shows the different fees and expenses that you may pay if you buy
and hold the different classes of shares of the Fund. Future expenses may be
greater or less than those indicated below.
<TABLE>
<CAPTION>
Shareholder Fees (Fees
paid directly from your
investment)(a): Class A Class B(b) Class C Class D
- ---------------------------------------------------------------
<S> <C> <C> <C> <C>
Maximum Sales Charge
(Load) imposed on
purchases (as a
percentage of offering
price) 4.00%(c) None None 4.00%(c)
- ---------------------------------------------------------------
Maximum Deferred Sales
Charge (Load) (as a
percentage of original
purchase price or
redemption proceeds,
whichever is lower) None(d) 4.0%(c) 1.0%(c) None(d)
- ---------------------------------------------------------------
Maximum Sales Charge
(Load) imposed on
Dividend Reinvestments None None None None
- ---------------------------------------------------------------
Redemption Fee None None None None
- ---------------------------------------------------------------
Exchange Fee None None None None
- ---------------------------------------------------------------
Annual Fund Operating Expenses
(Expenses that are deducted from
Fund assets):
- ---------------------------------------------------------------
Management Fee(e) 0.55% 0.55% 0.55% 0.55%
- ---------------------------------------------------------------
Distribution and/or
Service (12b-1) Fees(f) None 0.50% 0.60% 0.10%
- ---------------------------------------------------------------
Other Expenses
(including transfer
agency fees)(g) 0.10% 0.11% 0.11% 0.10%
- ---------------------------------------------------------------
Total Annual Fund
Operating Expenses 0.65% 1.16% 1.26% 0.75%
- ---------------------------------------------------------------
</TABLE>
(a) In addition, Merrill Lynch may charge clients a processing fee (currently
$5.35) when a client buys or redeems shares.
(b) Class B shares automatically convert to Class D shares about ten years
after you buy them. Then they will no longer be subject to distribution
fees and will pay lower account maintenance fees.
(c) Some investors may qualify for reductions in the sales charge (load).
(d) You may pay a deferred sales charge if you purchase $1 million or more and
you redeem within one year.
(e) The Fund pays the Manager a fee at the annual rate of 0.55% of the average
daily net assets of the Fund for the first $500 million; 0.525% of the
average daily net assets from $500 million to $1 billion; and 0.50% of the
average daily net assets above $1 billion. For the fiscal year ended August
31, 1999, the Manager received a fee equal to 0.55% of the Fund's average
daily
MERRILL LYNCH CALIFORNIA MUNICIPAL BOND FUND
6
<PAGE>
(footnotes continued from previous page)
net assets but the Manager voluntarily waived $20,299 of the management fee
due.
(f) The Fund calls the "Service Fee" an "Account Maintenance Fee." Account
Maintenance Fee is the term used elsewhere in this Prospectus and in all
other Fund materials. If you hold Class B or Class C shares for a long
time, it may cost you more in distribution (12b-1) fees than the maximum
sales charge that you would have paid if you had bought one of the other
classes.
(g) The Fund pays the Transfer Agent $11.00 for each Class A and Class D
shareholder account and $14.00 for each Class B and Class C shareholder
account and reimburses the Transfer Agent's out-of-pocket expenses. The
Fund pays a 0.10% fee for certain accounts that participate in the Merrill
Lynch Mutual Fund Advisor program. The Fund also pays a $0.20 monthly
closed account charge, which is assessed upon all accounts that close
during the year. This fee begins the month following the month the account
is closed and ends at the end of the calendar year. For the fiscal year
ended August 31, 1999, the Fund paid the Transfer Agent fees totaling
$207,676. The Manager provides accounting services to the Fund at its cost.
For the fiscal year ended August 31, 1999, the Fund reimbursed the Manager
$96,166 for these services.
Examples:
These examples are intended to help you compare the cost of investing in the
Fund with the cost of investing in other mutual funds.
These examples assume that you invest $10,000 in the Fund for the time periods
indicated, that your investment has a 5% return each year, that you pay the
sales charges, if any, that apply to the particular class and that the Fund's
operating expenses remain the same. This assumption is not meant to indicate
you will receive a 5% annual rate of return. Your annual return may be more or
less than the 5% used in this example. Although your actual costs may be higher
or lower, based on these assumptions your costs would be:
EXPENSES IF YOU DID REDEEM YOUR SHARES:
---
<TABLE>
<CAPTION>
1 Year 3 Years 5 Years 10 Years
- -------------------------------------------
<S> <C> <C> <C> <C>
Class A $464 $600 $748 $1,178
- -------------------------------------------
Class B $518 $568 $638 $1,409
- -------------------------------------------
Class C $228 $400 $692 $1,523
- -------------------------------------------
Class D $474 $630 $800 $1,293
- -------------------------------------------
EXPENSES IF YOU DID NOT REDEEM YOUR SHARES:
-------
<CAPTION>
1 Year 3 Years 5 Years 10 Years
- -------------------------------------------
<S> <C> <C> <C> <C>
Class A $464 $600 $748 $1,178
- -------------------------------------------
Class B $118 $368 $638 $1,409
- -------------------------------------------
Class C $128 $400 $692 $1,523
- -------------------------------------------
Class D $474 $630 $800 $1,293
- -------------------------------------------
</TABLE>
MERRILL LYNCH CALIFORNIA MUNICIPAL BOND FUND
7
<PAGE>
Details About the Fund [GRAPHIC]
ABOUT THE PORTFOLIO MANAGER
Walter O'Connor is Vice President and portfolio manager of the Fund. Mr.
O'Connor has been a Director (Municipal Tax-Exempt) of Merrill Lynch Asset
Management since 1997. Prior to that date, Mr. O'Connor was a Vice President of
Merrill Lynch Asset Management from 1993 to 1997.
ABOUT THE MANAGER
The Fund is managed by Fund Asset Management.
HOW THE FUND INVESTS
- --------------------------------------------------------------------------------
The Fund's main objective is to seek income exempt from Federal and California
income taxes. The Fund invests primarily in long term, investment grade
California municipal bonds. These may be obligations of a variety of issuers
including governmental entities or other qualifying issuers. Issuers may be
located in California or in other qualifying jurisdictions such as Puerto Rico,
the U.S. Virgin Islands and Guam.
The Fund may invest in either fixed rate or variable rate obligations. At least
80% of the Fund's total assets will be invested in investment grade securities.
The Fund may invest up to 20% of its total assets in high yield ("junk") bonds.
These bonds are generally more speculative and involve greater price
fluctuations than investment grade securities.
The Fund will invest at least 80% of its total assets in obligations that pay
interest exempt from Federal income tax and at least 65% of its total assets in
California municipal bonds. Under normal conditions, the Fund's weighted
average maturity will be more than ten years. For temporary periods, however,
the Fund may invest up to 35% of its total assets in short term tax exempt or
taxable money market obligations, although the Fund will not generally invest
more than 20% of its net assets in taxable money market obligations. As a
temporary measure for defensive purposes, the Fund may invest without
limitation in short term tax exempt or taxable money market obligations. These
short term investments may limit the potential for the Fund to achieve its
objective.
The Fund may use derivatives including futures, options, indexed securities and
inverse securities. Derivatives are financial instruments whose value is
derived from another security or an index such as the Lehman Brothers Municipal
Bond Index.
The Fund's investments may include private activity bonds that may subject
certain shareholders to a Federal alternative minimum tax.
Economic conditions in California are influenced by developments in a number of
industries including technology business services (such as computer software),
construction, computers and electronic components, as well as by the economies
of Canada and Latin America, California's largest trading partners. The Manager
believes that current economic conditions in California will enable the Fund to
continue to invest in high quality California municipal bonds.
MERRILL LYNCH CALIFORNIA MUNICIPAL BOND FUND
8
<PAGE>
Fund management considers a variety of factors when choosing investments, such
as:
. Credit Quality of Issuers --
based on bond ratings and other
factors including economic and
financial conditions.
. Yield Analysis -- takes into
account factors such as the
different yields available on
different types of obligations
and the shape of the yield curve
(longer term obligations
typically have higher yields).
. Maturity Analysis -- the weighted
average maturity of the portfolio
will be maintained within a
desirable range as determined
from time to time. Factors
considered include portfolio
activity, maturity of the supply
of available bonds and the shape
of the yield curve.
In addition, Fund management considers the availability of features that
protect against an early call of a bond by the issuer.
INVESTMENT RISKS
- --------------------------------------------------------------------------------
This section contains a summary discussion of the general risks of investing in
the Fund. As with any mutual fund, there can be no guarantee that the Fund will
meet its goals or that the Fund's performance will be positive for any period
of time.
Bond Market and Selection Risk -- Bond market risk is the risk that the bond
market will go down in value, including the possibility that the market will go
down sharply and unpredictably. Selection risk is the risk that the investments
that Fund management selects will underperform the market or other funds with
similar investment objectives and investment strategies.
Credit Risk -- Credit risk is the risk that the issuer will be unable to pay
the interest or principal when due. The degree of credit risk depends on both
the financial condition of the issuer and the terms of the obligation.
Interest Rate Risk -- Interest rate risk is the risk that prices of municipal
bonds generally increase when interest rates decline and decrease when interest
rates increase. Prices of longer term securities generally change more in
response to interest rate changes than prices of shorter term securities.
MERRILL LYNCH CALIFORNIA MUNICIPAL BOND FUND
9
<PAGE>
[GRAPHIC] Details About the Fund
State Specific Risk -- The Fund will invest primarily in California municipal
bonds. As a result, the Fund is more exposed to risks affecting issuers of
California municipal bonds than is a municipal bond fund that invests more
widely. California's economy is the largest among the fifty states and one of
the largest in the world. The diversified economy has major components in
agriculture, manufacturing, high technology, trade, entertainment, tourism,
construction and services. Moody's, Standard & Poor's and Fitch currently rate
the State of California's general obligation bonds Aa3, AA- and AA-,
respectively.
Call and Redemption Risk -- A bond's issuer may call a bond for redemption
before it matures. If this happens to a bond the Fund holds, the Fund may lose
income and may have to invest the proceeds in bonds with lower yields.
Borrowing And Leverage -- The Fund may borrow for temporary emergency purposes
including to meet redemptions. Borrowing may exaggerate changes in the net
asset value of Fund shares and in the yield on the Fund's portfolio. Borrowing
will cost the Fund interest expense and other fees. The costs of borrowing may
reduce the Fund's return. Certain securities that the Fund buys may create
leverage including, for example, when issued securities, forward commitments
and options.
Risks associated with certain types of obligations in which the Fund may invest
include:
General Obligation Bonds -- The faith, credit and taxing power of the issuer
that issues a general obligation bond secures payment of interest and repayment
of principal. Timely payments depend on the issuer's credit quality, ability to
raise tax revenues and ability to maintain an adequate tax base.
Revenue Bonds -- Payments of interest and principal on revenue bonds are made
only from the revenues generated by a particular facility, class of facilities
or the proceeds of a special tax or other revenue source. These payments depend
on the money earned by the particular facility or class of facilities.
Industrial development bonds are one type of revenue bond.
Industrial Development Bonds -- Municipalities and other public authorities
issue industrial development bonds to finance development of industrial
facilities for use by a private enterprise. The private enterprise pays the
principal and interest on the bond, and the issuer does not pledge its
MERRILL LYNCH CALIFORNIA MUNICIPAL BOND FUND
10
<PAGE>
faith, credit and taxing power for repayment. If the private enterprise
defaults on its payments, the Fund may not receive any income or get its money
back from the investment.
Moral Obligation Bonds -- Moral obligation bonds are generally issued by
special purpose public authorities of a state or municipality. If the issuer is
unable to meet its obligations, repayment of these bonds becomes a moral
commitment, but not a legal obligation, of the state or municipality.
Municipal Notes -- Municipal notes are shorter term municipal debt obligations.
They may provide interim financing in anticipation of tax collection, bond
sales or revenue receipts. If there is a shortfall in the anticipated proceeds,
the notes may not be fully repaid and the Fund may lose money.
Municipal Lease Obligations -- In a municipal lease obligation, the issuer
often agrees to budget for and appropriate municipal funds to make payments due
on the lease obligation. However, this does not ensure that funds will actually
be appropriated in future years. The issuer does not pledge its unlimited
taxing power for payment of the lease obligation, but the leased property
secures the obligation. In addition, the proceeds of a sale may not cover the
Fund's loss.
Insured Municipal Bonds -- Bonds purchased by the Fund may be covered by
insurance that guarantees timely interest payments and repayment of principal
on maturity. If a bond's insurer fails to fulfill its obligations or loses its
credit rating, the value of the bond could drop. Insured bonds are subject to
market risks.
Junk Bonds -- Junk bonds are debt securities that are rated below investment
grade by the major rating agencies or are unrated securities that Fund
management believes are of comparable quality. The Fund does not intend to
purchase debt securities that are in default or that Fund management believes
will be in default. Although junk bonds generally pay higher rates of interest
than investment grade bonds, they are high risk investments that may cause
income and principal losses for the Fund. Junk bonds generally are less liquid
and experience more price volatility than higher rated debt securities. The
issuers of junk bonds may have a larger
MERRILL LYNCH CALIFORNIA MUNICIPAL BOND FUND
11
<PAGE>
[GRAPHIC] Details About the Fund
amount of outstanding debt relative to their assets than issuers of investment
grade bonds. In the event of an issuer's bankruptcy, claims of other creditors
may have priority over the claims of junk bond holders, leaving few or no
assets available to repay junk bond holders. Junk bonds may be subject to
greater call and redemption risk than higher rated debt securities.
When Issued Securities, Delayed Delivery Securities And Forward Commitments --
When issued and delayed delivery securities and forward commitments involve
the risk that the security the Fund buys will lose value prior to its delivery
to the Fund. There also is the risk that the security will not be issued or
that the other party will not meet its obligation, in which case the Fund loses
the investment opportunity for the assets it has set aside to pay for the
security and any gain in the security's price.
Variable Rate Demand Obligations -- Variable rate demand obligations (VRDOs)
are floating rate securities that combine an interest in a long term municipal
bond with a right to demand payment before maturity from a bank or other
financial institution. If the bank or financial institution is unable to pay,
the Fund may lose money.
Illiquid Investments -- The Fund may invest up to 15% of its assets in illiquid
securities that it cannot easily resell within seven days at current value or
that have contractual or legal restrictions on resale. If the Fund buys
illiquid securities it may be unable to quickly resell them or may be able to
sell them only at a price below current value.
Derivatives -- The Fund may use derivative instruments including indexed and
inverse securities, options on portfolio positions, options on securities or
other financial indices, financial futures and options on such futures.
Derivatives allow the Fund to increase or decrease its risk exposure more
quickly and efficiently than other types of instruments.
Derivatives are volatile and involve significant risks, including:
Credit risk -- the risk that the
counterparty (the party on the
other side of the transaction) on
a derivative transaction will be
unable to honor its financial
obligation to the Fund.
Leverage risk -- the risk
associated with certain types of
investments or trading strategies
that relatively small market
movements may result in large
changes in the value of an
investment. Certain investments or
trading strategies that involve
leverage can result in losses that
greatly exceed the amount
originally invested.
MERRILL LYNCH CALIFORNIA MUNICIPAL BOND FUND
12
<PAGE>
Liquidity Risk -- the risk that
certain securities may be difficult
or impossible to sell at the time
that the seller would like or at
the price that the seller believes
the security is currently worth.
The Fund may use derivatives for hedging purposes including anticipatory
hedges. Hedging is a strategy in which the Fund uses a derivative to offset the
risk that other Fund holdings may decrease in value. While hedging can reduce
losses, it can also reduce or eliminate gains if the market moves in a
different manner than anticipated by the Fund or if the cost of the derivative
outweighs the benefit of the hedge. Hedging also involves the risk that changes
in the value of the derivative will not match those of the holdings being
hedged as expected by the Fund, in which case any losses on the holdings being
hedged may not be reduced. There can be no assurance that the Fund's hedging
strategy will reduce risk or that hedging transactions will be either available
or cost effective. The Fund is not required to use hedging and may choose not
to do so.
Indexed and Inverse Floating Rate Securities -- The Fund may invest in
securities whose potential returns are directly related to changes in an
underlying index or interest rate, known as indexed securities. The return on
indexed securities will rise when the underlying index or interest rate rises
and fall when the index or interest rate falls. The Fund may also invest in
securities whose return is inversely related to changes in an interest rate
(inverse floaters). In general, income on inverse floaters will decrease when
short term interest rates increase and increase when short term interest rates
decrease. Investments in inverse floaters may subject the Fund to the risks of
reduced or eliminated interest payments and losses of principal. In addition,
certain indexed securities and inverse floaters may increase or decrease in
value at a greater rate than the underlying interest rate, which effectively
leverages the Fund's investment. As a result, the market value of such
securities will generally be more volatile than that of fixed rate, tax exempt
securities. Both indexed securities and inverse floaters are derivative
securities and can be considered speculative.
STATEMENT OF ADDITIONAL INFORMATION
- --------------------------------------------------------------------------------
If you would like further information about the Fund, including how it invests,
please see the Statement of Additional Information.
MERRILL LYNCH CALIFORNIA MUNICIPAL BOND FUND
13
<PAGE>
Your Account [GRAPHIC]
MERRILL LYNCH SELECT PRICING SM SYSTEM
- --------------------------------------------------------------------------------
The Fund offers four share classes, each with its own sales charge and expense
structure, allowing you to invest in the way that best suits your needs. Each
share class represents an ownership interest in the same investment portfolio.
When you choose your class of shares you should consider the size of your
investment and how long you plan to hold your shares. Your Merrill Lynch
Financial Consultant can help you determine which share class is best suited to
your personal financial goals.
For example, if you select Class A or D shares, you generally pay a sales
charge at the time of purchase. If you buy Class D shares, you also pay an
ongoing account maintenance fee of 0.10%. You may be eligible for a sales
charge reduction or waiver.
If you select Class B or C shares, you will invest the full amount of your
purchase price, but you will be subject to a distribution fee of 0.25% on Class
B shares or 0.35% on Class C shares and an account maintenance fee of 0.25% on
both classes. Because these fees are paid out of the Fund's assets on an
ongoing basis, over time these fees increase the cost of your investment and
may cost you more than paying an initial sales charge. In addition, you may be
subject to a deferred sales charge when you sell Class B or C shares.
The Fund's shares are distributed by Merrill Lynch Funds Distributor, a
division of Princeton Funds Distributor, Inc., an affiliate of Merrill Lynch.
The Fund is a series of the Merrill Lynch California Municipal Series Trust.
MERRILL LYNCH CALIFORNIA MUNICIPAL BOND FUND
14
<PAGE>
The table below summarizes key features of the Merrill Lynch Select Pricing(SM)
System.
<TABLE>
<CAPTION>
Class A Class B Class C Class D
- -------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Availability Limited to certain Generally available Generally available Generally available
investors through Merrill through Merrill through Merrill
including: Lynch. Limited Lynch. Limited Lynch. Limited
. Current Class A availability through availability through availability
shareholders other securities other securities through other
. Participants in dealers. dealers. securities dealers.
certain Merrill
Lynch
sponsored programs
. Certain
affiliates of
Merrill Lynch.
- -------------------------------------------------------------------------------------------------------
Initial Sales Yes. Payable at No. Entire purchase No. Entire purchase Yes. Payable at
Charge? time of purchase. price is invested in price is invested in time of purchase.
Lower sales charges shares of the Fund. shares of the Fund. Lower sales charges
available for available for
larger investments. larger investments.
- -------------------------------------------------------------------------------------------------------
Deferred Sales No. (May be charged Yes. Payable if you Yes. Payable if you No. (May be charged
Charge? for purchases over redeem within four redeem within one for purchases over
$1 million that are years of purchase. year of purchase. $1 million that are
redeemed within redeemed within one
one year.) year.)
- -------------------------------------------------------------------------------------------------------
Account No. 0.25% Account 0.25% Account 0.10% Account
Maintenance and Maintenance Fee. Maintenance Fee. Maintenance Fee.
Distribution Fees? 0.25% Distribution 0.35% Distribution No Distribution
Fee. Fee. Fee.
- -------------------------------------------------------------------------------------------------------
Conversion to No. Yes, automatically No. No.
Class D shares? after approximately
ten years.
</TABLE>
- --------------------------------------------------------------------------------
MERRILL LYNCH CALIFORNIA MUNICIPAL BOND FUND
15
<PAGE>
[GRAPHIC] Your Account
Right of Accumulation -- permits you to pay the sales charge that would apply
to the cost or value (whichever is higher) of all shares you own in the Merrill
Lynch mutual funds that offer Select Pricing options.
Letter of Intent -- permits you to pay the sales charge that would be
applicable if you add up all shares of Merrill Lynch Select Pricing(SM) System
funds that you agree to buy within a 13 month period. Certain restrictions
apply.
Class A and Class D Shares -- Initial Sales Charge Options
If you select Class A or Class D shares, you will pay a sales charge at the
time of purchase.
<TABLE>
<CAPTION>
Dealer
Compensation
As a % of As a % of as a % of
Your Investment Offering Price Your Investment* Offering Price
- ------------------------------------------------------------------
<S> <C> <C> <C>
Less than
$25,000 4.00% 4.17% 3.75%
- ------------------------------------------------------------------
$25,000 but less
than $50,000 3.75% 3.90% 3.50%
- ------------------------------------------------------------------
$50,000 but less
than $100,000 3.25% 3.36% 3.00%
- ------------------------------------------------------------------
$100,000 but
less than
$250,000 2.50% 2.56% 2.25%
- ------------------------------------------------------------------
$250,000 but
less than
$1,000,000 1.50% 1.52% 1.25%
- ------------------------------------------------------------------
$1,000,000 and
over** 0.00% 0.00% 0.00%
- ------------------------------------------------------------------
</TABLE>
* Rounded to the nearest one-hundredth percent.
** If you invest $1,000,000 or more in Class A or Class D shares, you may not
pay an initial sales charge. However, if you redeem your shares within one
year after purchase, you may be charged a deferred sales charge. This charge
is 1% of the lesser of the original cost of the shares being redeemed or
your redemption proceeds.
No initial sales charge applies to Class A or Class D shares that you buy
through reinvestment of dividends.
A reduced or waived sales charge on a purchase of Class A or Class D shares may
apply for:
. Purchases under a Right of
Accumulation or Letter of Intent
. TMA SM Managed Trusts
. Certain Merrill Lynch investment
or central asset accounts
. Purchases using proceeds from the
sale of certain Merrill Lynch
closed-end funds under certain
circumstances
. Certain investors, including di-
rectors or trustees of Merrill
Lynch mutual funds and Merrill
Lynch employees
. Certain Merrill Lynch fee-based
programs
MERRILL LYNCH CALIFORNIA MUNICIPAL BOND FUND
16
<PAGE>
Only certain investors are eligible to buy Class A shares. Your Merrill Lynch
Financial Consultant can help you determine whether you are eligible to buy
Class A shares or to participate in any of these programs.
If you decide to buy shares under the initial sales charge alternative and you
are eligible to buy both Class A and Class D shares, you should buy Class A
since Class D shares are subject to a 0.10% account maintenance fee, while
Class A shares are not.
If you redeem Class A or Class D shares and within 30 days buy new shares of
the same class, you will not pay a sales charge on the new purchase amount. The
amount eligible for this "Reinstatement Privilege" may not exceed the amount of
your redemption proceeds. To exercise the privilege, contact your Merrill Lynch
Financial Consultant or the Fund's Transfer Agent at 1-800-MER-FUND.
Class B and Class C Shares -- Deferred Sales Charge Options
If you select Class B or Class C shares, you do not pay an initial sales charge
at the time of purchase. However, if you redeem your Class B shares within four
years after purchase, or your Class C shares within one year after purchase,
you may be required to pay a deferred sales charge. You will also pay
distribution fees of 0.25% for Class B shares and 0.35% for Class C shares and
account maintenance fees of 0.25% for Class B and Class C shares each year
under distribution plans that the Fund has adopted under Rule 12b-1. Because
these fees are paid out of the Fund's assets on an ongoing basis, over time
these fees increase the cost of your investment and may cost you more than
paying an initial sales charge. The Distributor uses the money that it receives
from the deferred sales charges and the distribution fees to cover the costs of
marketing, advertising and compensating the Merrill Lynch Financial Consultant
or other securities dealer who assists you in purchasing Fund shares.
MERRILL LYNCH CALIFORNIA MUNICIPAL BOND FUND
17
<PAGE>
[GRAPHIC] Your Account
Class B Shares
If you redeem Class B shares within four years after purchase, you may be
charged a deferred sales charge. The amount of the charge gradually decreases
as you hold your shares over time, according to the following schedule:
<TABLE>
<CAPTION>
Years Since
Purchase Sales Charge*
---------------------------------
<S> <C>
0 - 1 4.00%
---------------------------------
1 - 2 3.00%
---------------------------------
2 - 3 2.00%
---------------------------------
3 - 4 1.00%
---------------------------------
4 and thereafter 0.00%
---------------------------------
</TABLE>
* The percentage charge will apply to the lesser of the original cost of the
shares being redeemed or the proceeds of your redemption. Shares acquired
through reinvestment of dividends are not subject to a deferred sales
charge. Not all Merrill Lynch funds have identical deferred sales charge
schedules. If you exchange your shares for shares of another fund, the
higher charge will apply.
The deferred sales charge relating to Class B shares may be reduced or waived
in certain circumstances, such as:
. Redemption in connection with
participation in certain Merrill
Lynch fee-based programs
. Withdrawals resulting from
shareholder death or disability
as long as the waiver request is
made within one year of death or
disability or, if later,
reasonably promptly following
completion of probate, or in
connection with involuntary
termination of an account in
which Fund shares are held
. Withdrawal through the Merrill
Lynch Systematic Withdrawal Plan
of up to 10% per year of your
Class B account value at the time
the plan is established
Your Class B shares convert automatically into Class D shares approximately ten
years after purchase. Any Class B shares received through reinvestment of
dividends paid on converting shares will also convert at that time. Class D
shares are subject to lower annual expenses than Class B shares. The conversion
of Class B to Class D shares is not a taxable event for Federal income tax
purposes.
MERRILL LYNCH CALIFORNIA MUNICIPAL BOND FUND
18
<PAGE>
Different conversion schedules apply to Class B shares of different Merrill
Lynch mutual funds. For example, Class B shares of a fixed-income fund
typically convert approximately ten years after purchase compared to
approximately eight years for equity funds. If you acquire your Class B shares
in an exchange from another fund with a shorter conversion schedule, the Fund's
ten year conversion schedule will apply. If you exchange your Class B shares in
the Fund for Class B shares of a fund with a shorter conversion schedule, the
other fund's conversion schedule will apply. The length of time that you hold
both the original and exchanged Class B shares in both funds will count toward
the conversion schedule. The conversion schedule may be modified in certain
other cases as well.
Class C Shares
If you redeem Class C shares within one year after purchase, you may be charged
a deferred sales charge of 1.00%. The charge will apply to the lesser of the
original cost of the shares being redeemed or the proceeds of your redemption.
You will not be charged a deferred sales charge when you redeem shares that you
acquire through reinvestment of Fund dividends. The deferred sales charge
relating to Class C shares may be reduced or waived in connection with
involuntary termination of an account in which Fund shares are held and
withdrawals through the Merrill Lynch Systematic Withdrawal Plan.
Class C shares do not offer a conversion privilege.
HOW TO BUY, SELL, TRANSFER AND EXCHANGE SHARES
- --------------------------------------------------------------------------------
The chart on the following page summarizes how to buy, sell, transfer and
exchange shares through Merrill Lynch or other securities dealers. You may also
buy shares through the Transfer Agent. To learn more about buying, selling,
transferring or exchanging shares through the Transfer Agent, call1-800-MER-
FUND. Because the selection of a mutual fund involves many considerations, your
Merrill Lynch Financial Consultant may help you with this decision.
MERRILL LYNCH CALIFORNIA MUNICIPAL BOND FUND
19
<PAGE>
[GRAPHIC] Your Account
<TABLE>
<CAPTION>
If You Want To Your Choices Information Important for You to Know
- ---------------------------------------------------------------------------------------------------
<C> <C> <S>
Buy Shares First, select the share Refer to the Merrill Lynch Select Pricing table on page
class appropriate for 15. Be sure to read this prospectus carefully.
you
----------------------------------------------------------------------------------------
Next, determine the The minimum initial investment for the Fund is $1,000
amount of your for all accounts except that certain Merrill Lynch fee-
investment based programs have a $250 initial minimum investment.
(The minimums for initial investments may be waived
under certain circumstances.)
----------------------------------------------------------------------------------------
Have your Merrill Lynch The price of your shares is based on the next
Financial Consultant or calculation of net asset value after your order is
securities dealer submit placed. Any purchase orders placed prior to the close of
your purchase order business on the New York Stock Exchange (generally 4:00
p.m. Eastern time) will be priced at the net asset value
determined that day.
Purchase orders placed after that time will be priced at
the net asset value determined on the next business day.
The Fund may reject any order to buy shares and may
suspend the sale of shares at any time. Merrill Lynch
may charge a processing fee to confirm a purchase. This
fee is currently $5.35.
----------------------------------------------------------------------------------------
Or contact the Transfer To purchase shares directly, call the Transfer Agent at
Agent 1-800-MER-FUND and request a purchase application. Mail
the completed purchase application to the Transfer Agent
at the address on the inside back cover of this
Prospectus.
- ---------------------------------------------------------------------------------------------------
Add to Your Purchase additional The minimum investment for additional purchases is
Investment shares generally $50 except that certain programs, such as
automatic investment plans, may have higher minimums.
(The minimum for additional purchases may be waived
under certain circumstances.)
----------------------------------------------------------------------------------------
Acquire additional All dividends are automatically reinvested without a
shares through the sales charge.
automatic dividend
reinvestment plan
----------------------------------------------------------------------------------------
Participate in the You may invest a specific amount on a periodic basis
automatic investment through certain Merrill Lynch investment or central
plan asset accounts.
- ---------------------------------------------------------------------------------------------------
Transfer Shares Transfer to a You may transfer your Fund shares only to another
to Another participating securities securities dealer that has entered into an agreement
Securities dealer with Merrill Lynch. Certain shareholder services may not
Dealer be available for the transferred shares. You may only
purchase additional shares of funds previously owned
before the transfer. All future trading of these assets
must be coordinated by the receiving firm.
----------------------------------------------------------------------------------------
Transfer to a non- You must either:
participating securities . Transfer your shares to an account with the Transfer
dealer Agent; or
. Sell your shares, paying any applicable deferred
sales charge.
</TABLE>
- --------------------------------------------------------------------------------
MERRILL LYNCH CALIFORNIA MUNICIPAL BOND FUND
20
<PAGE>
<TABLE>
<CAPTION>
If You Want To Your Choices Information Important for You to Know
- ---------------------------------------------------------------------------------------------------
<C> <C> <S>
Sell Your Have your Merrill Lynch The price of your shares is based on the next
Shares Financial Consultant or calculation of net asset value after your order is
securities dealer submit placed. For your redemption request to be priced at the
your sales order net asset value on the day of your request, you must
submit your request to your dealer prior to that day's
close of business on the New York Stock Exchange
(generally 4:00 p.m. Eastern time). Any redemption
request placed after that time will be priced at the net
asset value at the close of business on the next
business day.
Securities dealers, including Merrill Lynch, may charge
a fee to process a redemption of shares. Merrill Lynch
currently charges a fee of $5.35. No processing fee is
charged if you redeem shares directly through the
Transfer Agent.
The Fund may reject an order to sell shares under
certain circumstances.
----------------------------------------------------------------------------------------
Sell through the You may sell shares held at the Transfer Agent by
Transfer Agent writing to the Transfer Agent at the address on the
inside back cover of this prospectus. All shareholders
on the account must sign the letter. A signature
guarantee will generally be required but may be waived
in certain limited circumstances. You can obtain a
signature guarantee from a bank, securities dealer,
securities broker, credit union, savings association,
national securities exchange and registered securities
association. A notary public seal will not be
acceptable. If you hold stock certificates, return the
certificates with the letter. The Transfer Agent will
normally mail redemption proceeds within seven days
following receipt of a properly completed request. If
you make a redemption request before the Fund has
collected payment for the purchase of shares, the Fund
or the Transfer Agent may delay mailing your proceeds.
This delay will usually not exceed ten days.
If you hold share certificates, they must be delivered
to the Transfer Agent before they can be converted.
Check with the Transfer Agent or your Merrill Lynch
Financial Consultant for details.
</TABLE>
- --------------------------------------------------------------------------------
MERRILL LYNCH CALIFORNIA MUNICIPAL BOND FUND
21
<PAGE>
[GRAPHIC] Your Account
<TABLE>
<CAPTION>
If You Want To Your Choices Information Important for You to Know
- ---------------------------------------------------------------------------------------------------
<C> <C> <S>
Sell Shares Participate in the You can choose to receive systematic payments from your
Systematically Fund's Systematic Fund account either by check or through direct deposit
Withdrawal Plan to your bank account on a monthly or quarterly basis. If
you have a Merrill Lynch CMA(R) or CBA(R) Account you
can arrange for systematic redemptions of a fixed dollar
amount on a monthly, bi-monthly, quarterly, semi-annual
or annual basis, subject to certain conditions. Under
either method you must have dividends automatically
reinvested. For Class B and C shares your total annual
withdrawals cannot be more than 10% per year of the
value of your shares at the time your plan is
established. The deferred sales charge is waived for
systematic redemptions. Ask your Merrill Lynch Financial
Consultant for details.
- ---------------------------------------------------------------------------------------------------
Exchange Your Select the fund into You can exchange your shares of the Fund for shares of
Shares which you want to many other Merrill Lynch mutual funds. You must have
exchange. Be sure to held the shares used in the exchange for at least 15
read that fund's calendar days before you can exchange to another fund.
prospectus
Each class of Fund shares is generally exchangeable for
shares of the same class of another fund. If you own
Class A shares and wish to exchange into a fund in which
you have no Class A shares (and are not eligible to
purchase Class A shares), you will exchange into Class D
shares.
Some of the Merrill Lynch mutual funds impose a
different initial or deferred sales charge schedule. If
you exchange Class A or D shares for shares of a fund
with a higher initial sales charge than you originally
paid, you will be charged the difference at the time of
exchange. If you exchange Class B shares for shares of a
fund with a different deferred sales charge schedule,
the higher schedule will apply. The time you hold Class
B or C shares in both funds will count when determining
your holding period for calculating a deferred sales
charge at redemption. If you exchange Class A or D
shares for money market fund shares, you will receive
Class A shares of Summit Cash Reserves Fund. Class B or
C shares of the Fund will be exchanged for Class B
shares of Summit.
Although there is currently no limit on the number of
exchanges that you can make, the exchange privilege may
be modified or terminated at any time in the future.
</TABLE>
- --------------------------------------------------------------------------------
MERRILL LYNCH CALIFORNIA MUNICIPAL BOND FUND
22
<PAGE>
Net Asset Value -- the market value of the Fund's total assets after deducting
liabilities, divided by the number of shares outstanding.
HOW SHARES ARE PRICED
- --------------------------------------------------------------------------------
When you buy shares, you pay the net asset value, plus any applicable sales
charge. This is the offering price. Shares are also redeemed at their net asset
value, minus any applicable deferred sales charge. The Fund calculates its net
asset value (generally by using market quotations) each day the New York Stock
Exchange is open after the close of business on the Exchange (the Exchange
generally closes at 4:00 p.m. Eastern time). The net asset value used in
determining your price is the next one calculated after your purchase or
redemption order is placed.
Generally, Class A shares will have the highest net asset value because that
class has the lowest expenses, and Class D shares will have a higher net asset
value than Class B or Class C shares. Class B shares will have a higher net
asset value than Class C shares because Class B shares have lower distribution
expenses than Class C shares. Also dividends paid on Class A and Class D shares
will generally be higher than dividends paid on Class B and Class C shares
because Class A and Class D shares have lower expenses.
PARTICIPATION IN MERRILL LYNCH FEE-BASED PROGRAMS
- --------------------------------------------------------------------------------
If you participate in certain fee-based programs offered by Merrill Lynch, you
may be able to buy Class A shares at net asset value, including by exchanges
from other share classes. Sales charges on the shares being exchanged may be
reduced or waived under certain circumstances.
You generally cannot transfer shares held through a fee-based program into
another account. Instead, you will have to redeem your shares held through the
program and purchase shares of another class, which may be subject to
distribution and account maintenance fees. This may be a taxable event and you
will pay any applicable sales charges.
If you leave one of these programs, your shares may be redeemed or
automatically exchanged into another class of Fund shares or into a money
market fund. The class you receive may be the class you originally owned when
you entered the program, or in certain cases, a different class. If the
exchange is into Class B shares, the period before conversion to Class D shares
may be modified. Any redemption or exchange will be at net asset value.
However, if you participate in the program for less than a specified period,
you may be charged a fee in accordance with the terms of the program.
MERRILL LYNCH CALIFORNIA MUNICIPAL BOND FUND
23
<PAGE>
[GRAPHIC] Your Account
Dividends -- Exempt-interest, ordinary income and capital gains paid to
shareholders. Dividends may be reinvested in additional Fund shares as they are
paid.
Details about these features and the relevant charges are included in the
client agreement for each fee-based program and are available from your Merrill
Lynch Financial Consultant.
DIVIDENDS AND TAXES
- --------------------------------------------------------------------------------
The Fund will distribute any net investment income monthly, and any net
realized long or short term capital gains at least annually. The Fund may also
pay a special distribution at the end of the calendar year to comply with
Federal tax requirements. If your account is with Merrill Lynch and you would
like to receive dividends in cash, contact your Merrill Lynch Financial
Consultant. If your account is with the Transfer Agent and you would like to
receive dividends in cash, contact the Transfer Agent.
Taxes
To the extent that the dividends distributed by the Fund are from municipal
bond interest income they are exempt from Federal income tax but may be subject
to state or local income taxes. Certain investors may be subject to a Federal
alternative minimum tax on dividends received from the Fund. So long as at
least 50% of the value of the Fund's total assets consists of California
Municipal Bonds at the end of each quarter of the Fund's taxable year, the
portion of dividends distributed by the Fund derived from California municipal
bond interest income will also be exempt from California income tax. Interest
income from other investments may produce taxable dividends. Dividends derived
from capital gains realized by the Fund will be subject to Federal income tax
and generally will be subject to California income tax as well. If you are
subject to income tax in a state other than California, the dividends derived
from California municipal bonds will not be exempt from income tax in that
state.
MERRILL LYNCH CALIFORNIA MUNICIPAL BOND FUND
24
<PAGE>
"BUYING A DIVIDEND"
You may want to avoid buying shares shortly before the Fund pays a dividend,
although the impact on you will be significantly less than if you were invested
in a fund paying fully taxable dividends. The reason? If you buy shares when a
fund has realized but not yet distributed taxable ordinary income (if any) or
capital gains, you will pay the full price for the shares and then receive a
portion of the price back in the form of a taxable dividend. Before investing
you may want to consult your tax adviser.
Generally, within 60 days after the end of the Fund's taxable year, the Trust
will tell you the amount of exempt-interest dividends and capital gain
dividends you received that year. Capital gain dividends are taxable as long
term capital gains to you regardless of how long you have held your shares. The
tax treatment of dividends from the Fund is the same whether you choose to
receive dividends in cash or to have them reinvested in shares of the Fund.
By law, the Fund must withhold 31% of your dividends and proceeds if you have
not provided a taxpayer identification number or social security number, or if
the number you have provided is incorrect.
If you redeem Fund shares or exchange them for shares of another fund, any gain
on the transaction may be subject to Federal income tax.
This section summarizes some of the consequences of an investment in the Fund
under current Federal and California income tax laws. It is not a substitute
for personal tax advice. Consult your personal tax adviser about the potential
tax consequences to you of an investment in the Fund under all applicable tax
laws.
MERRILL LYNCH CALIFORNIA MUNICIPAL BOND FUND
25
<PAGE>
Management of the Fund [GRAPHIC]
FUND ASSET MANAGEMENT
- --------------------------------------------------------------------------------
Fund Asset Management, the Fund's Manager, manages the Fund's investments and
its business operations under the overall supervision of the Trust's Board of
Trustees. The Manager has the responsibility for making all investment
decisions for the Fund. The Fund pays the Manager a fee at the annual rate of
0.55% of the average daily net assets of the Fund for the first $500 million;
0.525% of the average daily net assets from $500 million to $1 billion; and
0.50% of the average daily net assets above $1 billion. For the fiscal year
ended August 31, 1999, the fee payable to the Manager from the Fund was equal
to 0.55% of the Fund's average daily net assets, but the Manager voluntarily
waived a portion of the management fee due for the fiscal year.
Fund Asset Management was organized as an investment adviser in 1977 and offers
investment advisory services to more than 50 registered investment companies.
Fund Asset Management is a part of the Asset Management Group of ML & Co. The
Asset Management Group had approximately $518 billion in investment company and
other portfolio assets under management as of October 1999. This amount
includes assets managed for Merrill Lynch affiliates.
A Note About Year 2000
Many computer systems were designed using only two digits to designate years.
These systems may not be able to distinguish the Year 2000 from the Year 1900
(commonly known as the "Year 2000 Problem"). The Fund could be adversely
affected if the computer systems used by Fund management or other Fund service
providers do not properly address this problem before January 1, 2000. Fund
management expects to have addressed this problem before then, and does not
anticipate that the services it provides will be adversely affected. The Fund's
other service providers have told Fund management that they also expect to
resolve the Year 2000 Problem, and Fund management will continue to monitor the
situation as the Year 2000 approaches. However, if the problem has not been
fully addressed, the Fund could be negatively affected. The Year 2000 Problem
could also have a negative impact on the issuers of securities in which the
Fund invests, and this could hurt the Fund's investment returns.
MERRILL LYNCH CALIFORNIA MUNICIPAL BOND FUND
26
<PAGE>
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
The Financial Highlights table is intended to help you understand the Fund's
financial performance for the periods shown. Certain information reflects
financial results for a single Fund share. The total returns in the table
represent the rate an investor would have earned on an investment in the Fund
(assuming reinvestment of all dividends). This information has been audited by
Deloitte & Touche LLP, whose report, along with the Fund's financial
statements, is included in the Fund's annual report to shareholders, which is
available upon request.
<TABLE>
<CAPTION>
Class A Class B
-------------------------------------------- -------------------------------------------------
For the Year Ended August 31, For the Year Ended August 31,
-------------------------------------------- -------------------------------------------------
Increase (Decrease) in
Net Asset Value: 1999 1998 1997 1996 1995 1999 1998 1997 1996 1995
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Per Share Operating
Performance:
- --------------------------------------------------------------------------------------------------------------------------
Net asset value,
beginning of year $ 12.15 $ 11.81 $ 11.49 $ 11.40 $ 11.32 $ 12.16 $ 11.82 $ 11.49 $ 11.40 $ 11.32
- --------------------------------------------------------------------------------------------------------------------------
Investment income -- net .60 .63 .64 .64 .64 .54 .57 .58 .58 .59
- --------------------------------------------------------------------------------------------------------------------------
Realized and unrealized
gain (loss) on
investments -- net (.79) .34 .32 .09 .08 (.80) .34 .33 .09 .08
- --------------------------------------------------------------------------------------------------------------------------
Total from investment
operations (.19) .97 .96 .73 .72 (.26) .91 .91 .67 .67
- --------------------------------------------------------------------------------------------------------------------------
Less dividends and
distributions:
Investment
income -- net (.60) (.63) (.64) (.64) (.64) (.54) (.57) (.58) (.58) (.59)
Realized gain on
investments--net (.18) -- -- -- -- (.18) -- -- -- --
In excess of
realized gain on
investments--net (.08) -- -- -- -- (.08) -- -- -- --
- --------------------------------------------------------------------------------------------------------------------------
Total dividends and
distributions (.86) (.63) (.64) (.64) (.64) (.80) (.57) (.58) (.58) (.59)
- --------------------------------------------------------------------------------------------------------------------------
Net asset value, end of
year $ 11.10 $ 12.15 $ 11.81 $ 11.49 $ 11.40 $ 11.10 $ 12.16 $ 11.82 $ 11.49 $ 11.40
- --------------------------------------------------------------------------------------------------------------------------
Total Investment
Return:*
- --------------------------------------------------------------------------------------------------------------------------
Based on net asset value
per share (1.80%) 8.39% 8.55% 6.53% 6.75% (2.38%) 7.84% 8.09% 5.99% 6.25%
- --------------------------------------------------------------------------------------------------------------------------
Ratios to Average Net
Assets:
- --------------------------------------------------------------------------------------------------------------------------
Expenses .65% .65% .63% .65% .65% 1.16% 1.16% 1.14% 1.16% 1.16%
- --------------------------------------------------------------------------------------------------------------------------
Investment income -- net 5.07% 5.25% 5.49% 5.51% 5.83% 4.57% 4.75% 4.98% 5.01% 5.32%
- --------------------------------------------------------------------------------------------------------------------------
Supplemental Data:
- --------------------------------------------------------------------------------------------------------------------------
Net assets, end of year
(in thousands) $37,641 $45,544 $44,652 $42,668 $44,228 $269,191 $341,111 $376,018 $480,668 $616,199
- --------------------------------------------------------------------------------------------------------------------------
Portfolio turnover 106.84% 90.92% 73.60% 53.79% 53.40% 106.84% 90.92% 73.60% 53.79% 53.40%
- --------------------------------------------------------------------------------------------------------------------------
</TABLE>
* Total investment returns exclude the effects of sales charges.
MERRILL LYNCH CALIFORNIA MUNICIPAL BOND FUND
27
<PAGE>
[GRAPHIC] Management of the Fund
FINANCIAL HIGHLIGHTS (concluded)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Class C Class D
-------------------------------------------------- -------------------------------------------------------
For the Period For the Period
Increase (Decrease) For the Year Ended August 31, Oct. 21, 1994+ For the Year Ended August 31, Oct. 21, 1994+
in ---------------------------------- to August 31, --------------------------------------- to August 31,
Net Asset Value: 1999 1998 1997 1996 1995 1999 1998 1997 1996 1995
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Per Share Operating Performance:
- ----------------------------------------------------------------------------------------------------------------------------------
Net asset value,
beginning of period $ 12.15 $ 11.82 $ 11.49 $11.40 $10.94 $ 12.16 $ 11.82 $ 11.49 $ 11.40 $10.94
- ----------------------------------------------------------------------------------------------------------------------------------
Investment income --
net .53 .55 .57 .57 .49 .59 .62 .63 .63 .54
- ----------------------------------------------------------------------------------------------------------------------------------
Realized and
unrealized gain
(loss) on
investments -- net (.79) .33 .33 .09 .46 (.80) .34 .33 .09 .46
- ----------------------------------------------------------------------------------------------------------------------------------
Total from
investment
operations (.26) .88 .90 .66 .95 (.21) .96 .96 .72 1.00
- ----------------------------------------------------------------------------------------------------------------------------------
Less dividends and
distributions:
investment
income -- net (.53) (.55) (.57) (.57) (.49) (.59) (.62) (.63) (.63) (.54)
Realized gain on
investments--net (.18) -- -- -- -- (.18) -- -- -- --
In excess of
realized gain on
investments--net (.08) -- -- -- -- (.08) -- -- -- --
- ----------------------------------------------------------------------------------------------------------------------------------
Total dividends and
distributions (.79) (.55) (.57) (.57) (.49) (.85) (.62) (.63) (.63) (.54)
- ----------------------------------------------------------------------------------------------------------------------------------
Net asset value, end
of period $ 11.10 $ 12.15 $ 11.82 $11.49 $11.40 $ 11.10 $ 12.16 $ 11.82 $ 11.49 $11.40
- ----------------------------------------------------------------------------------------------------------------------------------
Total Investment
Return:**
- ----------------------------------------------------------------------------------------------------------------------------------
Based on net asset
value per share (2.40%) 7.65% 7.98% 5.88% 8.91%# (1.98%) 8.28% 8.53% 6.43% 9.39%#
- ----------------------------------------------------------------------------------------------------------------------------------
Ratios To Average Net Assets:
- ----------------------------------------------------------------------------------------------------------------------------------
Expenses 1.26% 1.26% 1.24% 1.26% 1.27%* .75% .75% .73% .75% .76%*
- ----------------------------------------------------------------------------------------------------------------------------------
Investment income --
net 4.46% 4.64% 4.87% 4.91% 5.04%* 4.98% 5.15% 5.39% 5.42% 5.59%*
- ----------------------------------------------------------------------------------------------------------------------------------
Supplemental Data:
- ----------------------------------------------------------------------------------------------------------------------------------
Net assets, end of
period
(in thousands) $11,769 $12,646 $10,904 $8,112 $3,131 $194,029 $205,507 $185,300 $111,817 $3,846
- ----------------------------------------------------------------------------------------------------------------------------------
Portfolio turnover 106.84% 90.92% 73.60% 53.79% 53.40% 106.84% 90.92% 73.60% 53.79% 53.40%
- ----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
* Annualized.
** Total investment returns exclude the effects of sales charges.
+ Commencement of operations.
# Aggregate total investment return.
MERRILL LYNCH CALIFORNIA MUNICIPAL BOND FUND
28
<PAGE>
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MERRILL LYNCH CALIFORNIA MUNICIPAL BOND FUND
<PAGE>
[This page intentionally left blank.]
MERRILL LYNCH CALIFORNIA MUNICIPAL BOND FUND
<PAGE>
[CHART]
POTENTIAL
INVESTORS
Open an account (two options).
MERRILL LYNCH TRANSFER AGENT
FINANCIAL CONSULTANT Financial Data Services, Inc.
OR SECURITIES DEALER ADMINISTRATIVE OFFICES
4800 Deer Lake Drive East
Advises shareholders on Jacksonville, Florida 32232-6484
their Fund investments.
MAILING ADDRESS
P.O. Box 45289
Jacksonville, Florida 32232-5289
Performs recordkeeping and
reporting services.
DISTRIBUTOR
Merrill Lynch Funds Distributor,
a division of Princeton Funds Distributor, Inc.
P.O. Box 9081
Princeton, New Jersey 08543-9081
Arranges for the sale of Fund shares.
COUNSEL CUSTODIAN
Brown & Wood LLP The Bank of New York
One World Trade Center THE FUND 90 Washington Street
New York, New York 10048-0557 The Board of Directors 12th Floor
oversees the Fund. New York, NY 10286
Provides legal advice
to the Fund. Holds the Fund's assets
for safekeeping.
INDEPENDENT AUDITORS MANAGER
Deloitte & Touche LLP Fund
Princeton Forrestal Village Asset Management, L.P.
116-300 Village Boulevard ADMINISTRATIVE OFFICES
Princeton, New Jersey 08540-6400 800 Scudders Mill Road
Plainsboro, New Jersey 08536
Audits the financial MAILING ADDRESS
statements of the Fund on behalf of P.O. Box 9011
the shareholders. Princeton, New Jersey 08543-9011
TELEPHONE NUMBER
1-800-MER-FUND
Manages the Fund's
day-to-day activities.
MERRILL LYNCH CALIFORNIA MUNICIPAL BOND FUND
<PAGE>
For More Information [GRAPHIC]
Shareholder Reports
Additional information about the Fund's investments is available in the Fund's
annual and semi-annual reports to shareholders. In the Fund's annual report
you will find a discussion of the market conditions and investment strategies
that significantly affected the Fund's performance during its last fiscal
year. You may obtain these reports at no cost by calling 1-800-MER-FUND.
The Fund will send you one copy of each shareholder report and certain other
mailings, regardless of the number of Fund accounts you have. To receive
separate shareholder reports for each account, call your Merrill Lynch
Financial Consultant or write to the Transfer Agent at its mailing address.
Include your name, address, tax identification number and Merrill Lynch
brokerage or mutual fund account number. If you have any questions, please
call your Merrill Lynch Financial Consultant or the Transfer Agent at 1-800-
MER-FUND.
Statement of Additional Information
The Fund's Statement of Additional Information contains further information
about the Fund and is incorporated by reference (legally considered to be part
of this prospectus). You may request a free copy by writing the Fund at
Financial Data Services, Inc., P.O. Box 45289, Jacksonville, Florida 32232-
5289 or by calling 1-800-MER-FUND.
Contact your Merrill Lynch Financial Consultant or the Fund at the telephone
number or address indicated above, if you have any questions.
Information about the Fund (including the Statement of Additional Information)
can be reviewed and copied at the SEC's Public Reference Room in Washington,
D.C. Call 1-800-SEC-0330 for information on the operation of the public
reference room. This information is also available on the SEC's Internet site
at http://www.sec.gov and copies may be obtained upon payment of a duplicating
fee by writing the Public Reference Section of the SEC, Washington, D.C.
20549-6009.
YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED IN THIS PROSPECTUS. NO ONE
IS AUTHORIZED TO PROVIDE YOU WITH INFORMATION THAT IS DIFFERENT FROM
INFORMATION CONTAINED IN THE PROSPECTUS.
Investment Company Act file #811-4264
Code #10327-12-99
(C)Fund Asset Management, L.P.
Prospectus
[LOGO] Merrill Lynch
Merrill Lynch California
Municipal Bond Fund
of Merrill Lynch California
Municipal Series Trust
December 3, 1999
<PAGE>
STATEMENT OF ADDITIONAL INFORMATION
Merrill Lynch California Municipal Bond Fund
of 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 income exempt from
Federal and California income taxes. The Fund invests primarily in a 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, that pay interest exempt, in the
opinion of bond counsel to the issuer, from Federal and California income
taxes. There can be no assurance that the investment objective of the Fund
will be realized. For more information on the Fund's investment objective and
policies, see "Investment Objective and Policies."
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
"Purchase of Shares."
----------------
This Statement of Additional Information of the Fund is not a prospectus and
should be read in conjunction with the Prospectus of the Fund, dated December
3, 1999 (the "Prospectus"), which has been filed with the Securities and
Exchange Commission (the "Commission") and can be obtained, without charge, by
calling (800) 637-3863 or by writing the Fund at the above address. The
Prospectus is incorporated by reference into this Statement of Additional
Information, and this Statement of Additional Information is incorporated by
reference into the Prospectus. The Fund's audited financial statements are
incorporated in this Statement of Additional Information by reference to its
1999 annual report to shareholders. You may request a copy of the annual
report at no charge by calling (800) 456-4587 ext. 789 between 8:00 a.m. and
8:00 p.m. on any business day.
----------------
Fund Asset Management -- Manager
Merrill Lynch Funds Distributor -- Distributor
----------------
The date of this Statement of Additional Information is December 3, 1999.
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Investment Objective and Policies.......................................... 2
Risk Factors and Special Considerations Relating to Municipal Bonds....... 3
Description of Municipal Bonds............................................ 3
Financial Futures Transactions and Options................................ 7
Description of Temporary Investments...................................... 11
Investment Restrictions................................................... 12
Portfolio Turnover........................................................ 14
Management of the Trust.................................................... 15
Trustees and Officers.................................................... 15
Compensation of Trustees.................................................. 16
Management and Advisory Arrangements...................................... 17
Code of Ethics............................................................ 18
Purchase of Shares......................................................... 19
Initial Sales Charge Alternatives -- Class A and Class D Shares........... 19
Reduced Initial Sales Charges............................................. 21
Deferred Sales Charge Alternatives -- Class B and Class C Shares.......... 23
Distribution Plans........................................................ 26
Limitations on the Payment of Deferred Sales Charges...................... 27
Redemption of Shares....................................................... 28
Redemption................................................................ 29
Repurchase................................................................ 29
Reinstatement Privilege -- Class A and Class D Shares..................... 29
Pricing of Shares.......................................................... 30
Determination of Net Asset Value.......................................... 30
Computation of Offering Price Per Share................................... 31
Portfolio Transactions..................................................... 31
Transactions in Portfolio Securities...................................... 31
Shareholder Services....................................................... 32
Investment Account........................................................ 33
Exchange Privilege........................................................ 33
Fee-Based Programs........................................................ 35
Automatic Investment Plans................................................ 35
Automatic Dividend Reinvestment Plan...................................... 35
Systematic Withdrawal Plan................................................ 36
Dividends and Taxes........................................................ 37
Dividends................................................................. 37
Taxes..................................................................... 37
Tax Treatment of Options and Futures Transactions......................... 40
Performance Data........................................................... 41
General Information........................................................ 44
Description of Shares..................................................... 44
Independent Auditors...................................................... 45
Custodian................................................................. 45
Transfer Agent............................................................ 45
Legal Counsel............................................................. 45
Reports to Shareholders................................................... 45
Shareholder Inquiries..................................................... 45
Additional Information.................................................... 45
Financial Statements....................................................... 46
Appendix I -- Economic and Financial Conditions in California.............. I-1
Appendix II -- Ratings of Municipal Bonds.................................. II-1
</TABLE>
<PAGE>
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Fund is to provide shareholders with income
exempt from Federal and California income tax. The Fund seeks to achieve its
objective by investing primarily in a 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, that 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 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 the Fund's total assets invested in
California Municipal Bonds. The investment objective as set forth in the first
sentence of this paragraph is a fundamental policy and may not be changed
without a vote of a majority of the outstanding shares of the Fund. See "How
the Fund Invests" in the Prospectus for a general discussion of the Fund's
goals, main investment strategies and main risks. The Fund is classified as a
diversified fund under the Investment Company Act of 1940, as amended (the
"Investment Company Act").
Under normal circumstances, except when acceptable securities are
unavailable as determined by Fund Asset Management, L.P. (the "Manager" or
"FAM"), the Fund's manager, or for temporary defensive purposes, the Fund will
invest at least 65% of its total assets in California Municipal Bonds. 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 weighted average maturity will be in excess of ten
years. 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 shall not exceed 20% of the Fund's
net assets.
The Fund may also invest in variable rate demand obligations ("VRDOs") and
VRDOs in the form of participation interests ("Participating VRDOs") in
variable rate tax-exempt obligations held by a financial institution. See
"Description of Temporary Investments." 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.
At least 80% of the Fund's total assets will be invested in Municipal Bonds
that 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 ("S&P") (currently AAA, AA,
A and BBB) or Fitch IBCA, Inc. ("Fitch") (currently AAA, AA, A and BBB). If
unrated, such securities will possess creditworthiness comparable, in the
opinion of the Manager, to other obligations in which the Fund may invest.
Securities rated in the lowest investment grade rating category may be
considered to have speculative characteristics.
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 S&P 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. See
"Description of Municipal Bonds --"High Yield' or "Junk' Bonds." 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
bonds but also the creditworthiness of the financial institution that provides
the credit enhancement.
2
<PAGE>
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 income tax, but not California income
tax. 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 could include trust certificates or other instruments evidencing
interest in one or more long-term California Municipal Bonds or Municipal
Bonds. Non-Municipal Tax-Exempt Securities also may include securities issued
by other investment companies that invest in California Municipal Bonds or
Municipal Bonds, to the extent such investments are permitted by the
Investment Company Act. Certain Non-Municipal Tax-Exempt Securities may be
characterized as derivative instruments. For purposes of the Fund's investment
objective and policies, Non-Municipal Tax-Exempt Securities that pay interest
that is exempt from Federal income tax will be considered "Municipal Bonds"
and Non-Municipal Tax-Exempt Securities that pay interest that is exempt from
Federal income tax and California income tax will be considered "California
Municipal Bonds." The Fund at all times will have at least 80% of its total
assets invested in securities the interest on which is exempt from Federal
taxation. However, interest received on certain otherwise tax-exempt
securities that 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. 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 that may
be enacted in the future may affect the availability of Municipal Bonds for
investment by the Fund. See "Dividends and Taxes -- Taxes."
Risk Factors and Special Considerations Relating to Municipal Bonds
The risks and special considerations involved in investment 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 "Investment Objective and
Policies -- Description of Municipal Bonds" and "-- Financial Futures
Transactions and Options."
The Fund ordinarily will invest at least 65% of its 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.
The Manager does not believe that the current economic conditions in
California will have a significant adverse effect on the Fund's ability to
invest in high quality California Municipal Bonds. 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. For a
discussion of economic and other conditions in California, see Appendix I --
"Economic and Financial Conditions in California."
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 a 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 Municipal
Bonds or the California Municipal Bonds in which the Fund invests.
Description of Municipal Bonds
Set forth below is a detailed description of the Municipal Bonds and
Temporary Investments in which the Fund may invest. Information with respect
to ratings assigned to tax-exempt obligations that the Fund may purchase is
set forth in Appendix II to this Statement of Additional Information.
3
<PAGE>
Municipal Bonds include debt obligations issued to obtain funds for various
public purposes, including the construction of a wide range of public
facilities, refunding of outstanding obligations and obtaining funds for
general operating expenses and loans to other public institutions and
facilities. In addition, certain types of bonds are issued by or on behalf of
public authorities to finance various privately owned or operated facilities,
including certain facilities for the local furnishing of electric energy or
gas, sewage facilities, solid waste disposal facilities and other specialized
facilities. Such obligations are included within the term Municipal Bonds if
the interest paid thereon is excluded from gross income for Federal income tax
purposes and, in the case of California Municipal Bonds, exempt from California
income taxes. Other types of industrial development bonds or private activity
bonds, the proceeds of which are used for the construction, equipment or
improvement of privately operated industrial or commercial facilities, may
constitute Municipal Bonds, although the current Federal tax laws place
substantial limitations on the size of such issues. In the case of certain
community facilities district special tax ("Mello-Roos" in the case of
California Municipal Bonds), tax increment (or tax allocation) and assessment
bonds, the payment of the special tax, tax increment and assessments may be
secured solely by remedies against the land (such as by foreclosure) and not
against the individual property owner, which could be time-consuming and
costly. The interest on Municipal Bonds may bear a fixed rate or be payable at
a variable or floating rate. The two principal classifications of Municipal
Bonds are "general obligation" and "revenue" bonds, which latter category
includes industrial development bonds ("IDBs") and, for bonds issued after
August 15, 1986, private activity bonds ("PABs").
General Obligation Bonds. General obligation bonds are secured by the
issuer's pledge of its faith, credit and taxing power for the payment of
principal and 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 base or inability to attract new industries, 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
issuer's maintenance of its tax base.
Revenue Bonds. 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.
IDBs and PABs. The Fund may purchase IDBs and PABs. IDBs and PABs 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 PABs
generally are 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
generally 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 PABs.
"Moral Obligation" Bonds. The Fund also may 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.
4
<PAGE>
Municipal Notes. Municipal notes are shorter term municipal debt obligations.
They may provide interim financing in anticipation of tax collection, bond
sales or revenue receipts. If there is a shortfall in the anticipated proceeds,
the note may not be fully repaid and the Fund may lose money.
Municipal Commercial Paper. Municipal commercial paper is generally unsecured
and issued to meet short-term financing needs. The lack of security presents
some risk of loss to the Fund.
Lease Obligations. Also included within the general category of Municipal
Bonds are certificates of participation ("COPs") issued by government
authorities or entities to finance the acquisition or construction of
equipment, land and/or facilities. The COPs represent participations in a
lease, an installment purchase contract or a conditional sales contract
(hereinafter collectively called "lease obligations") relating to such
equipment, land or facilities. Although lease obligations do not constitute
general obligations of the issuer for which the issuer's unlimited taxing power
is pledged, a lease obligation is frequently backed by the issuer's covenant to
budget for, appropriate and make the payments due under the lease obligation.
However, certain lease obligations contain "non-appropriation" clauses which
provide that the issuer has no obligation to make lease or installment purchase
payments in future years unless money is appropriated for such purpose on a
yearly basis. Although "non-appropriation" lease obligations are secured by the
leased property, disposition of the property in the event of foreclosure might
prove difficult. These securities represent a 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 net 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 S&P 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.
Indexed and Inverse Floating Obligations. The Fund may invest in California
Municipal Bonds and Municipal Bonds (and Non-Municipal Tax-Exempt Securities)
yielding a return based on a particular index of value or interest rates. For
example, the Fund may invest in California Municipal Bonds and Municipal Bonds
that pay interest based on an index of Municipal Bond interest rates. The
principal amount payable upon maturity of certain California Municipal Bonds
and Municipal Bonds also may be based on the value of the index. To the extent
the Fund invests in these types of California Municipal Bonds and Municipal
Bonds, the Fund's return on such California Municipal Bonds and Municipal Bonds
will be subject to risk with respect to the value of the particular index.
Interest and principal payable on the California Municipal Bonds and 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 vary inversely with a short-term
floating rate (which may be reset periodically by a dutch auction, a
remarketing agent or by reference to a short-term tax-exempt interest rate
index). The Fund may purchase synthetically-created inverse floating rate bonds
evidenced by custodial or trust receipts. Generally, income on inverse floating
rate bonds will decrease when short-term interest rates increase, and will
increase when short-term interest rates decrease. 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 net assets. The Manager, however,
believes that
5
<PAGE>
indexed and inverse floating obligations represent flexible portfolio
management instruments for the Fund which allow the Fund to seek potential
investment rewards, hedge other portfolio positions or vary the degree of
investment leverage relatively efficiently under different market conditions.
When Issued Securities, Delayed Delivery Transactions and Forward
Commitments. The Fund may purchase or sell securities that it is entitled to
receive on a when issued basis. The Fund may also purchase or sell securities
on a delayed delivery basis. The Fund may also purchase or sell securities
through a forward commitment. These transactions involve the purchase or sale
of securities by the Fund at an established price with payment and delivery
taking place in the future. The Fund enters into these transactions to obtain
what is considered an advantageous price to the Fund at the time of entering
into the transaction. The Fund has not established any limit on the percentage
of its assets that may be committed in connection with these transactions.
When the Fund purchases securities in these transactions, the Fund segregates
liquid securities in an amount equal to the amount of its purchase
commitments.
There can be no assurance that a security purchased on a when issued basis
will be issued or that a security purchased or sold through a forward
commitment will be delivered. The value of securities in these transactions on
the delivery date may be more or less than the Fund's purchase price. The Fund
may bear the risk of a decline in the value of the security in these
transactions and may not benefit from an appreciation in the value of the
security during the commitment period.
Call and Redemption Risk. The Fund may purchase a Municipal Bond issuer's
right to call all or a portion of such Municipal Bond for mandatory tender for
purchase (a "Call Right"). A holder of a Call Right may exercise such right to
require a mandatory tender for the purchase of related Municipal Bonds,
subject to certain conditions. A Call Right that is not exercised prior to
maturity of the related Municipal Bond will expire without value. The economic
effect of holding both the Call Right and the related Municipal Bond is
identical to holding a Municipal Bond as a non-callable security. Certain
investments in such obligations may be illiquid. The Fund may not invest in
such illiquid obligations if such investments, together with other illiquid
investments, would exceed 15% of the Fund's net assets.
"High Yield" or "Junk" Bonds. 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
S&P or Fitch or which, in the Manager's judgment, possess similar credit
characteristics. See Appendix II -- "Ratings of Municipal Bonds" for
additional information regarding ratings of debt securities. Junk bonds are
debt securities that are rated below investment grade by the major rating
agencies or are unrated securities that Fund management believes are of
comparable quality. Although junk bonds generally pay higher rates of interest
than investment grade bonds, they are high risk investments that may cause
income and principal losses for the Fund. The major risks in junk bond
investments include the following:
Junk bonds may be issued by less creditworthy companies. These securities
are vulnerable to adverse changes in the issuer's industry and to general
economic conditions. Issuers of junk bonds may be unable to meet their
interest or principal payment obligations because of an economic downturn,
specific issuer developments or the unavailability of additional financing.
The issuers of junk bonds may have a larger amount of outstanding debt
relative to their assets than issuers of investment grade bonds. If the issuer
experiences financial stress, it may be unable to meet its debt obligations.
The issuer's ability to pay its debt obligations also may be lessened by
specific issuer developments, or the unavailability of additional financing.
Junk bonds are frequently ranked junior to claims by other creditors. If the
issuer cannot meet its obligations, the senior obligations are generally paid
off before the junior obligations.
Junk bonds frequently have redemption features that permit an issuer to
repurchase the security from the Fund before it matures. If an issuer redeems
the junk bond, the Fund may have to invest the proceeds in bonds with lower
yields and may lose income.
Prices of junk bonds are subject to extreme price fluctuations. Negative
economic developments may have a greater impact on the prices of junk bonds
than on other higher rated fixed income securities.
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Junk bonds may be less liquid than higher rated fixed income securities even
under normal economic conditions. There are fewer dealers in the junk bond
market, and there may be significant differences in the prices quoted for junk
bonds by the dealers. Because they are less liquid, judgment may play a
greater role in valuing certain of the Fund's portfolio securities than in the
case of securities trading in a more liquid market.
The Fund may incur expenses to the extent necessary to seek recovery upon
default or to negotiate new terms with a defaulting issuer.
Yields. 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 with 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.
Financial Futures Transactions and Options
The Fund may hedge all or a portion of its portfolio investments against
fluctuations in interest rates through the use of options and certain
financial futures contracts and options thereon. While the Fund's use of
hedging strategies is intended to reduce the volatility of the net asset value
of the Fund's shares, the net asset value of the Fund's shares will fluctuate.
There can be no assurance that the Fund's hedging transactions will be
effective. Furthermore, the Fund may only engage in hedging activities from
time to time and may not necessarily be engaging in hedging activities when
movements in interest rates occur. The Fund has no obligation to enter into
hedging transactions and may choose not to do so.
The Fund is authorized to purchase and sell certain exchange traded
financial futures contracts ("financial futures contracts") solely for the
purpose of hedging its investments in Municipal Bonds against declines in
value and to hedge against increases in the cost of securities it intends to
purchase. However, any transactions involving financial futures or options
(including puts and calls associated therewith) will be in accordance with the
Fund's investment policies and limitations. A financial futures contract
obligates the seller of a contract to deliver and the purchaser of a contract
to take delivery of the type of financial instrument covered by the contract,
or in the case of index-based futures contracts to make and accept a cash
settlement, at a specific future time for a specified price. To hedge its
portfolio, the Fund may take an investment position in a futures contract
which will move in the opposite direction from the portfolio position being
hedged. 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. See "Dividends and Taxes -- Taxes" and
"-- Tax Treatment of Options and Futures Transactions."
Futures Contracts. A futures contract is an agreement between two parties to
buy and sell a security or, in the case of an index-based futures contract, to
make and accept a cash settlement for a set price on a future date. A majority
of transactions in 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. Futures
contracts have been designed by boards of trade which have been designated
"contracts markets" by the Commodity Futures Trading Commission ("CFTC").
The purchase or sale of a 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
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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 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 futures contract fluctuates making the long
and short positions in the futures contract more or less valuable, a process
known as "marking to the market." At any time prior to the settlement date of
the futures contract, the position may be closed out by taking an opposite
position that will operate to terminate the position in the 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 and general obligation bonds. Each bond included in
the Municipal Bond Index must be rated A or higher by Moody's or S&P 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 futures contract is traded only on the CBT. Like
other contract markets, the CBT assures performance under futures contracts
through a clearing corporation, a nonprofit organization managed by the
exchange membership which is also responsible for handling daily accounting of
deposits or withdrawals of margin.
The Fund may purchase and sell financial futures contracts on U.S.
Government securities as a hedge against adverse changes in interest rates as
described below. With respect to U.S. Government securities, currently there
are financial futures contracts based on long-term U.S. Treasury bonds,
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 futures contracts on U.S. Government securities and purchase
and sell Municipal Bond Index futures contracts in connection with its hedging
strategies.
Subject to policies adopted by the Trustees, the Fund also may engage in
other futures contracts transactions such as futures contracts on other
municipal bond indices that may become available if the Manager and the
Trustees of the Trust 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 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 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 that are being hedged. While the Fund will
incur commission expenses in selling and closing out futures positions,
commissions on 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 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
futures contracts as a hedge against any increase in the cost of such
Municipal Bonds resulting from a decrease in interest rates or otherwise,
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that may occur before such purchases can be effected. Subject to the degree
correlation between the Municipal Bonds and the 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 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 may also 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 futures contract
upon which it is based or the price of the underlying debt securities, it may
or may not be less risky than ownership of the futures contract or underlying
debt securities. Like the purchase of a futures contract, the Fund will
purchase a call option on a futures contract to hedge against a market advance
when the Fund is not fully invested.
The writing of a call option on a futures contract constitutes a partial
hedge against declining prices of the securities which are deliverable upon
exercise of the futures contract. If the futures price at expiration is below
the exercise price, the Fund will retain the full amount of the option premium
which provides a partial hedge against any decline that may have occurred in
the Fund's portfolio holdings.
Put Options on Futures Contracts. The purchase of a put option on a futures
contract is analogous to the purchase of a protective put option on portfolio
securities. The Fund will purchase a put option on a futures contract 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 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 Fund and
commodities brokers with respect to initial and variation margin. Section
18(f) of the Investment Company 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 futures
contract may be a "senior security" under the Investment Company 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
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 a 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
futures contracts, thereby ensuring that the use of such futures contract is
unleveraged. It is not anticipated that transactions in futures contracts will
have the effect of increasing portfolio turnover.
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Risk Factors in Futures Transactions and Options. Investment in futures
contracts involves the risk of imperfect correlation between movements in the
price of the futures contract and the price of the security being hedged. The
hedge will not be fully effective when there is imperfect correlation between
the movements in the prices of two financial instruments. For example, if the
price of the futures contract moves more than the price of the hedged
security, the Fund will experience either a loss or gain on the futures
contract which is not completely offset by movements in the price of the
hedged securities. To compensate for imperfect correlations, the Fund may
purchase or sell futures contracts in a greater dollar amount than the hedged
securities if the volatility of the hedged securities is historically greater
than the volatility of the futures contracts. Conversely, the Fund may
purchase or sell fewer futures contracts if the volatility of the price of the
hedged securities is historically less than that of the futures contracts.
The particular municipal bonds comprising the index underlying the Municipal
Bond Index financial futures contract may vary from the bonds held by the
Fund. As a result, the Fund's ability to hedge effectively all or a portion of
the value of its Municipal Bonds through the use of such financial futures
contracts will depend in part on the degree to which price movements in the
index underlying the financial futures contract correlate with the price
movements of the 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 Municipal Bonds held by the Fund may be greater. Municipal Bond
Index futures contracts were approved for trading in 1986. Trading in such
futures contracts may tend to be less liquid than trading 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.
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 liquidity
of a secondary market in a 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 moved beyond
the daily limit on a number of consecutive trading days. 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 upon the opening of a futures
position, futures transactions involve substantial leverage. As a result,
relatively small movements in the price of the futures contracts can result in
substantial unrealized gains or losses. 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. Because the Fund
will engage in the purchase and sale of 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
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increases in the value of securities held by the Fund or decreases in the
price of securities the Fund intends to acquire.
The amount of risk the Fund assumes when it purchases an option on a futures
contract is the premium paid for the option plus related transaction costs. In
addition to the correlation risks discussed above, the purchase of an option
on a futures contract also entails the risk that changes in the value of the
underlying futures contract will not be fully reflected in the value of the
option purchased.
Description of Temporary Investments
The Fund may invest in short-term tax-free and taxable securities subject to
the limitations set forth above and in the Prospectus under "How the Fund
Invests." 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. 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 ("FDIC"), except that up to 10% of total assets
may be invested in certificates of deposit of smaller institutions if such
certificates are fully insured by the FDIC.
VRDOs and Participating VRDOs. VRDOs are tax-exempt obligations which
contain a floating or variable interest rate adjustment formula and a 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 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.
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, the 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 a 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 determinations.
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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-3/VMIG-3 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
S&P), or F-1 through F-3 for notes, VRDOs and commercial paper (as determined
by Fitch). Temporary Investments, if not rated, must be of comparable quality
in the opinion of the Manager. 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.
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 primary dealer or an affiliate
thereof, in U.S. Government securities. Under such agreements, the bank or
primary dealer or an affiliate thereof 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 shall be dependent upon intervening fluctuations of
the market value of such security and the accrued interest on the security. In
such event, the Fund would have rights against the seller for breach of
contract with respect to any losses arising from market fluctuations following
the failure of the seller to perform. The Fund may not invest in repurchase
agreements maturing in more than seven days if such investments, together with
all other illiquid investments, would exceed 15% of the Fund's net 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. The treatment of purchase and sales contracts is less certain.
Suitability. The economic benefit of an investment in the Fund depends upon
many factors beyond the control of the Fund, the Manager and its affiliates.
Because of its emphasis on California Municipal Bonds, the Fund should be
considered a vehicle for diversification and not as a balanced investment
program. The suitability for any particular investor of a purchase of shares
in the Fund will depend upon, among other things, such investor's tax
situation, investment objectives and ability to accept the risks associated
with investing in California Municipal Bonds, including the risk of loss of
principal and the risk of receiving income that is not exempt from Federal
and/or California income taxes.
Investment Restrictions
The Fund has adopted a number of fundamental and non-fundamental investment
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 Investment Company Act
means the lesser of (i) 67% of the Fund's shares present at a meeting at which
more than 50% of the outstanding shares of the Fund are represented or (ii)
more than 50% of the Fund's outstanding shares). The Fund may not:
(1) Make any investment inconsistent with the Fund's classification as a
diversified company under the Investment Company Act.
(2) Invest more than 25% of its assets, taken at market value at the time
of each investment, in the securities of issuers in any particular industry
(excluding the U.S. Government and its agencies and
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instrumentalities). For purposes of this restriction, states,
municipalities and their political subdivisions are not considered part of
any industry.
(3) Make investments for the purpose of exercising control or management.
(4) Purchase or sell real estate, except that, to the extent permitted by
applicable law, the Fund may invest in securities directly or indirectly
secured by real estate or interests therein or issued by companies that
invest in real estate or interests therein.
(5) Make loans to other persons, except that the acquisition of bonds,
debentures or other corporate debt securities and investment in government
obligations, commercial paper, pass-through instruments, certificates of
deposit, bankers acceptances, repurchase agreements or any similar
instruments shall not be deemed to be the making of a loan, and except
further that the Fund may lend its portfolio securities, provided that the
lending of portfolio securities may be made only in accordance with
applicable law and the guidelines set forth in the Fund's Prospectus and
Statement of Additional Information, as they may be amended from time to
time.
(6) Issue senior securities to the extent such issuance would violate
applicable law.
(7) Borrow money, except that (i) the Fund may borrow from banks (as
defined in the Investment Company Act) in amounts up to 33 1/3% of its
total assets (including the amount borrowed), (ii) the Fund may borrow up
to an additional 5% of its total assets for temporary purposes, (iii) the
Fund may obtain short-term credit as may be necessary for the clearance of
purchases and sales of portfolio securities and (iv) the Fund may purchase
securities on margin to the extent permitted by applicable law. The Fund
may not pledge its assets other than to secure such borrowings or, to the
extent permitted by the Fund's investment policies as set forth in its
Prospectus and Statement of Additional Information, as they may be amended
from time to time, in connection with hedging transactions, short sales,
when-issued and forward commitment transactions and similar investment
strategies.
(8) Underwrite securities of other issuers except insofar as the Fund
technically may be deemed an underwriter under the Securities Act in
selling portfolio securities.
(9) Purchase or sell commodities or contracts on commodities, except to
the extent that the Fund may do so in accordance with applicable law and
the Fund's Prospectus and Statement of Additional Information, as they may
be amended from time to time, and without registering as a commodity pool
operator under the Commodity Exchange Act.
Under the non-fundamental investment restrictions, which may be changed by
the Board of Trustees without shareholder approval, 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
Investment Company 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 that mature within seven days or
securities, that 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, 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.
13
<PAGE>
The Fund's investments will be limited so as to qualify as a "regulated
investment company" for purposes of the Code. See "Dividends and Taxes--
Taxes." To qualify, among other requirements, the Trust will limit the Fund's
investments so that, at the close of each quarter of the taxable year, (i) not
more than 25% of the market value of the Fund's total assets will be invested
in the securities of a single issuer, and (ii) with respect to 50% of the
market value of its total assets, not more than 5% of the market value of its
total assets will be invested in the securities of a single issuer and the
Fund will not own more than 10% of the outstanding voting securities of a
single issuer. For purposes of this restriction, the Fund will regard each
state and each political subdivision, agency or instrumentality of such state
and each multi-state agency of which such state is a member and each public
authority which issues securities on behalf of a private entity as a separate
issuer, except that if the security is backed only by the assets and revenues
of a non-government entity then the entity with the ultimate responsibility
for the payment of interest and principal may be regarded as the sole issuer.
These tax-related limitations may be changed by the Trustees of the Trust to
the extent necessary to comply with changes to the Federal tax requirements.
The Fund is "diversified" under the Investment Company Act and must satisfy
the foregoing 5% and 10% requirements with respect to 75% of its total assets.
Because of the affiliation of Merrill Lynch, Pierce, Fenner & Smith
Incorporated ("Merrill Lynch") with the Manager, the Fund is prohibited from
engaging in certain transactions involving Merrill Lynch or its affiliates
except pursuant to an exemptive order under the Investment Company Act. See
"Portfolio Transactions." Without such an exemptive order the Fund would be
prohibited from engaging in portfolio transactions with Merrill Lynch or any
of its affiliates acting as principal.
Portfolio Turnover
The Manager will effect portfolio transactions without regard to the time
the securities have been held, if, in its judgment, such transactions are
advisable in light of a change in circumstances of a particular issuer or in
general market, financial or economic conditions. As a result of the
investment policies described herein, the Fund's portfolio turnover rate may
be higher than that of other investment companies; however, it is extremely
difficult to predict portfolio turnover rates with any degree of accuracy. The
portfolio turnover rate is calculated by dividing the lesser of the Fund's
annual sales or purchases of portfolio securities (exclusive of purchases or
sales of securities whose maturities at the time of acquisition were one year
or less) by the monthly average value of the securities in the portfolio
during the year. A high portfolio turnover may result in negative tax
consequences, such as an increase in capital gain dividends or in ordinary
income dividends of accrued market discount. See "Dividends and Taxes --
Taxes." High portfolio turnover may also involve correspondingly greater
transaction costs which are borne directly by the Fund.
14
<PAGE>
MANAGEMENT OF THE TRUST
Trustees and Officers
The Trustees of the Trust consist of seven individuals, five of whom are not
"interested persons" of the Trust as defined in the Investment Company Act
(the "non-interested Trustees"). The Trustees are responsible for the overall
supervision of the operations of the Trust and perform the various duties
imposed on the directors or trustees of investment companies by the Investment
Company Act. 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, executive officer and the
portfolio manager is P.O. Box 9011, Princeton, New Jersey 08543-9011.
Terry K. Glenn (59) -- President and Trustee(1)(2) -- Executive Vice
President of the Manager and Merrill Lynch Asset Management, L.P. ("MLAM")
(which terms as used herein include their corporate predecessors) since 1983;
Executive Vice President and Director of Princeton Services, Inc. ("Princeton
Services") since 1993; President of Princeton Funds Distributor, Inc. ("PFD")
since 1986 and Director thereof since 1991; President of Princeton
Administrators, L.P. since 1988.
James H. Bodurtha (55) -- Trustee(2)(3) -- 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 (60) -- Trustee(2)(3) -- 2 Washington Square Village, New
York, New York 10012. John M. Olin Professor of Humanities, New York
University since 1993 and Professor thereof since 1980; President, Hudson
Institute since 1997 and Trustee thereof 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 since 1996.
Robert R. Martin (72) -- Trustee(2)(3) -- 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 (70) -- Trustee(2)(3) -- 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 (47) -- Trustee(2)(3) -- 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 from 1991 to 1999; Director, TIBCO from 1994 to
1996; and Director, Genbel Securities Limited and Gensec Bank since 1999.
Arthur Zeikel (67) -- Trustee(1)(2) -- 300 Woodland Avenue, Westfield, New
Jersey 07090. Chairman of the Manager and MLAM from 1997 to 1999; President of
the Manager and MLAM from 1977 to 1997; Chairman of Princeton Services from
1997 to 1999, Director thereof from 1993 to 1999 and President thereof from
1993 to 1997; Executive Vice President of Merrill Lynch & Co., Inc. ("ML &
Co.") from 1990 to 1999.
Vincent R. Giordano (55) -- Senior Vice President(1)(2) -- Senior Vice
President of the Manager and MLAM since 1984; Senior Vice President of
Princeton Services since 1993.
Kenneth A. Jacob (48) -- 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.
15
<PAGE>
Walter O'Connor (38) -- Portfolio Manager and Vice President(1)(2) --
Director (Municipal Tax-Exempt) since 1997; Vice President of MLAM from 1993
to 1997; Assistant Vice President of MLAM from 1991 to 1993.
Donald C. Burke (39) -- Vice President and Treasurer(1)(2) -- Senior Vice
President and Treasurer of the Manager and MLAM since 1999; Senior Vice
President and Treasurer of Princeton Services since 1999; Vice President of
PFD since 1999; First Vice President of MLAM from 1997 to 1999; Vice President
of MLAM from 1990 to 1997; Director of Taxation of MLAM since 1990.
Alice A. Pellegrino (39) -- Secretary(1)(2) -- Vice President of MLAM since
1999; Attorney associated with MLAM since 1997; Associate with Kirkpatrick &
Lockhart LLP from 1992 to 1997.
- ----------
(1) Interested person, as defined in the Investment Company Act, of the Trust.
(2) Such Trustee or officer is a director, trustee or officer of certain other
investment companies for which FAM or MLAM acts as the investment adviser
or manager.
(3) Member of the Trust's Audit and Nominating Committee, which is responsible
for the selection of the independent auditors and the selection and
nomination of non-interested Trustees.
As of November 1, 1999, the Trustees, officers of the Trust and officers of
the Fund as a group (12 persons) owned an aggregate of less than 1% of the
outstanding shares of the Fund. At such date, Mr. Glenn, a Trustee and officer
of the Trust, Mr. Zeikel, a Trustee of the Trust and the other officers of the
Trust owned an aggregate of less than 1% of the outstanding shares of common
stock of ML & Co.
Compensation of Trustees
The Trust pays each non-interested 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 the non-
interested Trustees, a fee of $1,000 per year plus $250 per Committee meeting
attended. The Trust reimburses each non-interested 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.
The following table shows the compensation earned by the non-interested
Trustees for the fiscal year ended August 31, 1999 and the aggregate
compensation paid to them from all registered investment companies advised by
the Manager and its affiliate, MLAM ("MLAM/FAM-advised funds"), for the
calendar year ended December 31, 1998.
<TABLE>
<CAPTION>
Aggregate
Pension or Estimated Compensation from
Retirement Benefits Annual Trust and Other
Position with Compensation Accrued as Part of Benefits upon MLAM/FAM- Advised
Name Trust From Fund Fund Expense Retirement Funds(1)
- ---- ------------- ------------ ------------------- ------------- -----------------
<S> <C> <C> <C> <C> <C>
James H. Bodurtha....... Trustee $2,595 None None $163,500
Herbert I. London....... Trustee $2,595 None None $163,500
Robert R. Martin........ Trustee $2,595 None None $163,500
Joseph L. May........... Trustee $2,595 None None $163,500
Andre F. Perold......... Trustee $2,595 None None $163,500
</TABLE>
- ----------
(1) The Trustees serve on the boards of MLAM/FAM-advised funds as follows: Mr.
Bodurtha (29 registered investment companies consisting of 47 portfolios);
Mr. London (29 registered investment companies consisting of 47
portfolios); Mr. Martin (29 registered investment companies consisting of
47 portfolios); Mr. May (29 registered investment companies consisting of
47 portfolios); and Mr. Perold (29 registered investment companies
consisting of 47 portfolios).
Trustees of the Trust may purchase Class A shares of the Fund at net asset
value. See, "Purchase of Shares -- Initial Sales Charge Alternatives -- Class
A and Class D Shares -- Reduced Initial Sales Charges -- Purchase Privilege of
Certain Persons."
16
<PAGE>
Management and Advisory Arrangements
Management Services. The Manager provides the Fund with investment advisory
and management services. Subject to the supervision 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 the
office space, facilities, equipment and necessary personnel for management of
the Trust and the Fund.
Management Fee. The Trust has entered into a management agreement on behalf
of the Fund with the Manager (the "Management Agreement"), pursuant to which
the Manager receives for its services to the Fund monthly compensation at the
annual rate of 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 average daily net assets exceeding
$1.0 billion. For the fiscal year ended August 31, 1999, the Manager received
a fee equal to 0.55% of the Fund's average daily net assets but the Manager
voluntarily waived a portion of its fee. The Manager may discontinue this
waiver of fees at any time without notice. The table below sets forth
information about the total management fees paid by the Fund to the Manager
and the amount of any fee waiver for the periods indicated.
<TABLE>
<CAPTION>
Management Amount of Fee
Fee Voluntarily
Fiscal Year Ended August 31, Payable Waived by Manager
---------------------------- ---------- -----------------
<S> <C> <C>
1999......................................... $3,196,568 $20,299
1998......................................... $3,337,222 $35,762
1997......................................... $3,464,108 $41,862
</TABLE>
Payment of Fund Expenses. 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 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, a division of
PFD (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 non-
interested Trustees, state franchise taxes, costs of printing proxies and
other expenses relating to shareholder meetings and other expenses properly
payable by the Trust. The organizational expenses of the Trust were paid by
the Trust, and if additional Series are added to the Trust, the organizational
expenses will be allocated among the Series in a manner deemed equitable by
the Trustees. Depending upon the nature of a lawsuit, litigation costs may be
assessed to the specific Series to which the lawsuit relates or allocated on
the basis of the asset size of the respective Series. The Trustees have
determined that this is an appropriate method of allocation of expenses.
Accounting services are provided to the Trust by the Manager and the Trust
reimburses the Manager for its costs in connection with such services. 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 Trust pursuant to the Distribution Plans in compliance with Rule 12b-1
under the Investment Company Act. See "Purchase of Shares -- Distribution
Plans." Reference is made to "Management of the Fund" in the Prospectus for
certain information concerning the management and advisory arrangements of the
Trust.
Organization of the Manager. The Manager is a limited partnership, the
partners of which are ML & Co., a financial services holding company and the
parent of Merrill Lynch, and Princeton Services. ML & Co. and Princeton
Services are "controlling persons" of the Manager as defined under the
Investment Company Act
17
<PAGE>
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 herein, 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 Investment Company
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 or by vote of the shareholders of the Fund.
Transfer Agency Services. Financial Data Services, Inc. (the "Transfer
Agent"), 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 a fee of $11.00 per Class A or Class D account and $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.
Distribution Expenses. The Fund has entered into four 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.
Code of Ethics
The Board of Trustees of the Trust has adopted a Code of Ethics under Rule
17j-1 of the Investment Company 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 pre-clear any personal
securities investment (with limited exceptions, such as government
securities). The pre-clearance 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).
18
<PAGE>
PURCHASE OF SHARES
Reference is made to "How to Buy, Sell, Transfer and Exchange Shares" in the
Prospectus.
The Fund offers four classes of shares under the Merrill Lynch Select
Pricing SM System: shares of Class A and Class D are sold to investors
choosing the initial sales charge alternatives and shares of Class B and Class
C are sold to investors choosing the deferred sales charge alternatives. Each
Class A, Class B, Class C 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 (also known as service 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 contingent deferred sales charges ("CDSCs"),
distribution fees and account maintenance fees that are imposed on Class B and
Class C shares, as well as the account maintenance fees that are imposed on
Class D shares, are imposed directly against those classes and not against all
assets of the Fund and, accordingly, such charges do 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 are
calculated in the same manner at the same time and 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 Merrill Lynch Select Pricing (SM) System is used by more than 50
registered investment companies advised by MLAM or FAM. Funds advised by MLAM
or FAM that utilize the Merrill Lynch Select Pricing (SM) System are referred to
herein as "Select Pricing Funds."
The Fund offers its shares at a public offering price equal to the next
determined net asset value per share plus any sales charges applicable to the
class of shares selected by the investor. 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., Eastern time) which includes
orders received after the determination of net asset value on the previous
day, the applicable offering price will be based on the net asset value on the
day the order is placed with the Distributor, provided that the orders are
received by the Distributor prior to 30 minutes after the close of business on
the NYSE on that day. If the purchase orders are not received 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. Dealers have the responsibility
of submitting purchase orders to the Fund not later than 30 minutes after the
close of business on the NYSE in order to purchase shares at that day's
offering price.
The Fund or the Distributor may suspend the continuous offering of the
Fund's shares of any class at any time in response to conditions in the
securities markets or otherwise and may thereafter resume such offering from
time to time. Any order may be rejected by the Fund or the Distributor.
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 Transfer Agent are not
subject to the processing fee.
Initial Sales Charge Alternatives -- Class A and Class D Shares
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
19
<PAGE>
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 deferred sales charges
imposed in connection with purchases of Class B or Class C shares. Investors
not qualifying for reduced initial sales charges who expect to maintain their
investment for an extended period of time also may elect to purchase Class A
or Class D shares, because over time the accumulated ongoing account
maintenance and distribution fees on Class B or Class C shares may exceed the
initial sales charges and, in the case of Class D shares, the account
maintenance fee. Although some investors who previously purchased Class A
shares may no longer be eligible to purchase Class A shares of other Select
Pricing Funds, those previously purchased Class A shares, together with Class
B, Class C and Class D share holdings, will count toward a right of
accumulation which may qualify the investor for a reduced initial sales charge
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.
The term "purchase," as used in the Prospectus and 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, 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 Investment Company 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.
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
who currently own Class A shares in a shareholder account are entitled to
purchase additional Class A shares of the Fund in that account. Class A shares
are also 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 bank has $3 million or more initially invested in Select
Pricing Funds. Also eligible to purchase Class A shares at net asset value are
participants in certain investment programs including TMA SM 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 certain 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/FAM-advised investment companies. Certain persons who
acquired shares of certain MLAM/FAM-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 are met. In addition, Class A
shares of the Fund and certain other Select Pricing Funds are offered at net
asset value to shareholders of Merrill Lynch Senior Floating Rate Fund, Inc.
and, if certain conditions 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 Select Pricing Funds.
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.
20
<PAGE>
Class A and Class D Sales Charge Information
<TABLE>
<CAPTION>
Class A Shares
---------------------------------------------------------------------------------
For the Fiscal Year Gross Sales Sales Charges Sales Charges CDSCs Received on
Ended Charges Retained by Paid to Redemption of
August 31, Collected Distributor Merrill Lynch Load-Waived Shares
------------------- ----------- ------------- ------------- ------------------
<S> <C> <C> <C> <C>
1999 $11,530 $1,171 $10,359 $ 0
1998 $11,451 $1,294 $10,157 $ 0
1997 $11,680 $1,003 $10,677 $ 0
<CAPTION>
Class D Shares
---------------------------------------------------------------------------------
For the Fiscal Year Gross Sales Sales Charges Sales Charges CDSCs Received on
Ended Charges Retained by Paid to Redemption of
August 31, Collected Distributor Merrill Lynch Load-Waived Shares
------------------- ----------- ------------- ------------- ------------------
<S> <C> <C> <C> <C>
1999 $73,395 $2,461 $70,934 $ 0
1998 $72,367 $7,401 $64,966 $ 0
1997 $50,567 $4,949 $45,618 $ 0
</TABLE>
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.
Reduced Initial Sales Charges
Reduction 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 to obtain such investments.
Reinvested Dividends. No initial sales charges are imposed upon Class A and
Class D shares issued as a result of the automatic reinvestment of dividends.
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 any other Select Pricing 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 Intent. 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 Select Pricing Funds made within a 13-month period starting with the first
purchase pursuant to a Letter of Intent. The Letter of Intent is available
only to investors whose accounts are established and maintained at the Fund's
Transfer Agent. The Letter of Intent is not available to employee benefit
plans for which Merrill Lynch provides plan participant recordkeeping
services. The Letter of Intent 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 Intent may be
included under a subsequent Letter of Intent 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 Select Pricing Funds presently held, at cost or maximum offering price
(whichever is higher), on the date of the first purchase under the Letter of
Intent, 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 Intent (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
21
<PAGE>
rate and the sales charge applicable to the shares actually purchased through
the Letter. Class A or Class D shares equal to at least 5.0% 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 Intent must be at least 5.0% 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
the further reduced percentage sales charge that would be applicable to a
single purchase equal to the total dollar value of the Class A or Class D
shares then being purchased under such Letter, but there will be no
retroactive reduction of the sales charge on any previous purchase.
The value of any shares redeemed or otherwise disposed of by the purchaser
prior to termination or completion of the Letter of Intent will be deducted
from the total purchases made under such Letter. An exchange from the Summit
Cash Reserves Fund into the Fund that creates a sales charge will count toward
completing a new or existing Letter of Intent from the Fund.
TMA SM Managed Trusts. Class A shares are offered at net asset value to TMA
SM Managed Trusts to which Merrill Lynch Trust Company provides discretionary
trustee services.
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 investment for such accounts is $500, except that the initial
minimum investment for shares purchased for such accounts pursuant to the
Automatic Investment Program is $50.
Purchase Privilege of Certain Persons. Trustees of the Trust, members of the
Boards of other MLAM/FAM-advised funds, ML & Co. and its subsidiaries (the
term "subsidiaries," when used herein with respect to ML & Co., includes MLAM,
FAM 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. The Fund realizes economies of
scale and reduction of sales-related expenses by virtue of the familiarity of
these persons with the Fund. Employees and directors or trustees wishing to
purchase shares of the Fund must satisfy the Fund's suitability standards.
Class D shares of the Fund are offered at net asset value, without a sales
charge, to an investor that 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
shares 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 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 that has a business relationship with a Merrill
Lynch Financial Consultant and that 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 that has a business relationship with a Merrill Lynch
Financial Consultant and that 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.
22
<PAGE>
Closed-End Fund Investment Option. Class A shares of the Fund and certain
other Select Pricing Funds ("Eligible Class A Shares") are offered at net
asset value to shareholders of certain closed-end funds advised by FAM or MLAM
who purchased such closed-end fund shares prior to October 21, 1994 (the date
the Merrill Lynch Select Pricing SM System commenced operations) and wish to
reinvest the net proceeds 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 Select Pricing
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
Eligible 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/FAM-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 of the Fund 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.
Acquisition of Certain Investment Companies. Class D shares may be offered
at the net asset value in connection with the acquisition of the assets of or
merger or consolidation with a personal holding company or a public or private
investment company.
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 Select Pricing Funds.
Because no initial sales charges are deducted at the time of the 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 that do
not qualify for the reduction in initial sales charges. Both Class B and Class
C shares are subject to ongoing account maintenance fees and distribution
fees; however, the ongoing account maintenance and distribution fees
potentially may be offset to the extent any return is realized on the
additional funds initially invested in Class B or Class C shares. In addition,
Class B shares will be converted into Class D shares of the Fund after a
conversion period of approximately ten years, and thereafter investors will be
subject to lower ongoing fees.
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. See "Pricing of Shares -- Determination of Net Asset Value" below.
23
<PAGE>
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. In determining whether a CDSC is applicable to
a redemption, the calculation will be determined in the manner that results in
the lowest applicable rate being charged. 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. 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.
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.
The following table sets forth the Class B CDSC:
<TABLE>
<CAPTION>
Year Since
Purchase CDSC as a Percentage
Payment of Dollar Amount
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>
To provide an example, assume an investor purchased 100 shares at $10 per
share (at a cost of $1,000) and in the third year after purchase, the net
asset value per share is $12 and, during such time, the investor has acquired
10 additional shares 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 a CDSC because of dividend reinvestment. With respect
to the remaining 40 shares, the charge 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 may be waived on redemptions of shares in certain
circumstances, including any partial or complete redemption 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 or, if later, reasonably promptly following completion of
probate. The terms of the CDSC may be waived or its terms modified in
connection with certain fee-based programs. The Class B CDSC may also be
waived in connection with involuntary termination of an account in which Fund
shares are held or for withdrawals through the Merrill Lynch Systematic
Withdrawal Plan. See "Shareholder Services -- Fee-Based Programs" and "--
Systematic Withdrawal Plans."
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 the average daily 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 value 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 the 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.
24
<PAGE>
In general, Class B shares of equity Select Pricing Funds will convert
approximately eight years after initial purchase and Class B shares of taxable
and tax-exempt fixed income Select Pricing 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 on
to the holding period for the shares acquired. The Conversion Period also may
be modified for investors that participate in certain fee-based programs. See
"Shareholder Services -- Fee-Based Programs."
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.
Share certificates for Class B shares of the Fund to be converted must be
delivered to the Transfer Agent at least one week prior to the Conversion Date
applicable to those shares. In the event such certificates are not received by
the Transfer Agent at least one week prior to the Conversion Date, the related
Class B shares will convert to Class D shares on the next scheduled Conversion
Date after such certificates are delivered.
Contingent Deferred Sales Charges -- Class C Shares
Class C shares that are redeemed within one year of purchase may be subject
to a 1.0% CDSC charged as a percentage of the dollar amount subject thereto.
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. 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. It will be
assumed that the redemption is first of shares held for over one year or
shares acquired pursuant to reinvestment of dividends and then of shares held
longest during the one-year period. 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. The Class C CDSC may be waived in connection with involuntary
termination of an account in which Fund shares are held and withdrawals
through the Merrill Lynch Systematic Withdrawal Plan. See "Shareholder
Services -- Systematic Withdrawal Plan." The Class C CDSC of the Fund and
certain other Select Pricing Funds may be waived with respect to Class C
shares purchased by an investor with the net proceeds of a tender offer made
by certain MLAM/FAM-advised closed end funds, including Merrill Lynch Senior
Floating Rate Fund II, Inc. Such waiver is subject to the requirement that the
tendered shares shall have been held by the investor for a minimum of one year
and to such other conditions as are set forth in the prospectus for the
related closed end fund.
Class B and Class C Sales Charge Information
<TABLE>
<CAPTION>
Class B Shares*
--------------------------------------------------------------------------------
For the Fiscal Year CDSCs Received CDSCs Paid to
Ended August 31, by Distributor Merrill Lynch
------------------- -------------- -------------
<S> <C> <C>
1999 $262,836 $262,836
1998 $184,769 $184,769
1997 $307,864 $307,864
* Additional Class B 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.
<CAPTION>
Class C Shares
--------------------------------------------------------------------------------
For the Fiscal Year CDSCs Received CDSCs Paid to
Ended August 31, by Distributor Merrill Lynch
------------------- -------------- -------------
<S> <C> <C>
1999 $ 4,739 $ 4,739
1998 $ 10,718 $ 10,718
1997 $ 5,077 $ 5,077
</TABLE>
25
<PAGE>
Merrill Lynch compensates its Financial Consultants for selling Class B and
Class C shares at the time of purchase from its own funds. 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. See "Distribution Plans" below. Imposition of the CDSC and
the distribution fee on Class B and Class C shares is limited by the National
Association of Securities Dealers, Inc. ("NASD") asset-based sales charge
rule. See "Limitations on the Payment of Deferred Sales Charges" below.
Distribution Plans
Reference is made to "Fees and Expenses" 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 Investment Company 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 Distribution Plans for Class B, Class C and Class D shares each provides
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 with respect to Class B, Class
C and Class D shares. Each of those classes has exclusive voting rights with
respect to the 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).
The Distribution Plans for Class B and Class C shares each provides 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.
The Fund's Distribution Plans are subject to the provisions of Rule 12b-1
under the Investment Company Act. 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 each
related class of shareholders. Each Distribution Plan further provides that,
so long as the Distribution Plan remains in effect, the selection and
nomination of non-interested Trustees shall be committed to the discretion of
the non-interested Trustees then in office. In approving each Distribution
Plan in accordance with Rule 12b-1, the non-interested Trustees concluded that
there is reasonable likelihood that each 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 non-
interested 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 non-interested Trustees who have no direct or
indirect financial interest in the Distribution Plan, cast in person at a
meeting called for that purpose. Rule 12b-1 further requires that the Fund
preserve copies of the Distribution Plan and any report made pursuant to such
plan for a period of not less than six years from the date of the Distribution
Plan or such report, the first two years in an easily accessible place.
26
<PAGE>
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 and/or distribution fees paid to the
Distributor. 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 Trustees for their consideration in connection
with their deliberations as to the continuance of the Class B and Class C
Distribution Plans 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, 1998, the last date for which fully allocated accrual
data is available, the fully allocated accrual expenses of the Distributor and
Merrill Lynch for the period since the commencement of operations of Class B
shares exceeded the fully allocated accrual revenues by approximately
$3,653,000 (1.12% of Class B net assets at that date). As of August 31, 1999,
direct cash revenues for the period since the commencement of operations of
Class B shares exceeded direct cash expenses by $25,805,006 (9.59% of Class B
net assets at that date). As of December 31, 1998, the fully allocated accrual
expenses incurred by the Distributor and Merrill Lynch for the period since
the commencement of operations of Class C shares exceeded the fully allocated
accrual revenues by approximately $71,000 (.52% of Class C net assets at that
date). As of August 31, 1999, direct cash revenues for the period since the
commencement of operations of Class C shares exceeded direct cash expenses by
$164,525 (1.40% of Class C net assets at that date).
For the fiscal year ended August 31, 1999, the Fund paid the Distributor
$1,580,404 pursuant to the Class B Distribution Plan (based on average daily
net assets subject to such Class B Distribution Plan of approximately $316.1
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, 1999, the Fund paid
the Distributor $79,999 pursuant to the Class C Distribution Plan (based on
average daily net assets subject to such Class C Distribution Plan of
approximately $13.3 million), all of which was paid to Merrill Lynch for
providing account maintenance and distribution-related activities and services
in connection with Class C shares. For the fiscal year ended August 31, 1999,
the Fund paid the Distributor $208,037 pursuant to the Class D Distribution
Plan (based on average daily net assets subject to such Class D Distribution
Plan of approximately $208.0 million), all of which was paid to Merrill Lynch
for providing account maintenance activities in connection with Class D
shares.
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
27
<PAGE>
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, 1999
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 the Class B shares, the Distributor's
voluntary maximum.
<TABLE>
<CAPTION>
Data Calculated as of August 31, 1999
-------------------------------------------------------------------------------
(in thousands)
Annual
Distribution
Allowable Allowable Amounts Fee at
Eligible Aggregate Interest on Maximum Previously Aggregate Current Net
Gross Sales Unpaid Amount Paid to Unpaid Asset
Sales(1) Charge Balance(3) Payable Distributor(4) Balance Level(5)
---------- --------- ----------- -------- -------------- --------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Class B Shares for the
period
September 30, 1985
(commencement of
operations)
to August 31, 1999
Under NASD Rule as Adopted.. $1,505,498 $93,773 $118,694 $212,467 $34,208 $178,259 $673
Under Distributor's
Voluntary Waiver........... $1,505,498 $93,773 $ 7,848 $101,621 $34,208 $ 67,413 $673
Class C Shares, for the
period October 21, 1994
(commencement of operations)
to August 31, 1999
Under NASD Rule as Adopted.. $ 22,598 $ 1,402 $ 345 $ 1,747 $ 174 $ 1,573 $ 41
</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) Includes amounts attributable to exchanges from Summit Cash Reserves Fund
("Summit") which are not reflected in Eligible Gross Sales. Shares of
Summit can only be purchased by exchange from another fund (the "redeemed
fund"). Upon such an exchange, the maximum allowable sales charge payment
to the redeemed fund is reduced in accordance with the amount of the
redemption. This amount is then added to the maximum allowable sales
charge payment with respect to Summit. Upon an exchange out of Summit, the
remaining balance of this amount is deducted from the maximum allowable
sales charge payment to Summit and added to the maximum allowable sales
charge payment to the fund into which the exchange is made.
(3) 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.
(4) Consists of CDSC payments, distribution fee payments and accruals. See
"What are the Fund's fees and expenses?" 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 Advisor (Merrill Lynch MFA SM) 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.
(5) 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 "How to Buy, Sell, Transfer and Exchange Shares" in the
Prospectus.
The Fund 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 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.
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<PAGE>
The value of shares at the time of 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.
Redemption
A shareholder wishing to redeem shares held with the Transfer Agent may do
so without charge by tendering the shares directly to the Transfer Agent at
Financial Data Services, Inc., P.O. Box 45289, Jacksonville, Florida 32232-
5289. Redemption requests delivered other than by mail should be delivered to
Financial Data Services, Inc., 4800 Deer Lake Drive East, Jacksonville,
Florida 32246-6484. Proper notice of redemption in the case of shares
deposited with the Transfer Agent may be accomplished by a written letter
requesting redemption. Proper notice of redemption in the case of shares for
which certificates have been issued may be accomplished by a written letter as
noted above accompanied by certificates for the shares to be redeemed.
Redemption requests should not be sent to the Fund. The 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 signatures on the redemption requests may
require a guarantee by an "eligible guarantor institution" as such is defined
in Rule 17Ad-15 under the Securities Exchange Act of 1934 (the "Exchange
Act"), the existence and validity of which may be verified by the Transfer
Agent through the use of industry publications. In the event a signature
guarantee is required, notarized signatures are not sufficient. In general,
signature guarantees are waived on redemptions of less than $50,000 as long as
the following requirements are met: (i) all requests require the signature(s)
of all persons in whose name(s) shares are recorded on the Transfer Agent's
register (ii) all checks must be mailed to the stencil address of record on
the Transfer Agent's register and (iii) the stencil address must not have
changed within 30 days. Certain rules may apply regarding certain account
types such as but not limited to UGMA/UTMA accounts, Joint Tenancies With
Rights of Survivorship, contra broker transactions, and institutional
accounts.
At various times the Fund may be requested to redeem shares for which it has
not yet received good payment (e.g., cash, Federal funds or certified check
drawn on a U.S. bank). The Fund may delay or cause to be delayed the mailing
of a redemption check until such time as it has assured itself that good
payment (e.g., cash, Federal funds or certified check drawn on a U.S. bank)
has been collected for the purchase of such Fund shares, which will usually
not exceed 10 days.
Repurchase
The Fund also will repurchase Fund shares through a shareholder's listed
securities dealer. The Fund 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 the order is placed. Shares will be priced at the
net asset value calculated on the day the request is received, provided that
the request for repurchase is submitted to the dealer prior to the close of
business on the NYSE (generally, the NYSE closes at 4:00 p.m., Eastern time)
and such request is received by the Fund 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 Fund 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 Fund (other than any
applicable CDSC). Securities firms that do not have selected dealer agreements
with the Distributor, however, may impose a transaction charge on the
shareholder for transmitting the notice of repurchase to the Fund. 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 on accounts held at the Transfer Agent are not subject to the
processing fee. The Fund 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 Fund may redeem Fund shares as
set forth above.
Reinstatement Privilege -- Class A and Class D Shares
Shareholders who have redeemed their Class A or Class D shares of the Fund
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
29
<PAGE>
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.
PRICING OF SHARES
Determination of Net Asset Value
Reference is made to "How Shares are Priced" in the Prospectus.
The net asset value of the shares of all classes of the Fund is determined
by the Manager once daily Monday through Friday after the close of business on
the NYSE on each day the NYSE is open for trading. The NYSE generally closes
at 4:00 p.m., Eastern time. The NYSE is not open for trading 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 is computed by dividing 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
Distributor, 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 the Class D shares; moreover, the per share net
asset value of the Class B and Class C shares generally will be lower than the
per share net asset value of Class D shares reflecting the daily expense
accruals of the distribution fees and higher transfer agency fees applicable
with respect to Class B and Class C shares of the Fund. The per share net
asset value of Class C shares will generally be lower than the per share net
asset value of Class B shares reflecting the daily expense accruals of the
higher distribution fees applicable with respect to Class C shares. It is
expected, however, that the per share net asset value of the four classes 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 differentials between the classes.
The California Municipal Bonds and Municipal Bonds and other portfolio
securities in which the Fund invests are traded primarily in over-the-counter
("OTC") municipal bond and money markets and are valued at the last available
bid price for long positions and at the last available ask price for short
positions 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 use 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.
30
<PAGE>
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 on August 31, 1999 is set forth below.
<TABLE>
<CAPTION>
Class A Class B Class C Class D
----------- ------------ ----------- ------------
<S> <C> <C> <C> <C>
Net Assets................... $37,641,196 $269,191,558 $11,768,898 $194,028,766
=========== ============ =========== ============
Number of Shares
Outstanding................. 3,390,982 24,242,864 1,060,094 17,475,577
=========== ============ =========== ============
Net Asset Value Per Share
(net assets divided by
number of shares
outstanding)................ $ 11.10 $ 11.10 $ 11.10 $ 11.10
Sales Charge (for Class A and
Class D shares: 4.00% of
offering price; 4.17% of net
asset value per share)*..... .46 ** ** .46
----------- ------------ ----------- ------------
Offering Price............... $ 11.56 $ 11.10 $ 11.10 $ 11.56
=========== ============ =========== ============
</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 of shares. 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" herein.
PORTFOLIO TRANSACTIONS
Transactions in Portfolio Securities
Subject to policies established by the Trustees, 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. Where possible, the Trust
deals directly with the dealers who make a market in the securities involved
except in those circumstances where better prices and execution are available
elsewhere. It is the policy of the Trust to obtain the best results in
conducting portfolio transactions for the Fund, taking into account such
factors as price (including the applicable dealer spread or commission), the
size, type and difficulty of the transaction involved, the firm's general
execution and operations facilities and the firm's risk in positioning the
securities involved. The portfolio securities of the Fund generally are traded
on a principal basis and normally do not involve either brokerage commissions
or transfer taxes. The cost of portfolio securities transactions of the Fund
primarily consists of dealer or underwriter spreads. While reasonable
competitive spreads or commissions are sought, the Fund will not necessarily
be paying the lowest spread or commission available. Transactions with respect
to the securities of small and emerging growth companies in which the Fund may
invest may involve specialized services on the part of the broker or dealer
and thereby entail higher commissions or spreads than would be the case with
transactions involving more widely traded securities.
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.
Supplemental investment research obtained from such dealers might be used by
the Manager in servicing all of its accounts and all such research might not
be used by the Manager in connection with the Fund. 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.
Because of the affiliation of Merrill Lynch with the Manager, the Fund is
prohibited from engaging in certain transactions involving such firm or its
affiliates except pursuant to an exemptive order under the Investment Company
Act. Included among such restricted transactions are purchases from or sales
to Merrill Lynch of securities in transactions in which it acts as principal.
Under an exemptive order, the Trust may effect principal
31
<PAGE>
transactions with Merrill Lynch in high quality, short-term, tax-exempt
securities subject to conditions set forth in such order. Information
regarding transactions executed pursuant to the exemptive order is set forth
in the following table:
<TABLE>
<CAPTION>
For the
Fiscal Year Approximate Aggregate
Ended August Number of Market Value of
31, Transactions Transactions
------------ ------------ ---------------------
<S> <C> <C>
1999............................... 1 $ 4,800,000
1998............................... 0 0
1997............................... 4 $23,305,700
</TABLE>
An affiliated person of the Trust may serve as broker for the Fund in OTC
transactions conducted on an agency basis. Certain court decisions have raised
questions as to the extent to which investment companies should seek
exemptions under the Investment Company 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 Investment Company 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 that may
be purchased in any one issue and the assets of the Fund that may be invested
in a particular issue.
Section 11(a) of the Exchange Act 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. Securities may be held by, or be appropriate investments for, the
Fund as well as other funds or investment advisory clients of the Manager or
MLAM.
Because of different objectives or other factors, a particular security may
be bought for one or more clients of the Manager or an affiliate when one or
more clients of the Manager or an affiliate are selling the same security. If
purchases or sales of securities arise for consideration at or about the same
time that would involve the Fund or other clients or funds for which the
Manager or an affiliate acts as manager, 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 an affiliate 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.
SHAREHOLDER SERVICES
The Fund 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
and instructions as to how to participate in the various services or plans, or
how to change options with respect thereto, can be obtained from the Fund, by
calling the telephone number on the cover page hereof, or from the Distributor
or Merrill Lynch. Certain of these services are available only to U.S.
investors.
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<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 dividends. The
statements will also show any other activity in the account since the
preceding statement. Shareholders will also receive separate confirmations for
each purchase or sale transaction other than automatic investment purchases
and the reinvestment of dividends. A shareholder with an account held at the
Transfer Agent may make additions to his or her Investment Account at any time
by mailing a check directly to the Transfer Agent. A shareholder may also
maintain an account through Merrill Lynch. Upon the transfer of shares out of
a Merrill Lynch brokerage account, an Investment Account in the transferring
shareholder's name may be opened automatically at 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 may transfer their Fund shares from Merrill Lynch to another
securities dealer that has entered into a selected dealer agreement with
Merrill Lynch. Certain shareholder services may not be available for the
transferred shares. After the transfer, the shareholder may purchase
additional shares of funds owned before the transfer and all future trading of
these assets must be coordinated by the new firm. If a shareholder wishes to
transfer his or her shares to a securities dealer that has not entered into a
selected dealer agreement with Merrill Lynch, the shareholder must either (i)
redeem his or her shares, paying any applicable CDSC or (ii) continue to
maintain an Investment Account at the Transfer Agent for those shares. The
shareholder may also request the new securities dealer to maintain the shares
in an account at the Transfer Agent registered in the name of the securities
dealer for the benefit of the shareholder whether the securities dealer has
entered into a selected dealer agreement or not.
Exchange Privilege
U.S. shareholders of each class of shares of the Fund have an exchange
privilege with certain other Select Pricing Funds and Summit Cash Reserves
Fund ("Summit"), a series of Financial Institutions Series Trust, which is a
Merrill Lynch-sponsored money market fund specifically designated for exchange
by holders of Class A, Class B, Class C and Class D shares of Select Pricing
Funds. 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. Before effecting an
exchange, shareholders should obtain a currently effective prospectus of the
fund into which the exchange is to be made. Exercise of the exchange privilege
is treated as a sale of the exchanged shares and a purchase of the acquired
shares for Federal income tax purposes.
Exchanges of Class A and Class D Shares. Class A shareholders may exchange
Class A shares of the Fund for Class A shares of a second Select Pricing 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 Select
Pricing 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 Select Pricing 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 D
shares are exchangeable with shares of the same class of other Select Pricing
Funds.
Exchanges of Class A or Class D shares outstanding ("outstanding Class A or
Class D shares") for Class A or Class D shares of other Select Pricing Funds
or for Class A shares of Summit ("new Class A or Class D shares"), are
transacted on the basis of relative net asset value per Class A or Class D
share, respectively, plus an amount equal to the difference, if any, between
the sales charge previously paid on the outstanding Class A or
33
<PAGE>
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, respectively, of the other funds with a reduced sales
charge or without a sales charge.
Exchanges of Class B and Class C Shares. Certain Select Pricing Funds with
Class B or Class C shares outstanding ("outstanding Class B or Class C
shares") offer to exchange their Class B or Class C shares for Class B or
Class C shares, respectively, of certain other Select Pricing Funds or for
Class B shares of Summit ("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 CDSC schedule relating to the
Class B shares of the fund from which the exchange has been made. For purposes
of computing the CDSC that may be payable on a disposition of the new Class B
or Class C shares, the holding period for the outstanding Class B or Class C
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 Fund 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.
Exchanges for Shares of a Money Market Fund. Class A and Class D shares are
exchangeable for Class A shares of Summit and Class B and Class C shares are
exchangeable for Class B shares of Summit. Class A shares of Summit have an
exchange privilege back into Class A or Class D shares of Select Pricing
Funds; Class B shares of Summit have an exchange privilege back into Class B
or Class C shares of Select Pricing Funds and, in the event of such an
exchange, the period of time that Class B shares of Summit are held will count
toward satisfaction of the holding period requirement for purposes of reducing
any CDSC and toward satisfaction of any Conversion Period with respect to
Class B shares. Class B shares of Summit will be subject to a distribution fee
at an annual rate of 0.75% of average daily net assets of such Class B shares.
This exchange privilege does not apply with respect to certain Merrill Lynch
fee-based programs for which alternative exchange arrangements may exist.
Please see your Merrill Lynch Financial Consultant for further information.
Prior to October 12, 1998, exchanges from the Fund and other Select Pricing
Funds into a money market fund were directed to certain Merrill Lynch-
sponsored money market funds other than Summit. Shareholders who exchanged
Select Pricing Fund shares for shares of such other money market funds and
subsequently wish to exchange those money market fund shares for shares of the
Fund will be subject to the CDSC schedule applicable to such Fund shares, if
any. The holding period for those money market fund shares will not count
toward satisfaction of the holding period requirement for reduction of the
CDSC imposed on such shares, if any, and, with respect to Class B shares,
toward satisfaction of the Conversion Period. However, the holding period for
Class B or Class C shares received in exchange for such money market fund
shares will be aggregated with the holding period for the original shares for
purposes of reducing the CDSC or satisfying the Conversion Period. However,
the holding period for Class B or Class C shares of a Fund received in
exchange for such money market fund shares will be aggregated with the holding
period for the fund shares originally exchanged for such money market fund
shares for purposes of reducing the CDSC or satisfying the Conversion Period.
34
<PAGE>
Exchanges by Participants in the MFA Program. The Fund's exchange privilege
is also modified with respect to purchases of Class A and Class D shares by
investors under the MFA Program. First, the initial allocation of assets is
made under the MFA Program. Then any subsequent exchange under the MFA Program
of Class A or Class D shares of a Select Pricing Fund for Class A or Class D
shares of the Fund will be made solely on the basis of the relative net asset
values of the shares being exchanged. Therefore, there will not be a charge
for any difference between the sales charge previously paid on the shares of
the other Select Pricing Fund and the sales charge payable on the shares of
the Fund being acquired in the exchange under the MFA Program.
Exercise of the Exchange Privilege. 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 Select Pricing 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. It is
contemplated that the exchange privilege may be applicable to other new mutual
funds whose shares may be distributed by the Distributor.
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 1-800-MER-FUND or 1-800-637-3863.
Automatic Investment Plans
A shareholder may make additions to an Investment Account at any time by
purchasing Class A shares (if he or she is an eligible Class A investor) or
Class B, Class C or Class D shares at the applicable public offering price.
These purchases may be made either through the shareholder's securities
dealer, or by mail directly to the Transfer Agent, acting as agent for such
securities dealer. Voluntary accumulation also can be made through a service
known as the Fund's Automatic Investment Plan. The Fund would be authorized,
on a regular basis, to provide systematic additions to the Investment Account
of such shareholder through charges of $50 or more to the regular bank account
of the shareholder by either pre-authorized checks or automated clearing house
debits. An investor whose shares of the Fund are held within a CMA(R) or
CBA(R) Account may arrange to have periodic investments made in the Fund in
amounts of $100 or more through the CMA(R) or CBA(R) Automated Investment
Program.
Automatic Dividend Reinvestment Plan
Unless specific instructions are given as to the method of payment,
dividends will be automatically reinvested, without sales charge, in
additional full and fractional shares of the Fund. Such reinvestment will be
at the net
35
<PAGE>
asset value of shares of the Fund as determined after the close of business on
the NYSE on the monthly payment date for such dividends and distributions. No
CDSC will be imposed upon redemption of shares issued as a result of the
automatic reinvestment of dividends or capital gains distributions.
Shareholders may, at any time, by written notification to Merrill Lynch if
their account is maintained with Merrill Lynch, or by written notification or
by telephone (1-800-MER-FUND) to the Transfer Agent, if their account is
maintained with the Transfer Agent, elect to have subsequent dividends paid in
cash, rather than reinvested in shares of the Fund or vice versa (provided
that, in the event that a payment on an account maintained at the Transfer
Agent would amount to $10.00 or less, a shareholder will not receive such
payment in cash and such payment will automatically be reinvested in
additional shares). Commencing ten days after the receipt by the Transfer
Agent of such notice, those instructions will be effected. 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 dividend
checks. Cash payments can also be directly deposited to the shareholder's bank
account.
Systematic Withdrawal Plan
A shareholder may elect to receive systematic withdrawals from his or her
Investment Account by check or through automatic payment by direct deposit to
his or her bank account on either a monthly or quarterly basis as provided
below. Quarterly withdrawals are available for shareholders that 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 the class of shares to be redeemed. Redemptions will be mailed, or
the direct deposit for withdrawal payment will be made at net asset value as
determined after the close of business on the NYSE (generally, the NYSE closes
at 4:00 p.m., Eastern 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 net asset
value determined after the close of business on the following business day.
The check for the withdrawal payment will be made on the next business day
following redemption. When a shareholder is making systematic withdrawals,
dividends on all shares in the Investment Account are automatically reinvested
in shares of the Fund. 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 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."
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 be applied thereafter to Class D shares if the
shareholder so elects. If an investor wishes to change the amount being
withdrawn in a systematic withdrawal plan the investor should contact his or
her Merrill Lynch Financial Consultant.
Withdrawal payments should not be considered as dividends. 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 that maintain a Systematic Withdrawal Plan unless
such purchase is equal to at least one year's scheduled withdrawals or $1,200,
whichever is greater. Automatic 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)
36
<PAGE>
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 Automated Investment Program. For more information on the CMA(R) or
CBA(R) Systematic Redemption Program, eligible shareholders should contact
their Merrill Lynch Financial Consultant.
DIVIDENDS AND TAXES
Dividends
The net investment income of the Fund is declared as dividends daily prior
to the determination of the net asset value, which is calculated after the
close of business on the NYSE (generally, the NYSE closes at 4:00 p.m.,
Eastern 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 as of the
close of business on the "payment date" 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 gain dividends will be
reinvested automatically in shares of the Fund unless the shareholder elects
to receive such dividends in cash.
The per share dividends 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 "Pricing of Shares -- Determination of Net Asset Value."
See "Shareholder Services" for information as to how to elect either
dividend reinvestment or cash payments. Portions of dividends which are
taxable to shareholders as described below are subject to income tax whether
they are reinvested in shares of the Fund or received in cash.
Taxes
The Trust intends to continue to qualify the Fund for the special tax
treatment afforded regulated investment companies ("RICs") under the Code. 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 "General Information -- Description of Shares," the Trust
has established other 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. 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
37
<PAGE>
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 the Fund's taxable year, at least 50% of the value of the
Fund's total assets consists of obligations the interest on which is
excludable for gross income for Federal income tax purposes ("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. The
Fund will allocate interest from tax-exempt obligations (as well as ordinary
income, capital gains and tax preference items discussed below) among the
Class A, Class B, Class C and Class D shareholders according to a method
(which it believes is consistent with the Commission rule permitting the
issuance and sale of multiple classes of shares) that is based upon the gross
income that is 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.
Exempt-interest dividends 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.
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 income tax purposes or for 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 PABs or IDBs, if any, held by the Fund.
The portion of the Fund's exempt-interest dividends paid from interest
received by the Fund from California Municipal Bonds 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 generally will not be exempt, to any significant degree, from income
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 Trust will allocate exempt-interest dividends among Class A, Class
B, Class C and Class D shareholders for California income tax purposes based
on a method similar to that described above for Federal income tax purposes.
Distributions from investment income and capital gains, including exempt-
interest dividends, will be subject to California corporate franchise tax if
received by a corporate shareholder subject to such tax and may also be
subject to state taxes in states other than California and to local taxes
imposed by certain cities within California and outside of California.
Accordingly, investors in the Fund including, in particular, corporate
investors which may be subject to the California corporate franchise tax
should consult their tax advisors with respect to the application of such
taxes to an investment in the Fund, to the receipt of 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 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
38
<PAGE>
owned Fund shares, and for California income tax purposes, are treated as
capital gains which are taxed at ordinary income tax rates. Certain categories
of capital gains are taxable at different rates. Generally not later than 60
days after the close of the Fund's taxable year, the Trust will provide
shareholders with a written notice designating the amounts of any exempt-
interest dividends and capital gain dividends, as well as any 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 gains 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 a Federal alternative minimum tax. The alternative minimum tax
applies to interest received on certain PABs issued after August 7, 1986. PABs
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 a Federal alternative minimum tax. The Fund will purchase such
PABs, and the Trust will report to shareholders within 60 days after calendar
year-end the portion of the Fund's dividends declared during the year which
constitute an item of tax preference for alternative minimum tax purposes. The
Code further provides that corporations are subject to a Federal 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 described in "Investment
Objective and Policies -- Description of Municipal Bonds." Furthermore, the
Fund may also invest in instruments the return on which includes non-
traditional features such as indexed principal or interest payments ("non-
traditional 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 non-traditional instruments could be recharacterized as taxable
ordinary income.
No gain or loss will be recognized by Class B shareholders on the conversion
of their Class B shares into Class D shares. A shareholder's basis in the
Class D shares acquired will be the same as such shareholder's basis in the
Class B shares converted and the holding period of the acquired Class D shares
will include the holding period for the converted Class B shares.
If a shareholder exercises an exchange privilege within 90 days of acquiring
the shares, then the loss the shareholder can recognize on the exchange will
be reduced (or the gain increased) to the extent any sales charge paid to the
Fund reduces any sales charge the 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.
39
<PAGE>
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 that 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 tax advisors concerning the applicability of the United
States withholding tax.
Under certain provisions of the Code, some shareholders may be subject to a
31% withholding tax on certain ordinary income dividends and on capital gain
dividends and redemption payments ("backup withholding"). Generally,
shareholders subject to backup withholding will be those for whom no certified
taxpayer identification number is on file with the Trust or who, to the
Trust's knowledge, have furnished an incorrect number. When establishing an
account, an investor must certify under penalty of perjury that such number is
correct and that such shareholder 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 purchase and 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 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 contacts 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.
The foregoing is a general and abbreviated summary of the applicable
provisions of the Code, Treasury regulations and 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
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.
40
<PAGE>
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. 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.
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 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.
41
<PAGE>
Set forth below is the total return, yield and tax-equivalent yield
information for Class A, Class B, Class C and Class D shares of the Fund for
the periods indicated.
<TABLE>
<CAPTION>
Class A Shares Class B Shares
---------------------------------- ----------------------------------
Redeemable Value Redeemable Value
of a of a
Expressed as hypothetical Expressed as hypothetical
a percentage $1,000 a percentage $1,000
based on a investment at based on a investment at
hypothetical the end of hypothetical the end of
$1,000 investment the period $1,000 investment the period
----------------- ---------------- ----------------- ----------------
Average Annual Total Return
(including maximum applicable sales charge)
<S> <C> <C> <C> <C>
One year ended August
31, 1999............... (5.73)% $ 942.70 (6.02)% $ 939.80
Five years ended August
31, 1999............... 4.75 % $1,261.20 5.09 % $1,281.60
Ten years ended August
31, 1999............... 6.15 % $1,816.50 6.04 % $1,796.80
<CAPTION>
Annual Total Return
(excluding maximum applicable sales charge)
<S> <C> <C> <C> <C>
Year Ended August 31,
1999.................. (1.80)% $ 982.00 (2.38)% $ 976.20
1998.................. 8.39 % $1,083.90 7.84 % $1,078.40
1997.................. 8.55 % $1,085.50 8.09 % $1,080.90
1996.................. 6.53 % $1,065.30 5.99 % $1,059.90
1995.................. 6.75 % $1,067.50 6.25 % $1,062.50
1994.................. (0.92)% $ 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
<CAPTION>
Aggregate Total Return
(including maximum applicable sales charge)
<S> <C> <C> <C> <C>
Inception (September 30,
1985) to August 31,
1999................... -- -- 162.34 % $2,623.40
Inception (October 25,
1988) to August 31,
1999................... 96.11 % $1,961.10 -- --
<CAPTION>
Yield
<S> <C> <C> <C> <C>
30 days ended August 31,
1999................... 4.81 % -- 4.51 % --
<CAPTION>
Tax Equivalent Yield*
<S> <C> <C> <C> <C>
30 days ended August 31,
1999................... 6.68 % -- 6.26 % --
</TABLE>
- ----------
* Based on a Federal income tax rate of 28%.
42
<PAGE>
<TABLE>
<CAPTION>
Class C Shares Class D Shares
---------------------------------- ----------------------------------
Redeemable Value Redeemable Value
of a of a
Expressed as hypothetical Expressed as hypothetical
a percentage $1,000 a percentage $1,000
based on a investment at based on a investment at
hypothetical the end of hypothetical the end of
$1,000 investment the period $1,000 investment the period
----------------- ---------------- ----------------- ----------------
Average Annual Total Return
(including maximum applicable sales charge)
<S> <C> <C> <C> <C>
One year ended August
31, 1999............... (3.31)% $ 966.90 (5.90)% $ 941.00
Inception (October 21,
1994) to August 31,
1999................... 5.69% $1,308.40 5.33% $1,287.40
<CAPTION>
Annual Total Return
(excluding maximum applicable sales charge)
<S> <C> <C> <C> <C>
Year Ended August 31,
1999.................. (2.40)% $ 976.00 (1.98)% $ 980.20
1998.................. 7.65% $1,076.50 8.28% $1,082.80
1997.................. 7.98% $1,079.80 8.53% $1,085.30
1996.................. 5.88% $1,058.80 6.43% $1,064.30
Inception (October 21,
1994) to August 31,
1995................... 8.91% $1,089.10 9.39% $1,093.90
<CAPTION>
Aggregate Total Return
(including maximum applicable sales charge)
<S> <C> <C> <C> <C>
Inception (October 21,
1994) to August 31,
1999................... 30.84% $1,308.40 28.74% $1,287.40
<CAPTION>
Yield
<S> <C> <C> <C> <C>
30 days ended August 31,
1999................... 4.40% -- 4.72% --
<CAPTION>
Tax Equivalent Yield*
<S> <C> <C> <C> <C>
30 days ended August 31,
1999................... 6.11% -- 6.56% --
</TABLE>
- ----------
* Based on a Federal income tax rate of 28%.
In order to reflect the reduced sales charges in the case of Class A or
Class D shares, or the waiver of the CDSC in the case of Class B or Class C
shares applicable to certain investors, as described under "Purchase of
Shares" 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 not take into account the CDSC, and, therefore, may reflect
greater total return since, due to the reduced sales charges or the waiver of
CDSCs, a lower amount of expenses may be deducted.
On occasion, the Fund may compare its performance to the Lehman Brothers
Municipal Bond Index or other market indices or to performance data published
by Lipper Analytical Services, Inc., Morningstar Publications, Inc.
("Morningstar"), CDA Investment Technology, Inc., Money Magazine, U.S. News &
World Report, Business Week, Forbes Magazine, Fortune Magazine or other
industry publications. When comparing its performance to a market index, the
Fund may refer to various statistical measures derived from the historic
performance of the Fund and the index such as standard deviation and beta. In
addition, 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.
Total return 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.
43
<PAGE>
GENERAL INFORMATION
Description of Shares
The Trust is a business trust organized on March 20, 1985 under the laws of
Massachusetts. On December 22, 1987, the Fund changed its name from "Merrill
Lynch California Tax-Exempt Fund" to "Merrill Lynch California Municipal Bond
Fund." The Trust is an open-end management investment company comprised of
separate Series, each of which is a separate portfolio that will offer
separate shares. 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 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. The Trust is presently comprised of the Fund and
Merrill Lynch California Insured Municipal Bond Fund. Shareholder approval is
not required 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 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. All shares of the Trust
have equal voting rights. Each class has exclusive voting rights with respect
to matters relating to distribution and/or account maintenance expenditures,
as applicable (except that Class B shareholders may vote upon any material
changes to expenses charged under the Class D Distribution Plan). 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.
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 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 in accordance with the requirements of the Investment
Company Act to seek approval of new management and advisory arrangements, of a
material increase in distribution fees or 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 or similar rights and will be freely
transferable. Redemption and conversion privileges are as set forth elsewhere
herein and in the Prospectus. Shares do not have cumulative voting rights and
the holders of more than 50% of the shares of the Trust voting for the
election of Trustees can elect all of the Trustees if they choose to do so and
in such event the holders of the remaining shares would not be able to elect
any Trustees. No amendments may be made to the Declaration of Trust, other
than amendments necessary to conform 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.
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" only shall be liable.
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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.
Independent Auditors
Deloitte & Touche LLP, Princeton Forrestal Village, 116-300 Village
Boulevard, Princeton, New Jersey 08540-6400, has been selected as the
independent auditors of the Trust. The selection of independent auditors is
subject to approval by the non-interested Trustees of the Trust. The
independent auditors are responsible for auditing the annual financial
statements of the Fund.
Custodian
The Bank of New York (the "Custodian"), 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
Financial Data Services, Inc., 4800 Deer Lake Drive East, Jacksonville,
Florida 32246-6484, acts as the Trust'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 "How to Buy,
Sell, Transfer and Exchange Shares -- Through the Transfer Agent" 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 the Fund's 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.
Shareholder Inquiries
Shareholder inquiries may be addressed to the Fund at the address or
telephone number set forth on the cover page of this Statement of Additional
Information.
Additional Information
The Prospectus and this Statement of Additional Information do not contain
all the information set forth in the Registration Statement and the exhibits
relating thereto, which the Trust has filed with the Securities and Exchange
Commission, Washington, D.C., under the Securities Act and the Investment
Company Act, to which reference is hereby made.
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Under a separate agreement, ML & Co. has granted the Trust the right to use
the "Merrill Lynch" name and has reserved the right to withdraw its consent to
the use of such name by the Trust at any time or to grant the use of such name
to any other company, and the Trust has granted ML & Co. under certain
conditions, the use of any other name it might assume in the future, with
respect to any corporation organized by ML & Co.
To the knowledge of the Trust, the following persons or entities owned
beneficially 5% or more of any class of the Fund's shares as of November 1,
1999.
<TABLE>
<CAPTION>
Percent and
Name Address Class
---- ------------------------- ------------
<S> <C> <C>
Merrill Lynch Trust Co. P.O. Box 30532 5.5% Class A
New Brunswick, N.J. 08989
</TABLE>
FINANCIAL STATEMENTS
The Fund's audited financial statements are incorporated in this Statement
of Additional Information by reference to its 1999 annual report to
shareholders. You may request a copy of the annual report at no charge by
calling (800) 456-4587 ext. 789 between 8:00 a.m. and 8:00 p.m. on any
business day.
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APPENDIX I
ECONOMIC AND FINANCIAL CONDITIONS IN CALIFORNIA
The following information is a brief summary of factors affecting the
economy of the State of California and does not purport to be a complete
description of such factors. Other factors will affect issuers. The summary is
based primarily upon one or more of the most recent publicly available
offering statements on debt offerings of California issuers; however, it has
not been updated. The Fund has not independently verified the information.
General Economic Conditions
The economy of the State of California (sometimes referred to herein as the
"State") is the largest among the 50 states and one of the largest in the
world. This diversified economy has major components in high technology,
trade, entertainment, agriculture, manufacturing, tourism, construction and
services. Since 1994, California's economy has been performing strongly after
suffering a deep recession.
California's July 1, 1998 population of over 33.4 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 1980s.
California's population is concentrated in metropolitan areas. As of the
April 1, 1990 census, 96% of the State's population resided in the 23
Metropolitan Statistical Areas in the State. As of July 1, 1997, the five-
county Los Angeles area accounted for 49% of the State's population, with over
16.0 million residents. The 10-county San Francisco Bay Area represented 21%,
with a population of over 7.0 million.
In the Governor's Budget released on May 14, 1999, the Department of Finance
projected that the California economy will show strong growth in 1999, but
slowdown in 2000. The economic expansion has been marked by strong growth in
high technology business services (including computer software), construction,
computer and electronic components manufacturing, and tourism related
industries. The Asian economic crisis, which began in 1997, has had some
dampening effects on the State's economy, particularly in high technology
manufacturing. However, improving economic conditions in Asia, ongoing
strength in NAFTA partners, and growth in Europe, combined with ongoing
strength in stock markets, have improved the short-term outlook.
1995-96 through 1998-99 Fiscal Years
The California economy grew strongly during the 1995-96 to 1998-99 fiscal
years, and as a result, the General Fund (the principal operating fund that
holds most major revenue sources for the State) took in substantially greater
tax revenues (around $2.2 billion in 1995-96, $1.6 billion in 1996-97, $2.4
billion in 1997-98 and $1.0 billion in 1998-99) than were initially planned
when the budgets were enacted. These additional funds were largely directed to
school spending as mandated by Proposition 98 to make up shortfalls from
reduced federal health and welfare aid in 1995-96 and 1996-97 and particularly
in 1998-99 to fund new program incentives. The accumulated budget deficit from
the recession years was finally eliminated. The Department of Finance
estimates that the State's budget reserve (the Special Fund for Economic
Uncertainties or SFEU) totaled $639.8 million as of June 30, 1997 and $1,782
billion as of June 30, 1998. In the 1999 Budget Act, signed by the Governor on
June 29, 1999, the Department of Finance projects the budget reserve had a
balance of about $1,932 billion at June 30, 1999 and will have a balance of
$880 million at June 30, 2000.
The following were major features of the 1998 Budget Act and certain
additional fiscal bills enacted before the end of the legislative session:
1. The most significant feature of the 1998-99 budget was agreement on a
total of $1.4 billion of tax cuts. The central element was a bill that
provided for a phased-in reduction of the Vehicle License Fee
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("VLF"). Since the VLF is transferred to cities and counties under existing
law, the bill provided for the General Fund to replace the lost revenues.
Starting on January 1, 1999, the VLF has been reduced by 25 percent, at a
cost to the General Fund of approximately $500 million in the 1998-99
fiscal year and about $1 billion annually thereafter.
In addition to the cut in VLF, the 1998-99 budget included both temporary
and permanent increases in the personal income tax dependent credit ($612
million General Fund cost in 1998-99, but less in future years), a
nonrefundable renters' tax credit ($133 million), and various targeted
business tax credits ($106 million).
2. On November 8, 1998, voters of the State approved Proposition 98, a
combined initiative constitutional amendment and statute called the
"Classroom Instructional Improvement and Accountability Act." Proposition
98 changed State funding of public education below the university level,
primarily by guaranteeing local school and community college ("K-14")
schools a minimum share of General Fund revenues. Proposition 98 funding
for K-14 schools was increased by $1.7 billion in General Fund moneys over
revised 1997-98 levels, over $300 million higher than the minimum
Proposition 98 guarantee. Of the 1998-99 funds, major new programs included
money for instructional and library materials, deferred maintenance,
support for increasing the school year to 180 days and reduction of class
sizes in Grade 9. The Budget also included $250 million as repayment of
prior years loans to schools, as part of the settlement of the California
Teachers' Association v. Gould lawsuit. That lawsuit, filed in 1992,
requires that the State and K-14 schools share in repayment of prior years'
emergency loans to schools.
3. Funding for higher education increased substantially above the actual
1997-98 level. General Fund support was increased by $340 million (15.6%)
for the University of California and $267 million (14.1%) for the
California State University system. In addition, Community Colleges funding
increased by $300 million (6.6%).
4. The Budget included increased funding for health, welfare and social
services programs. A 4.9% grant increase was included in the basic welfare
grants, the first increase in those grants in 9 years.
5. Funding for the judiciary and criminal justice programs increased by
about 11% over 1997-98, primarily to reflect increased State support for
local trial courts and a rising prison population.
6. Major legislation enacted after the 1998 Budget Act included new
funding for resources projects, a share of the purchase of the Headwaters
Forest, funding for the Infrastructure and Economic Development Bank ($50
million) and funding for the construction of local jails. The State
realized savings of $433 million from a reduction in the State's
contribution to the State Teacher's Retirement System in 1998-99.
The May Revision to the 1999-2000 Governor's Budget (hereafter shortened to
"1999-00"), released on May 14, 1999 (the "1999 May Revision"), reported that
stronger than expected economic conditions in the State for the latter part of
1998 and into 1999 would produce total 1998-99 General Fund revenues of about
$57.9 billion, almost $1.0 billion above the 1998 Budget Act estimates and
$1.6 billion above the initial estimates in the January 1999-00 Governor's
Budget. The 1999 May Revision projects 1998-99 General Fund expenditures of
$58.6 billion, about $400 million higher than the January 1999-00 Governor's
Budget estimate. Some of this additional revenue will be directed to K-14
schools under Proposition 98.
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) a change 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 (this
provision has been amended by subsequent Federal law) 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.
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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. As required by the federal Law, CalWORKs contains new time
limits on receipt of welfare aid, both lifetime as well as for any current
time on aid. 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.
The longer-term impact of the new federal Law and CalWORKs cannot be
determined until there has been more experience and until an independent
evaluation of the CalWORKs program is completed. In the short-term, the
CalWORKs program shows a continued trend of declining welfare caseloads. The
CalWORKs caseload trend is projected to be 646,000 in 1998-99 and 602,000 in
1999-00, down from a high of 921,000 cases in 1994-95.
The 1999 Budget Act proposes expenditures that will continue to meet, but
not exceed, the federally-required $2.9 billion combined State and county
maintenance-of-effort (MOE) requirement. Total CalWORKs-related expenditures
are estimated to be $7.3 billion for 1998-99 and $7.3 billion for 1999-00,
including child care transfer amounts for the Department of Education.
Tobacco Litigation. In late 1998, the State signed a settlement agreement
with the four major cigarette manufacturers, which was later ratified by a
State court judge having jurisdiction over a pending lawsuit brought by the
State against these companies. Under the settlement, the companies will pay
California governments a total of approximately $25 billion over a period of
25 years. In addition, payments of approximately $1 billion per year will
continue in perpetuity. Under the State's settlement, half of these moneys
will be paid to the State, and half to local governments (cities and
counties). The State's 1999-2000 Budget includes receipt of about $560 million
of these settlement moneys to the General Fund by June 30, 2000.
The specific amount to be received by the State and local governments is,
however, subject to adjustment for a number of reasons. Various details in the
settlement allow reduction of the companies' payments because of events such
as certain federal government actions or reductions in cigarette sales. In the
event that any of the companies goes into bankruptcy the State could seek to
terminate the agreement with respect to those companies filing bankruptcy
actions thereby reinstating all claims against those companies. The State may
then pursue those claims in the bankruptcy litigation, or as otherwise
provided by law. Also, several parties have brought a lawsuit challenging the
settlement and seeking damages: see "Pending Litigation" below.
1999-00 Fiscal Year Budget. On January 8, 1999, Governor Davis released his
proposed budget for fiscal year 1999-00 (the "January Governor's Budget"). The
January Governor's Budget generally reported that General Fund revenues for
fiscal year 1998-99 and fiscal year 1999-00 would be lower than earlier
projections (primarily due to weaker overseas economic conditions perceived in
late 1998), while some welfare caseloads would be higher than earlier
projections. The January Governor's Budget proposed $60.5 billion of General
Fund expenditures in fiscal year 1999-00, with a $415 million SFEU reserve or
budget reserve at June 30, 2000.
The 1999 May Revision showed an additional $4.3 billion of revenues for
combined fiscal years 1998-99 and 1999-00. The Legislature enacted the 1999
Budget Act in a timely fashion, meeting the Constitutional deadline for budget
enactment for only the second time in the 1990's.
The final 1999 Budget Act estimated General Fund revenues and transfers of
$63.0 billion, and contained expenditures totaling $63.7 billion after the
Governor used his line-item veto to reduce the legislative Budget Bill
expenditures by $581 million (both General Fund and special fund). The 1999
Budget Act also contained expenditures of $16.1 billion from special funds and
$1.5 billion from bond funds. The Administration estimated that the budget
reserve would have a balance at June 30, 2000, of about $880 million. Not
included in this amount was an additional $300 million that (after the
Governor's vetoes) was "set aside" to provide funds for employee salary
increases (to be negotiated in bargaining with employee unions), and for
litigation reserves. The 1999 Budget Act anticipates normal cash flow
borrowing during the fiscal year.
The principal features of the 1999 Budget Act include the following:
1. Proposition 98 funding for K-12 schools was increased by $1.6 billion
in General Fund moneys over revised 1998-99 levels, $108.6 million higher
than the minimum Proposition 98 guarantee. Of the 1999-00
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funds, major new programs included money for reading improvement, new
textbooks, school safety, improving teacher quality, funding teacher
bonuses, providing greater accountability for school performance,
increasing preschool and after school care programs and funding deferred
maintenance of school facilities. The Budget also includes $310 million as
repayment of prior years' loans to schools, as part of the settlement of
the California Teachers' Association v. Gould lawsuit.
2. Funding for higher education increased substantially above the actual
1998-99 level. General Fund support was increased by $184 million (7.3%)
for the University of California ("UC") and $126 million (5.9%) for the
California State University ("CSU") system. In addition, Community Colleges
funding increased by $324.3 million (6.6%). As a result, undergraduate fees
at UC and CSU will be reduced for the second consecutive year, and the per-
unit charge at Community Colleges will be reduced by $1.
3. The Budget included increased funding of nearly $600 million for
health and human services.
4. About $800 million from the General Fund will be directed toward
infrastructure costs, including $425 million in additional funding for the
Infrastructure Bank, initial planning costs for a new prison in the Central
Valley, additional equipment for train and ferry service, and payment of
deferred maintenance for state parks.
5. The Legislature enacted a one-year additional reduction of 10 percent
of the Vehicle License Fee for calendar year 2000, at a General Fund cost
of about $250 million in each of fiscal year 1999-00 and 2000-01 to make up
lost funding to local governments. Conversion of this one-time reduction to
a permanent cut will remain subject to the revenue tests in the legislation
adopted last year. Several other targeted tax cuts, primarily for
businesses, were also approved, at a cost of $54 million in 1999-00.
6. A one-time appropriation of $150 million, to be split between cities
and counties, was made to offset property tax shifts during the early
1990's. Additionally, an ongoing $50 million will be given to cities for
jail booking or processing fees charged by counties when an individual
arrested by city personnel is taken to a county detention facility.
Local Governments
The primary units of local government in California are the counties,
ranging in population from 1,200 (Alpine) to over 9,600,000 (Los Angeles).
Counties are responsible for providing many basic services, including indigent
healthcare, welfare, courts, jails and public safety in unincorporated areas.
There are also about 470 incorporated cities and thousands of other 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
governmental entities, and have been required to maintain many services.
In the aftermath of Proposition 13, the State provided aid from the General
Fund to make up some of the loss of property and tax moneys, including taking
over the principal responsibility for funding local K-12 schools and community
colleges. During the recession, the Legislature eliminated remnants of this
post-Proposition 13 aid to entities other than K-14 education districts, by
requiring cities and counties to transfer some of their property tax revenues
to school districts. However, the Legislature also has provided additional
funding sources (such as sales taxes) and reduced requirements for local
services.
Since then the State has also provided additional funding to counties and
cities through such programs as health and welfare realignment, welfare
reform, trial court restructuring, an annual program supporting local public
safety departments, and various other measures.
The 1999 Budget Act includes a $150 million one-time grant of money from the
General Fund to local agencies for relief from the 1992 and 1993 property tax
shifts. Legislation has been passed, subject to voter
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approval at the election in November, 2000, to provide a more permanent
payment to local governments to offset the property tax shift. In addition,
legislation was enacted in 1999 to provide annually up to $50 million relief
to cities based on 1997-98 costs of jail booking and processing fees paid to
counties.
The entire statewide welfare system has been changed in response to the
change in federal welfare law enacted in 1996 (see "Federal 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 and their costs for administrative and
support services are capped at 1996-97 levels. 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.
Historically, funding for the State's trial court system was divided between
the State and the counties. However, Chapter 850, Statutes of 1997,
restructured the State's trial court funding system. Funding for the courts,
with the exception of costs for facilities, local judicial benefits, and
revenue collection, was consolidated at the State level. County contribution
for both their general fund and fine and penalty amounts is capped at the
1994-95 level and becomes part of the Trial Court Trust Fund, which supports
all trial court operations. The State assumed responsibility for future growth
in trial court funding. The consolidation of funding is intended to streamline
the operation of the courts, provide a dedicated revenue source, and relieve
fiscal pressure on the counties. Beginning in 1998-99, the county general fund
contribution for court operations is reduced by $300 million, and cities will
retain $62 million in fine and penalty revenue previously remitted to the
State. The General Fund reimbursed the $362 million revenue loss to the Trial
Court Trust Fund. The 1999 Budget Act includes funds to further reduce the
county general fund contribution by an additional $96 million by reducing by
100 percent the contributions of the next 18 smallest counties and by 10
percent the general fund contribution of the remaining 21 counties.
On November 5, 1996, voters approved Proposition 218, called the "Right to
Vote on Taxes Act," which adds new Articles XIIIC and XIIID into the
California Constitution. These new provisions enact limits 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. There are a number of
ambiguities concerning the Proposition and its impact on local governments and
their bonded debt that 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 revenues to local government would be
reduced by several hundred million dollars. Proposition 218 does not affect
the State or its ability to levy or collect taxes.
On December 23, 1997, a consortium of California counties filed a test claim
with the Commission on State Mandates (the "Commission") asking the Commission
to determine whether the property tax shift from counties to the Educational
Revenue Augmentation Fund, which is a funding source for schools, is a
reimbursable state mandated cost. On August 11, 1998, the State Department of
Justice, on behalf of the State Department of Finance, filed a rebuttal in
opposition to the counties' claim. The test claim was heard on October 29,
1998, and the Commission on State Mandates found in favor of the State. In
March, 1999, Sonoma County filed suit in the Superior Court to overturn the
Commission's decision. In October 1999, a Sonoma County Superior Court Judge
ruled in favor of the county. The State will continue to contest this lawsuit.
Should the courts find in favor of the counties, the impact to the State
General Fund could be as high as $10.0 billion with an annual Proposition 98
General Fund cost of at least $3.75 billion. This cost would grow in
accordance with the annual assessed value growth rate.
Constitutional and Statutory Limitations; Recent and Pending Initiatives;
Pending Litigation
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 45, an amendment to Article XIIIA, was approved by
the voters of the
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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.
At the November 8, 1988 general election, California voters approved an
initiative known as Proposition 98. Proposition 98 changed State funding of
public education below the university level and the operation of the State
Appropriations Limit, primarily by guaranteeing K-14 schools a minimum share
of General Fund revenues. Under Proposition 98 (as modified by Proposition
111, which was enacted on June 5, 1990), K-14 schools are guaranteed the
greater of (a) in general, a fixed percent of General Fund revenues ("Test
1"), (b) the amount appropriated to K-14 schools in the prior year, adjusted
for changes in the cost of living (measured as in Article XIIIB by reference
to State per capita personal income) and enrollment ("Test 2"), or (c) a third
test, which would replace Test 2 in any year when the percentage growth in per
capita General Fund revenues from the prior year plus one half of one percent
is less than the percentage growth in State per capita personal income ("Test
3"). Under Test 3, schools would receive the amount appropriated in the prior
year adjusted for changes in enrollment and per capita General Fund revenues,
plus an additional small adjustment factor. If Test 3 is used in any year, the
difference between Test 3 and Test 2 would become a "credit" to schools that
would be the basis of payments in future years when per capita General Fund
revenue growth exceeds per capita personal income growth. Legislation adopted
prior to the end of the 1998-99 fiscal year, implementing Proposition 98,
determined the K-14 schools' funding guarantee under Test 1 to be 40.3 percent
of General Fund tax revenues, based on 1986-87 appropriations. However, that
percent has been adjusted to approximately 35 percent to account for a
subsequent redirection of local property taxes, since such redirection
directly affects the share of General Fund revenues to schools.
Proposition 98 permits the Legislature by two-thirds vote of both houses,
with the Governor's concurrence, to suspend the K-14 schools' minimum funding
formula for a one-year period. Proposition 98 also contains provisions
transferring certain State tax revenues in excess of the Article XIIIB limit
to K-14 schools.
During the recession in the early 1990s, 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'
entitlements. By implementing these actions, per-pupil funding from
Proposition 98 sources stayed almost constant at approximately $4,220 from the
1991-92 fiscal year to the 1993-94 fiscal year.
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 either as appropriations that count toward
satisfying the Proposition 98 guarantee, or as appropriations from "below" the
current base. Repayments are spread over the eight-year period of the 1994-95
fiscal year through the 2001-02 fiscal year to reduce any adverse fiscal
impact.
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Substantially increased General Fund revenues, above initial budget
projections, in the 1994-95 to 1998-99 fiscal years have resulted in
retroactive increases in Proposition 98 appropriations from subsequent fiscal
years' budgets. Because of the State's increasing revenues, per-pupil funding
at the K-12 level has increased by about 44 percent from the level in place
from 1991-1992 through 1993-94, and is estimated at about $6,025 per the
average daily attendance rate of students in 1999-00. A significant amount of
the "extra" Proposition 98 monies in the last few years has been allocated to
special programs, most particularly an initiative to allow each classroom from
grades K-3 to have no more than 20 pupils by the end of the 1997-98 school
year. Furthermore, since General Fund revenue growth is expected to continue
in 1999-00, there are also new initiatives to increase school safety, improve
schools' accountability for pupil performance, provide additional textbooks to
schools, fund deferred maintenance projects, increase beginning teachers'
salaries, and provide performance incentives to teachers.
On November 8, 1994, the voters approved Proposition 187, an initiative
statute ("Proposition 187"). Proposition 187 specifically prohibits funding by
the State of social services, health care services and public school education
for the benefit of any person not verified as either a United States citizen
or a person legally admitted to the United States. Among the provisions in
Proposition 187 pertaining to public school education, the measure requires,
commencing January 1, 1995, that every school district in the State verify the
legal status of every child enrolling in the district for the first time. By
January 1, 1996, each school district must also verify the legal status of
children already enrolled in the district and of all parents or guardians of
all students. If the district "reasonably suspects" that a student, parent or
guardian is not legally in the United States, that district must report the
student to the United States Immigration and Naturalization Service and
certain other parties. The measure also prohibits a school district from
providing education to a student it does not verify as either a United States
citizen or a person legally admitted to the United States.
Opponents of Proposition 187 filed at least eight lawsuits (which were
subsequently consolidated) challenging the constitutionally and validity of
the measure. On March 18, 1998, a United States District Court judge entered a
final judgment in the case, holding key portions of the measure
unconstitutional and permanently enjoining the State from implementing those
sections that would have required law enforcement, teachers and social
services and health care workers to verify a person's immigration status and
subsequently report illegal immigrants to authorities and deny them social
services, health care and education benefits. An appeal by the State Attorney
General was filed with the Ninth Circuit Court of Appeals on March 25, 1998.
Governor Gray Davis subsequently asked the United States Ninth Circuit Court
of Appeal to serve as mediator on the issue. On April 26, 1999, the Ninth
Circuit Court of Appeal granted Governor Davis' request for mediation of the
controversy. In response, David B. Lombardi, Chief Mediator for the Ninth
Circiut Mediation Office ordered a stay until June 18, 1999 of all appellate
proceedings in connection with the six cases then pending before the Court of
Appeal involving Proposition 187 challenges. On June 1, 1999, the Howard
Jarvis Taxpayers' Association sued Governor Davis in the California Supreme
Court challenging Governor Davis' right to submit Proposition 187 to
mediation, which the plaintiff claims undermines the public's right of
initiative. On June 30, 1999, the California Supreme Court declined to hear
the case. Since that time, Governor Davis had the State's appeal withdrawn,
letting stand the District Court rulings.
At the November 1998 elections voters approved Proposition 2. This
proposition requires the General Fund to repay loans made from certain
transportation special accounts (such as the State Highway Account) at least
once per fiscal year, or up to 30 days after adoption of the annual budget
act. Since the General Fund may reborrow from the transportation accounts soon
after the annual repayment is made, the proposition is not expected to have
any adverse impact on the State's cash flow.
State Appropriations Limit. The State is subject to an annual appropriations
limit imposed by Article XIIIB of the State Constitution (the "Appropriations
Limit"). The Appropriations Limit does not restrict appropriations to pay debt
service on voter-authorized bonds.
Article XIIIB prohibits the State from spending "appropriations subject to
limitation" in excess of the Appropriations Limit. "Appropriations subject to
limitation," for the State, are authorizations to spend "proceeds of taxes,"
which consist of tax revenues, and certain other funds, including proceeds
from regulatory licenses, user charges or other fees to the extent that such
proceeds exceed "the cost reasonably borne by that entity in providing the
regulation, product or service," but "proceeds of taxes" exclude most state
aid to local
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governments, tax refunds and some benefit payments such as unemployment
insurance. No limit is imposed on appropriations of funds which are not
"proceeds of taxes," such as reasonable user charges or fees and certain other
non-tax funds.
Not included in the Appropriations Limit are appropriations for the debt
service cost of bonds existing or authorized by January 1, 1979, or
subsequently authorized by the voters, appropriations required to comply with
mandates of courts or the federal government, appropriations for qualified
capital outlay projects, appropriations of revenues derived from any increase
in gasoline taxes and motor vehicle weight fees above January 1, 1990 levels,
and appropriation of certain special taxes imposed by initiative (e.g.,
cigarette and tobacco taxes). The Appropriations Limit may also be exceeded in
cases of emergency.
The State's Appropriations Limit in each year is based on the limit for the
prior year, adjusted annually for changes in state per capita personal income
and changes in population, and adjusted, when applicable, for any transfer of
financial responsibility of providing services to or from another unit of
government or any transfer of the financial source for the provisions of
services from tax proceeds to non-tax proceeds. The measurement of change in
population is a blended average of statewide overall population growth, and
change in attendance at local school and community college ("K-14") districts.
The Appropriations Limit is tested over consecutive two-year periods. Any
excess of the aggregate "proceeds of taxes" received over such two-year period
above the combined Appropriations Limits for those two years is divided
equally between transfers to K-14 districts and refunds to taxpayers.
The Legislature has enacted legislation to implement Article XIIIB that
defines certain terms used in Article XIIIB and sets forth the methods for
determining the Appropriations Limit. California Government Code Section 7912
requires an estimate of the Appropriations Limit to be included in the
Governor's Budget, and thereafter to be subject to the budget process and
established in the Budget Act.
The following table shows the State Appropriations Limit for the past four
fiscal years and the current fiscal year. As of the enactment of the 1999-00
Budget, the Department of Finance projects the State's Appropriations subject
to limitations will be $6.1 billion under the State's Appropriations Limit in
fiscal year 1999-00.
State's Appropriations Limit
(Millions)
<TABLE>
<CAPTION>
Fiscal Years
------------------------------------------------
1995-96 1996-97 1997-98 1998-99* 1999-00*
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
State Appropriations
Limit................... $ 39,309 $ 42,002 $ 44,778 $ 47,573 $ 50,673
Appropriations Subject to
Limit................... (34,186) (35,103) (40,743) (42,674) (44,528)
-------- -------- -------- -------- --------
Amount (Over)/Under
Limit................... $ 5,123 $ 6,899 $ 4,035 $ 4,899 $ 6,145
======== ======== ======== ======== ========
</TABLE>
- ----------
* Estimated/Projected
SOURCE: State of California, Department of Finance.
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 the 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). 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 on State
Mandates for redetermination. The Commission on State Mandates expanded the
claim to include supplemental claims filed by several other educational
institutions are determined that part, but not all, of the claims should have
been paid by the State. To date, the Legislature has not appropriated funds.
The liability to the State, if all potentially eligible school districts
pursue timely claims, has been estimated by the Department of Finance at more
than $1 billion. The Commission on State Mandates issued a decision in
December 1998 determining that a small number of
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components of the State's special education program are state mandated local
costs. The administrative proceeding is in the "parameters and guidelines"
stage where the commission is considering whether and to what extent the costs
associated with the state mandated components of the special education program
are offset by funds that the State already allocates to that program. The
State's position is that all costs are offset by existing funding. The State
has the option to seek judicial review of the mandate finding.
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 past costs of cleanup of the site, a declaration that the defendants are
each fully liable for future costs, and an order that the cleanup be
completed. However, the defendants have filed a counterclaim against the State
for alleged negligent acts, resulting in significant findings of liability
against the State as owner, operator and generator of the wastes taken to that
site. The State has appealed. Present estimates of the cleanup range from $400
million to $600 million. Potential State liability falls within this same
range. However, all or a portion of any judgment against the State could be
satisfied by recoveries from the State's insurance carriers. The State has
filed a suit against certain of these carriers and trial is currently set for
January 16, 2001.
The State is a defendant in a coordinated action involving 3,000 plaintiffs
seeking recovery for damages caused by the Yube 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. In 1992, the State and plaintiffs filed
appeals. In August 1999, the court of appeal issued a decision reversing the
trial court's judgment against the State and remanding the case for retrial on
the inverse condemnation cause of action. Plaintiffs have petitioned the
California Supreme Court for review.
In Just Say No To Tobacco Dough Campaign v. State of California, 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. The
Supreme Court has granted the State's demurrer and the plaintiffs have asked
the court to reconsider its ruling. In July, 1999, the court again sustained
the State's demurrer to the amended complaint and issued a judgment dismissing
the case. Plaintiffs appealed. The matter will be briefed and will be
scheduled for oral argument before the court. If the State loses, the General
Fund and funds from other sources would be used to reimburse the $166 million.
On June 24, 1998, plaintiffs in Howard Jarvis Taxpayers Association et. al.
v. Kathleen Connell filed a complaint for certain declaratory and injunctive
relief challenging the authority of the State Controller to make payments from
the State Treasury in the absence of a State budget. On July 21, 1998, the
trial court issued a preliminary injunction prohibiting the State Controller
from paying moneys from the State Treasury for fiscal year 1998-99, with
certain limited exceptions, in the absence of a State budget. The preliminary
injunction, among other things, prohibited the State Controller from making
any payments pursuant to any continuing appropriation. On July 22 and 27,
1998, various employee unions that had intervened in the case appealed the
trial court's preliminary injunction and asked the Court of Appeal to stay the
preliminary injunction. On July 28, 1998, the Court of Appeal granted the
unions' requests and stayed the preliminary injunction pending the Court of
Appeal's decision on the merits of the appeal. On August 5, 1998, the Court of
Appeal denied the plaintiffs' request to reconsider the stay. Also on July 22,
1998, the State Controller asked the California Supreme Court to immediately
stay the trial court's preliminary injunction and to overrule the order
granting the preliminary injunction on the merits. On July 29, 1998, the
Supreme Court transferred the State Controller's request to the Court of
Appeal. The matters are now pending before the Court of Appeal. No date has
been set for oral argument.
A judgment was entered for the plaintiff in August 1998 in the case of
Ceridian Corporation v. Franchise Tax Board, a suit that challenged the
validity of two sections of the California Tax laws. The first related to
deduction from corporate taxes for dividends received from insurance companies
to the extent the insurance companies have California activities. The second
related to corporate deduction of dividends to the extent the earnings of the
dividend-paying corporation have already been included in the measure of their
California tax. On August 13, 1998, the court issued a judgment against the
Franchise Tax Board on both issues. The Franchise Tax Board has appealed the
judgment. Briefing is underway. If both sections of the California Tax law are
ultimately
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<PAGE>
invalidated, and all dividends become deductible, then the General Fund can
become liable for approximately $200 to $250 million annually.
In Professional Engineers in California Government v. Wilson, the Superior
Court has ruled that $30.7 million of the $258.2 million transferred from the
State Highway Account to the General Fund violated the California
Constitution. The court also invalidated $130.9 million transferred from the
Motor Vehicle Account to the General Fund. On April 30, 1999, the court found
that the $130 million transfer from the State Highway Account to the Motor
Vehicle Account also violated the California Constitution. The Sate decided not
to appeal this case and reversed the challenged transfers pursuant to the
court's decision.
In Capitola Land v. Anderson and other related state and federal cases,
plaintiffs sought payments from the State under the APDC-Foster Care program.
Judgment was rendered against the State in Capitola, which the State appealed
and lost. The State then filed a state plan amendment with the federal
Department of Health and Human Services ("DHHS") to enable the State to comply
with the Capitola ruling and receive federal funding. The DHHS denied the
state plan amendment, and the State has filed suit against DHHS. The
Legislature also enacted a statute which required federal funding (50%
contribution) in order to comply with the Capitola judgment. The State then
refused to implement the Capitola judgment based on the new statute. Certain
plaintiffs moved for an order of contempt against the State, which was granted
by the trial court, but was stayed and annulled by the Court of Appeal. The
plaintiffs' petition for review was denied. If, as a result of this
litigation, compliance with the Capitola judgment is required and the judgment
is applied retroactively, liability to the State could exceed $200 million.
In January of 1997, California experienced major flooding in six different
areas with preliminary estimates of property damage of approximately 1.6 to
2.0 billion. A substantial number of plaintiffs have joined an existing suit
against the State, local agencies, and private companies and contractors
seeking compensation for the damages they suffered as a result of the 1997
flooding. Property damages have been estimated up to $2 billion. The State is
defending the action.
Plaintiffs in County of San Bernardino v. Barlow Respiratory Hospital and
related actions seek mandamus relief requiring the State to retroactively
increase out-patient Medi-Cal reimbursement rates. Plaintiffs have estimated
the damages to be several hundred million dollars. The State is defending
these cases, as well as related federal cases addressing the calculation of
Medi-Cal reimbursement rates in the future.
The State is involved in two refund actions, Cigarettes Cheaper!, et al. v.
Board of Equalization, et al. and California Assn. of Retail Tobacconists
(CART), et al. v. Board of Equalization, et al. that challenge the
constitutionality of Proposition 10, approved by the voters in 1998.
Plaintiffs allege that Proposition 10, which increases the excise tax on
tobacco products, violates 11 sections of the California Constitution and
related provisions of law. Plaintiffs Cigarettes Cheaper! seek declaratory and
injunctive relief and a refund of over $4 million. The CART case filed by
retail tobacconists in San Diego seeks a refund of $5 million. The State is
contesting these cases. If the statute is declared unconstitutional, exposure
may include the entire $750 million collected annually with interest.
Hunt-Wesson, Inc. v. Franchise Tax Board was tried in February, 1997 with
judgment for the taxpayer. The judgment was reversed on appeal and plaintiff's
petition for review in the California Supreme Court was denied. On September
28, 1999, the United States Supreme Court granted the taxpayer's petition for
writ of certiorari. The Franchise Tax Board estimates that if the interest-
offset provisions are declared unconstitutional, the result would involve
potential reduction of state revenues in the $90 million range annually, with
past year collection and interest exposure of $500 million.
Guy F. Atkinson Company of California v. Franchise Tax Board is a
corporation tax refund action involving the solar energy system tax credit
provided for under the Revenue & Taxation Code. The case went to trial in May
1998 and the trial court entered judgment in favor of the Franchise Tax Board.
The taxpayer has filed an appeal to the California Court of Appeal and
briefing is due to be completed in October 1999. The Franchise Tax Board
estimates that the cost would be $150 million annually if the plaintiff
prevails. Allowing refunds for all open years would entail a refund of at
least $500 million.
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<PAGE>
Jordan et al. v. Department of Motor Vehicles, et al. and Josephs v. Zalin,
et al. challenge the validity of the Vehicle Smog Impact Fee, a $300 fee that
is collected by the Department of Motor Vehicles from vehicle registrants when
a vehicle without a California new-vehicle certification is first registered
in California. The Jordan plaintiffs contend that the fee violates the
interstate commerce and equal protection clauses of the United States
Constitution as well as Article XIX of the State Constitution. The Josephs
case is a class action civil rights case brought against the current and
former directors of the Department of Motor Vehicles in their individual
capacities claiming the collection of the Vehicle Smog Impact Fee violates the
interstate commerce, equal protection, and privileges and immunities clauses
of the United States Constitution. The trial court gave a judgment for the
plaintiffs in the Jordan case, and additionally ordered the State to file
refund claims on behalf of all payers of the fees since 3 years prior to the
filing of the complaint. The judgment has been appealed, briefing is completed
and the case has been argued. In Josephs, the Court of Appeal ruled that the
taxpayer had an adequate remedy and thus the civil rights action could not
proceed. A further appeal is possible. The exposure to the State if the trial
court's decision in Jordan is upheld in full is $350 million including
interest. In addition, any revenue collected between the date of the trial
court's decision and any final decision of a higher court is subject to
refund.
Jordan et al. v. Department of Motor Vehicles, et al. and Josephs v. Zolin,
et al. challenge the validity of the Vehicle Smog Impact Fee, a $300 fee that
is collected by the Department of Motor Vehicles from vehicle registrants when
a vehicle without a California new-vehicle certification is first registered
in California. The Jordan plaintiffs contend that the fee violates the
interstate commerce and equal protection clauses of the United States
Constitution as well as Article XIX of the State Constitution. The Josephs
case is a class action civil rights case brought against the current and
former directors of the Department of Motor Vehicles in their individual
capacities claiming the collection of the Vehicle Smog Impact Fee violates the
interstate commerce, equal protection, and privileges and immunities clauses
of the United States Constitution. The trial court gave a judgment for the
plaintiffs in the Jordan case and additionally ordered the State to file
refund claims on behalf of all payers of the fees since 3 years prior to the
filing of the complaint. In October 1999 the Court of Appeals upheld the trial
court judgment and the State has declined to appeal further. In Josephs, the
Court of Appeal ruled that the taxpayer had an adequate remedy and thus the
civil rights action could not proceed. A further appeal is possible. Although
refunds through the court actions could be limited by a three-year statute of
limitations, with a potential liability of about $350 million, the Governor
has proposed refunding fees collected back to the initiation of these fees in
1990. The exposure to the State if the fees are refunded in full could be up
to $800 million.
Craig Brown, et al. v. Department of Health and Human Services, et al. is a
Federal Mandate Proceeding. In fiscal years 1991-92 and 1992-93, the State
used credits from three Public Employees Retirement System (PERS) accounts in
place of General Fund employer pension contributions. The federal Department
of Health and Human Services (DHHS) has determined that federally funded
programs were overcharged in these fiscal years because they did not receive
the pension credits the State programs received and that California owes the
federal government $120 million for overpayments plus an additional $80
million in interest through mid 1999. The DHHS Grant Appeals Board upheld this
determination. The present case is aimed at overturning the DHHS
determination. On June 6, 1999, the court ruled against the State. The State
has appealed to the Ninth Circuit. The estimated potential loss is over $220
million, which would be payable from the General Fund or, possibly, recovered
by the federal government through offsets against current grant payments to
the State.
PTI, Inc., et al. v. Philip Morris, et al. was filed by five distributors in
the cigarette import-/re-entry business, seeking to overturn the tobacco
Master Settlement Agreement ("MSA") entered between 46 states and the tobacco
industry in November, 1998. See "Tobacco Litigation" above. The primary focus
of the complaint is the provision of the MSA encouraging participating states
to adopt a statute requiring nonparticipating manufacturers to either become
participating manufacturers and share the financial obligations under the MSA
or pay money into an escrow account. Plaintiffs seek compensatory and punitive
damages against the State and State officials and an order placing tobacco
settlement funds into a trust to be administered by the court for the
treatment of medical expenses of persons injured by tobacco products. A motion
to dismiss the complaint is currently scheduled for hearing in February 2000.
The potential fiscal impact of an adverse ruling is largely unknown, but could
exceed the full amount of the settlement (estimated to be $1 billion annually,
of which 50% will go directly to the State's General Fund and the other 50%
directly to the State's 58 counties and 4 largest cities).
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<PAGE>
Arnett v. California Public Employees Retirement System, et. al. was filed
by seven former employees of the State of California and local agencies,
seeking back wages, damages and injunctive relief. Plaintiffs are former
public safety members who began employment after the age of 40 and are
recipients of Industrial Disability Retirement ("IDR") benefits. Plaintiffs
contend that the formula which determines the amount of IDR benefits violates
the federal Age Discrimination in Employment Act of 1967. Plaintiffs contend
that, but for their ages at hire, they would receive increased monthly IDR
benefits similar to their younger counterparts who began employment before the
age of 40. On August 17, 1999, the Ninth Circuit Court of Appeals reversed the
District Court's dismissal of the complaint for failure to state a claim. The
State may seek further review in the United States Supreme Court. However, the
case has now been remanded back to the District Court and trial will most
likely occur in December 2000. In the event of an unfavorable result, CalPERS
has estimated the liability to the State as approximately $315.5 million.
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<PAGE>
APPENDIX II
RATINGS OF MUNICIPAL BONDS
Description of Moody's Investors Service, Inc.'s ("Moody's") Long-Term Debt
Ratings
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-edged." 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 risk 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.
Short-term Notes: The three ratings of Moody's for short-term notes are
MIG1/VMIG1, MIG2/VMIG2, and MIG3/VMIG3. MIG1/VMIG1 denotes "best quality
. . . strong protection by established cash flows"; MIG2/VMIG2 denotes "high
quality" with ample margins of protection; MIG3/VMIG3 notes are of "favorable
quality . . . but . . . lacking the undeniable strength of the preceding
grades".
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Description of Moody's Short-Term Debt 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 senior short-term promissory obligations. Prime-1 repayment
ability will often be evidenced by the many 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 earnings 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 senior 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 debt obligations. The effect of industry
characteristics and market composition may be more pronounced. Variability in
earnings and profitability may result in changes in the level of debt
protection measurements and 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, Division of the McGraw-Hill Companies, Inc.
("Standard & Poor's") Issue Credit Rating Definitions
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 (including ratings on medium term note programs and commercial paper
programs). It takes into consideration the creditworthiness of guarantors,
insurers, or other forms of credit enhancement on the obligation and takes
into account the currency in which the obligation is denominated.
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 Standard & Poor's considers
reliable. Standard & Poor's does not perform an audit in connection with any
credit 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.
The ratings are based, in varying degrees, on the following considerations:
I. Likelihood of payment capacity and willingness of the obligor as to
the timely payment of interest and repayment of principal in accordance
with the terms of the obligation;
II. Nature of and provisions of the obligation;
III. Protection afforded to, 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.
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Long-Term Issue Credit Ratings
<TABLE>
<C> <S>
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 obligations 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 Debt rated "BB," "B," "CCC," "CC" and "C" is regarded as having
B significant speculative characteristics. "BB" indicates the least degree
CCC of speculation and "C" the highest degree of speculation. While such bonds
CC will likely have some quality and protective characteristics, these may be
C 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 if payments on an obligation are jeopardized.
</TABLE>
Plus (+) or Minus (-): The ratings from "AA" to "CCC" may be modified by the
addition of a plus or minus sign to show relative standing within the major
rating categories.
Description of Standard & Poor's Commercial Paper Ratings
A Standard & Poor's commercial paper rating is a current assessment of the
likelihood of timely payment of debt having an original maturity of no more
than 365 days. Ratings are graded into several categories, ranging from "A-1"
for the highest-quality obligations to "D" for the lowest. These categories
are as follows:
<TABLE>
<C> <S>
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."
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.
</TABLE>
II-3
<PAGE>
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.
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 posses 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.
c
The "c" subscript is used to provide additional information to
investors that the bank may terminate its obligation to purchase
tendered bonds if the long-term credit rating of the issuer is below
an investment-grade level and/or the issuer's bonds are deemed
taxable.
p
The letter "p" indicates that the rating is provisional. A
provisional rating assumes the successful completion of the project
financed by the debt being rated and indicates that payment of debt
service requirements is largely or entirely dependent upon the
successful, timely completion of the project. This rating, however,
while addressing credit quality subsequent to completion of the
project, makes no comment on the likelihood of or the risk of
default upon failure of such completion. The investor should
exercise his own judgment with respect to such likelihood and risk.
*
Continuance of the ratings is contingent upon Standard & Poor's
receipt of an executed copy of the escrow agreement or closing
documentation confirming investments and cash flows.
r
The "r" highlights derivative, hybrid, and certain other obligations
that Standard & Poor's believes may experience high volatility or
high variability in expected returns as a result of noncredit risks.
Examples of such obligations are securities with principal or
interest return indexed to equities, commodities, or currencies;
certain swaps and options, and interest-only and principal-only
mortgage securities. The absence of an "r" symbol should not be
taken as an indication that an obligation will exhibit no volatility
or variability in total return.
Description of Fitch IBCA, Inc.'s ("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 rating
represents 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 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 guarantees unless otherwise indicated.
II-4
<PAGE>
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.
<TABLE>
<C> <S>
AAA Bonds considered to be investment grade and of the highest credit quality.
The obligor has an exceptionally strong ability to pay interest and repay
principal, which is unlikely to be affected by reasonably foreseeable
events.
AA Bonds considered to be investment grade and of very high credit quality.
The obligor's ability to pay interest and repay principal is very strong,
although not quite as strong as bonds rated "AAA." Because bonds rated in
the "AAA" and "AA" categories are not significantly vulnerable to
foreseeable future developments, short-term debt of these issuers is
generally rated "F-1+."
A Bonds considered to be investment grade and of high credit quality. The
obligor's ability to pay interest and repay principal is considered to be
strong, but may be more vulnerable to adverse changes in economic
conditions and circumstances than bonds with higher ratings.
BBB Bonds considered to be investment grade and of satisfactory-credit
quality. The obligor's ability to pay interest and repay principal is
considered to be adequate. Adverse changes in economic conditions and
circumstances, however, are more likely to have adverse impact on these
bonds, and therefore impair timely payment. The likelihood that the
ratings of these bonds will fall below investment grade is higher than for
bonds with higher ratings.
</TABLE>
Plus (+) or Minus (-): Plus and minus signs are used with a rating symbol to
indicate the relative position of a credit within the rating category. Plus
and minus signs, however, are not used in the "AAA" category.
<TABLE>
<C> <S>
NR Indicates that Fitch does not rate the specific issue.
Conditional A conditional rating is premised on the successful completion of a
project or the occurrence of a specific event.
Suspended A rating is suspended when Fitch deems the amount of information
available from the issuer to be inadequate for rating purposes.
Withdrawn A rating will be withdrawn when an issue matures or is called or
refinanced and, at Fitch's discretion, when an issuer fails to
furnish proper and timely information.
FitchAlert Ratings are placed on FitchAlert to notify investors of an
occurrence that is likely to result in a rating change and the
likely direction of such change. These are designated as
"Positive," indicating a potential upgrade, "Negative," for
potential downgrade, or "Evolving," where ratings may be raised or
lowered. FitchAlert is relatively short-term, and should be
resolved within 12 months.
</TABLE>
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's 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
II-5
<PAGE>
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 rating are of similar but not necessarily identical
credit quality since rating categories cannot fully reflect the differences in
degrees of credit risk.
<TABLE>
<C> <S>
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 Bonds are in default on interest and/or principal payments. Such bonds are
DD extremely speculative and should be valued on the basis of their ultimate
D recovery value in liquidation or reorganization of the obligor. "DDD"
represents the highest potential for recovery on these bonds, and "D"
represents the lowest potential for recovery.
</TABLE>
Plus (+) or Minus (-): Plus and minus signs are used with a rating symbol to
indicate the relative position of a credit within the rating category. Plus
and minus signs, however, are not used in the "DDD," "DD," or "D" categories.
Description of Fitch's Short-Term Ratings
Fitch's short-term ratings apply to debt obligations that are payable on
demand or have original maturities of up to three years, including commercial
paper, certificates of deposit, medium-term notes, and municipal and
investment notes.
The short-term ratings place 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:
<TABLE>
<C> <S>
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.
</TABLE>
II-6
<PAGE>
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.
II-7
<PAGE>
CODE #10328-12-99
<PAGE>
PART C. OTHER INFORMATION
Item 23. Exhibits.
<TABLE>
<CAPTION>
Exhibit
Number
-------
<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 the 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 the Registrant.(a)
3 --Portions of the Declaration of Trust, Certificate of Establishment
and Designation and By-Laws of the Registrant defining the rights of
holders of the Fund as a series of the Registrant.(b)
4(a) --Form of 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)
5(a) --Form of Revised Class A Shares Distribution Agreement between the
Registrant and Merrill Lynch Funds Distributor, Inc. (now known as
Princeton Funds Distributor, Inc.) (the "Distributor") (including
Form of Selected Dealers Agreement).(d)
(b) --Class B Shares Distribution Agreement between the Registrant and the
Distributor.(a)
(c) --Form of Class C Shares Distribution Agreement between the Registrant
and the Distributor. (including Form of Selected Dealers
Agreement).(d)
(d) --Form of Class D Shares Distribution Agreement between the Registrant
and the Distributor. (including Form of Selected Dealers
Agreement).(d)
(e) --Letter Agreement between the Fund and the Distributor dated
September 15, 1993, in connection with the Merrill Lynch Mutual Fund
Advisor program.(c)
6 --None.
7 --Form of Custody Agreement between the Registrant and The Bank of New
York.(a)
8 --Transfer Agency, Dividend Disbursing Agency and Shareholder
Servicing Agency Agreement between the Registrant and Merrill Lynch
Financial Data Services, Inc. (now known as Financial Data Services,
Inc.)(a)
9 --Opinion of Brown & Wood, counsel for the Registrant.(f)
10 --Consent of Deloitte & Touche LLP, independent auditors for the
Registrant.
11 --None.
12 --Certificate of Fund Asset Management, L.P.(a)
</TABLE>
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<PAGE>
<TABLE>
<CAPTION>
Exhibit
Number
-------
<C> <S>
13(a) --Amended and Restated Class B Distribution Plan of the Registrant and
Amended and Restated Class B Distribution Plan Sub-Agreement.(c)
(b) --Form of Class C Distribution Plan of the Registrant and Class C
Distribution Plan Sub-Agreement.(d)
(c) --Form of Class D Distribution Plan of the Registrant and Class D
Distribution Plan Sub-Agreement.(d)
14 --Merrill Lynch Select Pricing SM System Plan pursuant to Rule 18f-
3.(e)
</TABLE>
- ----------
(a) Filed on December 29, 1995 as an Exhibit to Post-Effective Amendment No.
11 to the Registrant's Registration Statement on Form N-1A under the
Securities Act of 1933, as amended (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. 13
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 the Registrant (File No. 2-
99473).
(f) Filed on August 14, 1985 as an Exhibit to Pre-Effective No. 2 to the
Registration Statement. Refiled with this Post-Effective Amendment No. 16
pursuant to Electronic Data Gathering Analysis and Retrieval (EDGAR)
requirements.
Item 24. Persons Controlled by or under Common Control with Registrant.
The Registrant is not controlled by or under common control with any other
person.
Item 25. 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,
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<PAGE>
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 moneys 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 that 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 (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.
Item 26. 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, Merrill Lynch Corporate High Yield 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 Lunch
Phoenix Fund, Inc., Merrill Lynch Special Value Fund, Inc., Merrill Lynch
World Income Fund, Inc., and The Municipal Fund Accumulation Program, Inc.,
and for the following closed-end registered investment companies: Apex
Municipal Fund, Inc., Corporate High Yield Fund, Inc., Corporate High Yield
Fund II, Inc., Corporate High Yield Fund III, Inc., Debt Strategies Fund,
Inc., Debt Strategies Fund II, Inc., Debt Strategies Fund III, Inc., Income
Opportunities Fund 1999, Inc., Income Opportunities Fund 2000, Inc., Merrill
Lynch Municipal Strategy Fund, Inc., MuniAssets Fund, Inc., MuniEnhanced Fund,
Inc., MuniHoldings Fund, Inc., MuniHoldings Fund II, Inc., MuniHoldings
California Insured Fund, Inc., MuniHoldings California Insured Fund II, Inc.,
MuniHoldings California Insured Fund III, Inc., MuniHoldings California
Insured Fund IV, Inc., MuniHoldings California Insured Fund V, Inc.,
MuniHoldings Florida Insured Fund, MuniHoldings Florida Insured Fund II,
MuniHoldings
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<PAGE>
Florida Insured Fund III, MuniHoldings Florida Insured Fund IV, MuniHoldings
Florida Insured Fund V, MuniHoldings Insured Fund, Inc., MuniHoldings Insured
Fund II, Inc., MuniHoldings Insured Fund III, Inc., MuniHoldings Insured Fund
IV, Inc., MuniHoldings Michigan Insured Fund, Inc., MuniHoldings Michigan
Insured Fund II, Inc., MuniHoldings New Jersey Insured Fund, Inc.,
MuniHoldings New Jersey Insured Fund II, Inc., MuniHoldings New Jersey Insured
Fund III, Inc., MuniHoldings New Jersey Insured Fund IV, Inc., MuniHoldings
New York Fund, Inc., MuniHoldings New York Insured Fund, Inc., MuniHoldings
New York Insured Fund II, Inc., MuniHoldings New York Insured Fund III, Inc.,
MuniHoldings New York Insured Fund IV, Inc., MuniHoldings Pennsylvania Insured
Fund, 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. 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 Disciplined
Equity Fund, Inc., Merrill Lynch Dragon Fund, Inc., Merrill Lynch EuroFund,
Merrill Lynch Fundamental Growth Fund, Inc., Merrill Lynch Global Allocation
Fund, Inc., Merrill Lynch Global Bond Fund for Investment and Retirement,
Merrill Lynch Global Growth Fund, Inc., Merrill Lynch Global Holdings, Inc.,
Merrill Lynch Global Resources Trust, Merrill Lynch Global SmallCap Fund,
Inc., Merrill Lynch Global Technology 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 Index Funds, 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 Real Estate Fund, Inc.,
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 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 for the following closed-end registered
investment companies: Merrill Lynch High Income Municipal Bond Fund, Inc.,
Merrill Lynch Senior Floating Rate Fund, Inc. and Merril Lynch Senior Floating
Rate Fund II, 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 Advisors Trust.
The address of each of these registered 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-
2665. The address of the Manager, MLAM, Princeton Services, Inc. ("Princeton
Services") and Princeton Administrators, L.P. ("Princeton Administrators") is
also P.O. Box 9011, Princeton, New Jersey 08543-9011. The address of Princeton
Funds Distributor, Inc. ("PFD") and of Merrill Lynch Funds Distributor
("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 10281-1201. The address of the Fund's
transfer agent, Financial Data Services, Inc. ("FDS"), 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 or entity has been engaged since
September 1, 1997 for his, her or its own account or in the capacity of
director, officer, partner or trustee. In addition, Mr. Glenn is President and
Mr. Burke is Vice President and Treasurer of all or substantially all of the
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<PAGE>
investment companies described in the first two paragraphs of this Item 26, and
Messrs. Doll, Giordano and Monagle are officers of one or more of such
companies.
<TABLE>
<CAPTION>
Position(s) with Other Substantial Business,
Name the Manager Profession, Vocation or Employment
---- ------------------- ------------------------------------------------
<C> <C> <S>
ML & Co................. Limited Partner Financial Services Holding Company; Limited
Partner of MLAM
Princeton Services...... General Partner General Partner of MLAM
Jeffrey M. Peek......... President President of MLAM; President and Director of
Princeton Services; Executive Vice President of
ML & Co.; Managing Director and Co-Head of the
Investment Banking Division of Merrill Lynch in
1997
Terry K. Glenn.......... Executive Vice Executive Vice President of MLAM; Executive Vice
President President and Director of Princeton Services;
President and Director of PFD; Director of FDS;
President of Princeton Administrators
Gregory A. Bundy........ Chief Operating Chief Operating Officer and Managing Director
Officer and MLAM; Chief Operating Officer and Managing
Managing Director Director of Princeton Services; Co-CEO of
Merrill Lynch Australia from 1997 to 1999
Donald C. Burke......... Senior Vice Senior Vice President, Treasurer and Director of
President Taxation of MLAM; Senior Vice President and
and Treasurer Treasurer of Princeton Services; Vice President
of PFD; First Vice President of MLAM from 1997
to 1999; Vice President of MLAM from 1990 to
1997
Michael G. Clark........ Senior Vice Senior Vice President of MLAM; Senior Vice
President President of Princeton Services; Treasurer and
Director of PFD; First Vice President of MLAM
from 1997 to 1999; Vice President of MLAM from
1996 to 1997
Robert C. Doll.......... Senior Vice Senior Vice President of MLAM; Senior Vice
President President of Princeton Services; Chief
Investment Officer of Oppenheimer Funds, Inc. in
1999 and Executive Vice President thereof from
1991 to 1999
Linda L. Federici....... Senior Vice Senior Vice President of MLAM; Senior Vice
President President of Princeton Services
Vincent R. Giordano..... Senior Vice Senior Vice President of MLAM; Senior Vice
President President of Princeton Services
Michael J. Hennewinkel.. Senior Vice Senior Vice President, Secretary and General
President, Counsel of MLAM; Senior Vice President of
Secretary and Princeton Services
General Counsel
Philip L. Kirstein...... Senior Vice Senior Vice President of MLAM; Senior Vice
President President, Secretary, General Counsel and
Director of Princeton Services
</TABLE>
C-5
<PAGE>
<TABLE>
<CAPTION>
Position(s) with Other Substantial Business,
Name the Manager Profession, Vocation or Employment
---- ------------------- ---------------------------------------------
<C> <C> <S>
Debra W. Landsman-Yaros.. Senior Vice Senior Vice President of MLAM; Senior Vice
President President of Princeton Services; Vice
President of PFDS
Stephen M. M. Miller..... Senior Vice Executive Vice President of Princeton
President Administrators; Senior Vice President of
Princeton Services
Joseph T. Monagle, Jr.... Senior Vice Senior Vice President of MLAM; Senior Vice
President President of Princeton Services
Brian A. Murdock......... Senior Vice Senior Vice President of MLAM; Senior Vice
President President of Princeton Services
Gregory D. Upah.......... Senior Vice Senior Vice President of MLAM; Senior Vice
President President of Princeton Services
</TABLE>
Item 27. Principal Underwriters.
(a) MLFD, a division of PFD, acts as the principal underwriter for the
Registrant and for each of the open-end registered investment companies
referred to in the first two paragraphs of Item 26 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. The Municipal Fund Accumulation Program, Inc. MLFD also acts as
the principal underwriter for the following closed-end registered investment
companies: Merrill Lynch High Income Municipal Bond Fund, Inc., Merrill Lynch
Municipal Strategy Fund, Inc., Merrill Lynch Senior Floating Rate Fund, Inc.
and Merrill Lynch Senior Floating Rate Fund II, Inc. A separate division of
PFD acts as the principal underwriter of a number of other investment
companies.
(b) Set forth below is information concerning each director and officer of
PFD. The principal business address of each such person is P.O. Box 9081,
Princeton, New Jersey 08543-9081, except that the address of Messrs. Breen,
Crook, Fatseas and Wasel is One Financial Center, 23rd Floor, Boston,
Massachusetts 02111-2665.
<TABLE>
<CAPTION>
Position(s) and Office(s) Position(s) and Office(s)
Name with PFD with Registrant
- ---- ------------------------- ----------------------------
<S> <C> <C>
Terry K. Glenn.......... President and Director President and Trustee
Michael G. Clark........ Treasurer and Director None
Thomas J. Verage........ Director None
Robert W. Crook......... Senior Vice President None
Michael J. Brady........ Vice President None
William M. Breen........ Vice President None
Donald C. Burke......... Vice President Vice President and Treasurer
James T. Fatseas........ Vice President None
Debra W. Landsman- Vice President None
Yaros..................
Michelle T. Lau......... Vice President None
Salvatore Venezia....... Vice President None
William Wasel........... Vice President None
Robert Harris........... Secretary None
</TABLE>
(c) Not applicable.
Item 28. Location of Accounts and Records.
All accounts, books and other documents required to be maintained by Section
31(a) of the 1940 Act and the rules thereunder are maintained at the offices
of the Registrant (800 Scudders Mill Road, Plainsboro, New Jersey 08536), and
its transfer agent, Financial Data Services, Inc. (4800 Deer Lake Drive East,
Jacksonville, Florida 32246-6484).
C-6
<PAGE>
Item 29. Management Services.
Other than as set forth under the caption "Management of the Fund -- Fund
Asset Management" 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 30. Undertakings.
Not applicable.
C-7
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act and the Investment
Company Act, the Registrant certifies that it meets all the requirements for
effectiveness of this Registration Statement under Rule 485(b) under the
Securities Act and has duly caused this Registration Statement to be signed on
its behalf by the undersigned, duly authorized, in the Township of Plainsboro,
and the State of New Jersey, on the 3rd day of December 1999.
Merrill Lynch California Municipal Series
Trust
By: /s/ Donald C. Burke
---------------------------------------
Donald C. Burke Vice President and
Treasurer
Pursuant to the requirements of the Securities Act, this Registration
Statement has been signed below by the following persons in the capacities and
on the date(s) indicated.
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
Terry K. Glenn* President and Trustee
______________________________________ (Principal Executive
(Terry K. Glenn) Officer)
Donald C. Burke* Vice President and
______________________________________ Treasurer
(Donald C. Burke) (Principal Financial and
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)
Arthur Zeikel* Trustee
______________________________________
(Arthur Zeikel)
/s/ Donald C. Burke December 3, 1999
*By: _________________________________
(Donald C. Burke, Attorney-in-Fact)
</TABLE>
C-8
<PAGE>
POWER OF ATTORNEY
The undersigned Directors/Trustees and officers of each of the registered
investment companies listed below hereby authorize Terry K. Glenn, Donald C.
Burke and Joseph T. Monagle, Jr., or any of them, as attorney-in-fact, to sign
on his or her behalf in the capacities indicated any Registration Statement or
amendment thereto (including post-effective amendments) for each of the
following registered investment companies and to file the same, with all
exhibits thereto, with the Securities and Exchange Commission: Merrill Lynch
California Municipal Series Trust, Merrill Lynch Multi-State Municipal Series
Trust, Merrill Lynch Multi-State Limited Maturity Municipal Series Trust,
Merrill Lynch Convertible Fund, Inc., Merrill Lynch Consults International
Portfolio, Merrill Lynch Growth Fund, Merrill Lynch World Income Fund, Inc.,
MuniEnhanced Fund, Inc., MuniHoldings California Insured Fund II, Inc.,
MuniHoldings Florida Insured Fund III, MuniHoldings Michigan Insured Fund,
Inc., MuniHoldings New York Fund, Inc., MuniHoldings New York Insured Fund II,
Inc., MuniHoldings New York Insured Fund III, Inc., MuniHoldings Pennsylvania
Insured Fund, MuniVest Pennsylvania Insured Fund, MuniYield Fund, Inc.,
MuniYield Arizona Fund, Inc., MuniYield California Fund, Inc., MuniYield
California Insured Fund, Inc., MuniYield California Insured Fund II, Inc.,
MuniYield Florida Fund, MuniYield Michigan Fund, Inc., MuniYield New Jersey
Fund, Inc., MuniYield New York Insured Fund, Inc., MuniYield New York Insured
Fund II, Inc., MuniYield Quality Fund, Inc. and MuniYield Quality Fund II,
Inc.
Dated: April 7, 1999
<TABLE>
<S> <C>
/s/ Terry K. Glenn /s/ Joseph L. May
_____________________________________
______________________________________
Terry K. Glenn Joseph L. May
(President/Principal Executive (Director/Trustee)
Officer/
Director/Trustee)
/s/ Andre F. Perold
______________________________________
/s/ James H. Bodurtha Andre F. Perold
_____________________________________
(Director/Trustee)
James H. Bodurtha
(Director/Trustee) /s/ Arthur Zeikel
______________________________________
/s/ Herbert I. London Arthur Zeikel
_____________________________________
(Director/Trustee)
Herbert I. London
(Director/Trustee) /s/ Donald C. Burke
______________________________________
/s/ Robert R. Martin Donald C. Burke
_____________________________________
(Vice President/Treasurer/Principal
Robert R. Martin Financial
(Director/Trustee) and Accounting Officer)
</TABLE>
C-9
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit
Number Description
------- -----------
<C> <S>
9 Opinion of Brown & Wood, LLP, counsel for the Registrant.
Consent of Deloitte & Touche LLP, independent auditors for the
10 Registrant.
</TABLE>
<PAGE>
Exhibit 9
BROWN, WOOD, IVEY, MITCHELL & PETTY
ONE WORLD TRADE CENTER, NEW YORK, N.Y. 10048
212-839-5300
-----
TELECOPIER: 212-839-5599
August 14, 1985
Merrill Lynch California Municipal
Series Trust
633 Third Avenue
New York, New York 10017
Dear Sirs:
We have acted as counsel for Merrill Lynch California Municipal Series
Trust, a trust organized under the laws of the Commonwealth of Massachusetts
(the "Trust"), in connection with the organization of the Trust, its
registration as an open-end investment company under the Investment Company Act
of 1940 and the division of the shares of beneficial interest of the Trust, par
value $.10 per share, to create a separate series of the Trust designated
"Merrill Lynch California Tax-Exempt Fund". This opinion is being furnished in
connection with the registration of an indefinite number of shares of beneficial
interest of Merrill Lynch California Tax Exempt Fund (the "Shares") under the
Securities Act of 1933, which is being effected pursuant to a registration
statement on Form N-1A (File No. 2-96581), as amended (the "Registration
Statement").
As counsel for the Trust, we are familiar with the proceedings taken by
it in connection with the authorization, issuance and sale of the Shares. In
addition, we have examined and are familiar with the Declaration of Trust of the
Trust, as amended, the By-Laws of the Trust, the instrument creating Merrill
Lynch California Tax-Exempt Fund and such other documents as we have deemed
relevant to the matters referred to in this option.
Based upon the foregoing, we are of the opinion that the Shares, upon
issuance and sale in the manner referred to in the Registration Statement for
consideration not less than the par value thereof, will be legally issued, fully
paid and non-assessable shares of beneficial interest of the Trust.
In rendering this opinion, we have relied as to matters of Massachusetts
law upon the opinion of Gaston Snow & Ely Bartlett, dated August 6, 1985,
rendered to the Trust.
We hereby consent to the filing of this opinion as an exhibit to the
Registration Statements and to the use of our name in the prospectus and
statement of additional information constituting parts thereof.
Very truly yours,
/s/ Brown, Wood, Ivey, Mitchell & Petty
1
<PAGE>
Exhibit 10
INDEPENDENT AUDITORS' CONSENT
Merrill Lynch California Municipal Bond Fund of
Merrill Lynch California Municipal Series Trust:
We consent to the incorporation by reference in this Post-Effective Amendment
No. 16 to Registration Statement No. 2-96581 of our report dated October 4, 1999
appearing in the annual report to shareholders of Merrill Lynch California
Municipal Bond Fund for the year ended August 31, 1999, and to the reference
to us under the caption "Financial Highlights" in the Prospectus, which is a
part of such Registration Statement.
/s/ Deloitte & Touche LLP
Deloitte & Touche LLP
Princeton, New Jersey
November 29, 1999
