<PAGE> 1
PROSPECTUS
AUGUST 4, 1997
MERRILL LYNCH CONVERTIBLE FUND, INC.
P.O. BOX 9011, PRINCETON, NEW JERSEY 08543-9011 - PHONE NO. (609) 282-2800
------------------------
Merrill Lynch Convertible Fund, Inc. (the "Fund") is a non-diversified,
open-end management investment company that seeks to provide shareholders with
high total return by investing primarily in a portfolio of convertible debt
securities, convertible preferred stocks and synthetic convertible securities.
Total return is the combination of capital appreciation and investment income.
The investment philosophy of the Fund is based on the belief that the
characteristics of convertible securities make them appropriate investments for
an investment company seeking a high total return from capital appreciation and
investment income. The securities in which the Fund invests may be issued by
both United States and non-United States issuers. The Fund may employ a variety
of techniques to hedge against market or currency risk or to enhance total
return. There can be no assurance that the investment objective of the Fund will
be realized.
Investments on an international basis in foreign securities markets involve
risks and special considerations not typically associated with investments in
securities of United States issuers. See "Risk Factors and Special
Considerations."
------------------------
Pursuant to the Merrill Lynch Select Pricing(SM) System, the Fund offers
four classes of shares, each with a different combination of sales charges,
ongoing fees and other features. The Merrill Lynch Select Pricing(SM) System
permits an investor to choose the method of purchasing shares that the investor
believes is most beneficial given the amount of the purchase, the length of time
the investor expects to hold the shares and other relevant circumstances. See
"Merrill Lynch Select Pricing(SM) System" on page 3.
Shares may be purchased directly from Merrill Lynch Funds Distributor, Inc.
(the "Distributor"), P.O. Box 9081, Princeton, New Jersey 08543-9081 [(609)
282-2800], or from securities dealers that have entered into selected dealer
agreements with the Distributor, including Merrill Lynch, Pierce, Fenner & Smith
Incorporated ("Merrill Lynch"). The minimum initial purchase is $1,000 and the
minimum subsequent purchase is $50, except that for retirement plans, the
minimum initial purchase is $100 and the minimum subsequent purchase is $1, and
for participants in certain fee-based programs, the minimum initial purchase is
$500 and the minimum subsequent purchase is $50. To permit the Fund to invest
the net proceeds from the sale of its shares in an orderly manner, the Fund may,
from time to time, suspend the sale of its shares, except for dividend
reinvestments. Merrill Lynch may charge its customers a processing fee
(presently $5.35) for confirming purchases and repurchases. Purchases and
redemptions made directly through the Fund's transfer agent are not subject to
the processing fee. See "Purchase of Shares" and "Redemption of Shares."
------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION NOR HAS THE COMMISSION PASSED UPON THE ACCURACY
OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
------------------------
This Prospectus is a concise statement of information about the Fund that
is relevant to making an investment in the Fund. This Prospectus should be
retained for future reference. A statement containing additional information
about the Fund, dated August 4, 1997 (the "Statement of Additional
Information"), has been filed with the Securities and Exchange Commission (the
"Commission") and is available, without charge, by calling or by writing the
Fund at the above telephone number or address. The Statement of Additional
Information is hereby incorporated by reference into this Prospectus.
------------------------
MERRILL LYNCH ASSET MANAGEMENT--MANAGER
MERRILL LYNCH FUNDS DISTRIBUTOR, INC.--DISTRIBUTOR
<PAGE> 2
FEE TABLE
A general comparison of the sales arrangements and other nonrecurring and
recurring expenses applicable to shares of the Fund follows:
<TABLE>
<CAPTION>
CLASS A(A)+ CLASS B(B) CLASS C CLASS D
----------- ----------------------- -------------- ---------
<S> <C> <C> <C> <C>
SHAREHOLDER TRANSACTION EXPENSES
Maximum Sales Charge Imposed on Purchases
(as a percentage of offering price)...... 5.25%(c) None None 5.25%(c)
Sales Charge Imposed on Dividend
Reinvestments............................ None None None None
Deferred Sales Charge (as a percentage of
original purchase price or redemption
proceeds, whichever is lower)............ None(d) 4.0% during the first 1.0% for one None(d)
year, decreasing 1.0% year(f)
annually to 0.0% after
the fourth year(e)
Exchange Fee............................... None None None None
ANNUAL FUND OPERATING EXPENSES (AS A
PERCENTAGE OF AVERAGE NET ASSETS)(G):
Investment Advisory Fees(h)................ 0.60% 0.60% 0.60% 0.60%
12b-1 Fees (includes account maintenance
fees and distribution fees)(i)........... None 1.00% 1.00% 0.25%
(Class B shares convert
to Class D shares
automatically after
approximately eight
years and cease being
subject to distribution
fees)
Other Expenses:
Custodial Fees........................... .01% .01% .01% .01%
Shareholder Servicing Costs(j)........... .04% .05% .05% .04%
Other.................................... .29% .29% .29% .29%
------ ----- ----- -----
Total Other Expenses................... .34% .35% .35% .34%
------ ----- ----- -----
Total Fund Operating Expenses.............. .94% 1.95% 1.95% 1.19%
====== ===== ===== =====
</TABLE>
- ---------------
(a) Class A shares are sold to a limited group of investors including existing
Class A shareholders, certain retirement plans and certain participants in
fee-based programs. See "Purchase of Shares -- Initial Sales Charge
Alternatives -- Class A and Class D Shares" on page 31 and "Shareholder
Services -- Fee-Based Programs" on page 41.
(b) Class B shares convert to Class D shares automatically approximately eight
years after initial purchase. See "Purchase of Shares -- Deferred Sales
Charge Alternatives -- Class B and Class C Shares" on page 32.
(c) Reduced for purchases of $25,000 and over, and waived for purchases of
Class A shares by certain retirement plans and participants in connection
with certain fee-based programs. Class A and Class D purchases of
$1,000,000 or more may not be subject to an initial sales charge. See
"Purchase of Shares -- Initial Sales Charge Alternatives -- Class A and
Class D Shares" on page 31.
(d) Class A and Class D shares are not subject to a contingent deferred sales
charge ("CDSC"), except that certain purchases of $1,000,000 or more which
are not subject to an initial sales charge may instead be subject to a CDSC
of 1.0% of amounts redeemed within the first year after purchase. Such CDSC
may be waived in connection with certain fee-based programs. See
"Shareholder Services -- Fee-Based Programs" on page 41.
(e) The CDSC may be modified in connection with certain fee-based programs. See
"Shareholder Services -- Fee-Based Programs" on page 41.
(f) The CDSC may be waived in connection with certain fee-based programs. See
"Shareholder Services -- Fee-Based Programs" on page 41.
(g) Information is estimated for the fiscal year ending December 31, 1997.
(h) See "Management of the Fund -- Management and Advisory Arrangements" on page
26.
(i) See "Purchase of Shares -- Distribution Plans" on page 36.
(j) See "Management of the Fund -- Transfer Agency Services" on page 28.
+ Upon conversion of the Fund to open-end status, the Fund's outstanding
Capital Shares were designated Class A shares.
2
<PAGE> 3
EXAMPLE:
<TABLE>
<CAPTION>
CUMULATIVE EXPENSES PAID
FOR THE PERIOD OF:
-------------------------------------
1 YEAR 3 YEARS 5 YEARS 10 YEARS
------ ------- ------- --------
<S> <C> <C> <C> <C>
An investor would pay the following expenses on a $1,000
investment including the maximum $52.50 initial sales charge
(Class A and Class D shares only) and assuming (1) the Total
Fund Operating Expenses for each class set forth on page 2,
(2) a 5% annual return throughout the periods and (3)
redemption at the end of the period (including any applicable
CDSC for Class B and Class C shares):
Class A................................................... $ 62 $ 81 $ 102 $162
Class B................................................... $ 60 $ 81 $ 105 $208*
Class C................................................... $ 30 $ 61 $ 105 $227
Class D................................................... $ 64 $ 88 $ 115 $189
An investor would pay the following expenses on the same $1,000
investment assuming no redemption at the end of the period:
Class A................................................... $ 62 $ 81 $ 102 $162
Class B................................................... $ 20 $ 61 $ 105 $208*
Class C................................................... $ 20 $ 61 $ 105 $227
Class D................................................... $ 64 $ 88 $ 115 $189
</TABLE>
- ---------------
* Assumes conversion to Class D shares approximately eight years after purchase.
The foregoing Fee Table is intended to assist investors in understanding
the costs and expenses that a shareholder in the Fund will bear directly or
indirectly. The expenses set forth under "Other Expenses" are based on estimated
amounts through the end of the Fund's first fiscal year as an open-end
investment company on an annualized basis. The Example set forth above assumes
reinvestment of all dividends and distributions and utilizes a 5% annual rate of
return as mandated by Commission regulations. THE EXAMPLE SHOULD NOT BE
CONSIDERED A REPRESENTATION OF PAST OR FUTURE EXPENSES OR ANNUAL RATE OF RETURN,
AND ACTUAL EXPENSES OR ANNUAL RATE OF RETURN MAY BE MORE OR LESS THAN THOSE
ASSUMED FOR PURPOSES OF THE EXAMPLE. Class B and Class C shareholders who hold
their shares for an extended period of time may pay more in Rule 12b-1
distribution fees than the economic equivalent of the maximum front-end sales
charge permitted under the Conduct Rules of the National Association of
Securities Dealers, Inc. ("NASD"). Merrill Lynch may charge its customers a
processing fee (presently $5.35) for confirming purchases and repurchases.
Purchases and redemptions made directly through the Fund's transfer agent are
not subject to the processing fee. See "Purchase of Shares" and "Redemption of
Shares."
MERRILL LYNCH SELECT PRICING(SM) SYSTEM
The Fund offers four classes of shares under the Merrill Lynch Select
Pricing(SM) System. The shares of each class may be purchased at a price equal
to the next determined net asset value per share subject to the sales charges
and ongoing fee arrangements described below. Shares of Class A and Class D are
sold to investors choosing the initial sales charge alternatives, and shares of
Class B and Class C are sold to investors choosing the deferred sales charge
alternatives. The Merrill Lynch Select Pricing(SM) System is used by more than
50 registered investment companies advised by Merrill Lynch Asset Management,
L.P. ("MLAM" or the "Manager") or Fund Asset Management, L.P. ("FAM"), an
affiliate of MLAM. Funds advised by
3
<PAGE> 4
MLAM or FAM that utilize the Merrill Lynch Select Pricing(SM) System are
referred to herein as "MLAM-advised mutual funds."
Each Class A, Class B, Class C or Class D share of the Fund represents an
identical interest in the investment portfolio of the Fund and has the same
rights, except that Class B, Class C and Class D shares bear the expenses of the
ongoing account maintenance fees and Class B and Class C shares bear the
expenses of the ongoing distribution fees and the additional incremental
transfer agency costs resulting from the deferred sales charge arrangements. The
CDSCs, distribution fees and account maintenance fees that are imposed on Class
B and Class C shares, as well as the account maintenance fees that are imposed
on Class D shares, are imposed directly against those classes and not against
all assets of the Fund and, accordingly, such charges will not affect the net
asset value of any other class or have any impact on investors choosing another
sales charge option. Dividends paid by the Fund for each class of shares will be
calculated in the same manner at the same time and will differ only to the
extent that account maintenance and distribution fees and any incremental
transfer agency costs relating to a particular class are borne exclusively by
that class. Each class has different exchange privileges. See "Shareholder
Services -- Exchange Privilege."
Investors should understand that the purpose and function of the initial
sales charges with respect to the Class A and Class D shares are the same as
those of the deferred sales charges and distribution fees with respect to the
Class B and Class C shares in that the sales charges and distribution fees
applicable to each class provide for the financing of the distribution of the
shares of the Fund. The distribution-related revenues paid with respect to a
class will not be used to finance the distribution expenditures of another
class. Sales personnel may receive different compensation for selling different
classes of shares.
The following table sets forth a summary of the distribution arrangements
for each class of shares under the Merrill Lynch Select Pricing(SM) System,
followed by a more detailed description of each class and a discussion of the
factors that investors should consider in determining the method of purchasing
shares under the Merrill Lynch Select Pricing(SM) System that the investor
believes is the most beneficial under his or her particular circumstances. More
detailed information as to each class of shares is set forth under "Purchase of
Shares."
<TABLE>
<S> <C> <C> <C> <C> <C> <C>
- ------------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------
CONVERSION
CLASS SALES CHARGE(1) ACCOUNT FEATURE
MAINTENANCE DISTRIBUTION
FEE FEE
----------------------------------------------------------------------------------------------------------
A Maximum 5.25% initial sales charge(2)(3) No No No
----------------------------------------------------------------------------------------------------------
B CSDC for a period of four years, at a B shares convert to
rate of 4.0% during the first year, D shares automatically
decreasing 1.0% annually to 0.0%(4) 0.25% 0.75% after approximately
eight years(5)
----------------------------------------------------------------------------------------------------------
C 1.0% CDSC for one year(6) 0.25% 0.75% No
----------------------------------------------------------------------------------------------------------
D Maximum 5.25% initial sales charge(3) 0.25% No No
----------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
- ---------------
(1) Initial sales charges are imposed at the time of purchase as a percentage of
the offering price. CDSCs are imposed if the redemption occurs within the
applicable CDSC time period. The charge will be assessed on an amount equal
to the lesser of the proceeds of redemption or the cost of the shares being
redeemed.
(2) Offered only to eligible investors. See "Purchase of Shares -- Initial Sales
Charge Alternatives -- Class A and Class D Shares -- Eligible Class A
Investors."
(3) Reduced for purchases of $25,000 or more and waived for purchases of Class A
shares by certain retirement plans and participants in connection with
certain fee-based programs. Class A and Class D share purchases of
$1,000,000 or more may not be subject to an
4
<PAGE> 5
initial sales charge but instead may be subject to a 1.0% CDSC if redeemed
within one year. Such CDSC may be waived in connection with certain
fee-based programs. A 0.75% sales charge for 401(k) purchases over
$1,000,000 will apply. See "Class A" and "Class D" below.
(4) The CDSC may be modified in connection with certain fee-based programs.
(5) The conversion period for dividend reinvestment shares and the conversion
and holding periods for certain retirement plans was modified. Also, Class B
shares of certain other MLAM-advised mutual funds into which exchanges may
be made have a ten-year conversion period. If Class B shares of the Fund are
exchanged for Class B shares of another MLAM-advised mutual fund, the
conversion period applicable to the Class B shares acquired in the exchange
will apply, and the holding period for the shares exchanged will be tacked
onto the holding period for the shares acquired.
(6) The CDSC may be waived in connection with certain fee-based programs.
Class A: Upon the conversion of the Fund to open-end status, the Fund's
outstanding Capital Shares were designated Class A shares. No sales
charge was due as a result of the conversion. Until September 4, 1997,
Class A shares are offered at net asset value to the former holders of
Income Shares of the Fund whose shares were redeemed on July 31, 1997,
prior to the Fund's conversion to open-end status. Class A shares incur
an initial sales charge when they are purchased and bear no ongoing
distribution or account maintenance fees. Class A shares are offered to
a limited group of investors and also will be issued upon reinvestment
of dividends on outstanding Class A shares. Investors who currently own
Class A shares of the Fund in a shareholder account are entitled to
purchase additional Class A shares of the Fund in that account. Other
eligible investors include participants in certain fee-based programs.
In addition, Class A shares will be offered at net asset value to
Merrill Lynch & Co., Inc. ("ML & Co.") and its subsidiaries (the term
"subsidiaries" when used herein with respect to ML & Co. includes the
Manager, FAM and certain other entities directly or indirectly wholly
owned and controlled by ML & Co.), and their directors and employees
and to members of the Boards of MLAM-advised mutual funds. The maximum
initial sales charge of 5.25% is reduced for purchases of $25,000 and
over and waived for purchases by certain retirement plans and
participants in connection with certain fee-based programs. Purchases
of $1,000,000 or more may not be subject to an initial sales charge,
but if the initial sales charge is waived such purchases may be subject
to a 1.0% CDSC if the shares are redeemed within one year after
purchase. Such CDSC may be waived in connection with certain fee-based
programs. Sales charges are also reduced under a right of accumulation
that takes into account the investor's holdings of all classes of all
MLAM-advised mutual funds. See "Purchase of Shares -- Initial Sales
Charge Alternatives -- Class A and Class D Shares."
Class B: Class B shares do not incur a sales charge when they are purchased, but
they are subject to an ongoing account maintenance fee of 0.25% and an
ongoing distribution fee of 0.75% of the Fund's average net assets
attributable to the Class B shares, as well as a CDSC if they are
redeemed within four years of purchase. Such CDSC may be modified in
connection with certain fee-based programs. Approximately eight years
after issuance, Class B shares will convert automatically into Class D
shares of the Fund, which are subject to an account maintenance fee but
no distribution fee; Class B shares of certain other MLAM-advised
mutual funds into which exchanges may be made convert into Class D
shares automatically after approximately ten years. If Class B shares
of the Fund are exchanged for Class B shares of another MLAM-advised
mutual fund, the conversion period applicable to the Class B shares
acquired in the exchange will apply, as will the Class D account
maintenance fee of the acquired fund upon the conversion, and the
holding period for the shares exchanged will be tacked onto the holding
period for the shares acquired. Automatic conversion of Class B shares
into Class D shares will occur at least once a month on the basis of
the
5
<PAGE> 6
relative net asset values of the shares of the two classes on the
conversion date, without the imposition of any sales load, fee or other
charge. Conversion of Class B shares to Class D shares will not be
deemed a purchase or sale of the shares for Federal income tax
purposes. Shares purchased through reinvestment of dividends on Class B
shares also will convert automatically to Class D shares. The
conversion period for dividend reinvestment shares and the conversion
and holding periods for certain retirement plans is modified as
described under "Purchase of Shares -- Deferred Sales Charge
Alternatives -- Class B and Class C Shares -- Conversion of Class B
Shares to Class D Shares."
Class C: Class C shares do not incur a sales charge when they are purchased, but
they are subject to an ongoing account maintenance fee of 0.25% and an
ongoing distribution fee of 0.75% of the Fund's average net assets
attributable to the Class C shares. Class C shares are also subject to
a 1.00% CDSC if they are redeemed within one year of purchase. Such
CDSC may be waived in connection with certain fee-based programs.
Although Class C shares are subject to a CDSC for only one year (as
compared to four years for Class B), Class C shares have no conversion
feature and, accordingly, an investor who purchases Class C shares will
be subject to distribution fees that will be imposed on Class C shares
for an indefinite period subject to annual approval by the Fund's Board
of Directors and regulatory limitations.
Class D: Class D shares incur an initial sales charge when they are purchased
and are subject to an ongoing account maintenance fee of 0.25% of the
Fund's average net assets attributable to Class D shares. Class D
shares are not subject to an ongoing distribution fee or any CDSC when
they are redeemed. The maximum initial sales charge of 5.25% is reduced
for purchases of $25,000 or more. Purchases of $1,000,000 or more may
not be subject to an initial sales charge, but if the initial sales
charge is waived, such purchases may be subject to a 1.0% CDSC if the
shares are redeemed within one year after purchase. Such CDSC may be
waived in connection with certain fee-based programs. The schedule of
initial sales charges and reductions for Class D shares is the same as
the schedule for Class A shares, except that there is no waiver for
purchases by retirement plans and participants in connection with
certain fee-based programs. Class D shares also will be issued upon
conversion of Class B shares as described above under "Class B." See
"Purchase of Shares -- Initial Sales Charge Alternatives -- Class A and
Class D Shares."
The following is a discussion of the factors that investors should consider
in determining the method of purchasing shares under the Merrill Lynch Select
Pricing(SM) System that the investor believes is most beneficial under his or
her particular circumstances.
Initial Sales Charge Alternatives. Investors who prefer an initial sales
charge alternative may elect to purchase Class D shares or, if an eligible
investor, Class A shares. Investors choosing the initial sales charge
alternative who are eligible to purchase Class A shares should purchase Class A
shares rather than Class D shares because there is an account maintenance fee
imposed on Class D shares. Investors qualifying for significantly reduced
initial sales charges may find the initial sales charge alternative particularly
attractive because similar sales charge reductions are not available with
respect to the CDSCs imposed in connection with purchases of Class B or Class C
shares. Investors not qualifying for reduced initial sales charges who expect to
maintain their investment for an extended period of time also may elect to
purchase Class A or Class D shares, because over time the accumulated ongoing
account maintenance and distribution fees on Class B or Class C shares may
exceed the initial sales charge and, in the case of Class D shares, the account
maintenance fee. Although some investors who previously purchased Class A shares
may no longer be eligible
6
<PAGE> 7
to purchase Class A shares of other MLAM-advised mutual funds, those previously
purchased Class A shares, together with Class B, Class C and Class D share
holdings, will count toward a right of accumulation which may qualify the
investor for reduced initial sales charges on new initial sales charge
purchases. In addition, the ongoing Class B and Class C account maintenance and
distribution fees will cause Class B and Class C shares to have higher expense
ratios, pay lower dividends and have lower total returns than the initial sales
charge shares. The ongoing Class D account maintenance fees will cause Class D
shares to have a higher expense ratio, pay lower dividends and have a lower
total return than Class A shares.
Deferred Sales Charge Alternatives. Because no initial sales charges are
deducted at the time of purchase, Class B and Class C shares provide the benefit
of putting all of the investor's dollars to work from the time the investment is
made. The deferred sales charge alternatives may be particularly appealing to
investors who do not qualify for a reduction in initial sales charges. Both
Class B and Class C shares are 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 eight years, and thereafter investors will be
subject to lower ongoing fees.
Certain investors may elect to purchase Class B shares if they determine it
to be most advantageous to have all their funds invested initially and intend to
hold their shares for an extended period of time. Investors in Class B shares
should take into account whether they intend to redeem their shares within the
CDSC period and, if not, whether they intend to remain invested until the end of
the conversion period and thereby take advantage of the reduction in ongoing
fees resulting from the conversion into Class D shares. Other investors,
however, may elect to purchase Class C shares if they determine that it is
advantageous to have all their assets invested initially and they are uncertain
as to the length of time they intend to hold their assets in MLAM-advised mutual
funds. Although Class C shareholders are subject to a shorter CDSC period at a
lower rate, they forego the Class B conversion feature, making their investment
subject to account maintenance and distribution fees for an indefinite period of
time. In addition, while both Class B and Class C distribution fees are subject
to the limitations on asset-based sales charges imposed by the NASD, the Class B
distribution fees are further limited under a voluntary waiver of asset-based
sales charges. See "Purchase of Shares -- Limitations on the Payment of Deferred
Sales Charges."
7
<PAGE> 8
FINANCIAL HIGHLIGHTS
The financial information in the table below has been audited in conjunction
with the annual audits of the financial statements of the Fund by Deloitte &
Touche LLP, independent auditors. Financial statements for the fiscal year ended
December 31, 1996 and the independent auditors' report thereon are included in
the Statement of Additional Information. Financial information is not presented
for Class B, Class C and Class D shares since no shares of those classes were
publicly issued as of the date of this Prospectus. Prior to August 4, 1997, the
Class A shares were designated Capital Shares and the Fund operated as a
closed-end "dual purpose" management investment company. Further information
about the performance of the Fund is contained in the Fund's most recent annual
report to shareholders which may be obtained, without charge, by calling or by
writing the Fund at the telephone number or address on the front cover of this
Prospectus.
The following per share data and ratios have been derived from information
provided in the Fund's audited financial statements:
<TABLE>
<CAPTION>
CLASS A SHARES(1)
-----------------------------------------------------------
FOR THE YEAR ENDED DECEMBER 31,
-----------------------------------------------------------
1996++ 1995 1994 1993
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Increase (Decrease) in Net Asset Value:
INCOME SHARES(2):
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of year...................... $ 9.32 $ 9.30 $ 9.30 $ 9.30
-------- -------- -------- --------
Investment income -- net.............................. 1.21 1.23 1.19 1.20
Dividends of investment income -- net................. (1.22) (1.21) (1.19) (1.20)
-------- -------- -------- --------
Net asset value, end of year............................ $ 9.31 $ 9.32 $ 9.30 $ 9.30
======== ======== ======== ========
Market price per share, end of year..................... $ 9.625 $ 10.00 $ 10.00 $ 10.625
======== ======== ======== ========
TOTAL INVESTMENT RETURN:**
Based on market value per share......................... 9.22% 13.58% 6.61% 7.20%
======== ======== ======== ========
Based on net asset value per share...................... 13.35% 13.82% 13.28% 13.50%
======== ======== ======== ========
CAPITAL SHARES:
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of year...................... $ 13.43 $ 11.13 $ 13.21 $ 12.87
-------- -------- -------- --------
Realized and unrealized gain (loss) on investments and
foreign currency transactions-net................... 2.78 2.66 (2.12) 1.43
Distributions of realized gain on investments-net..... (.64) (.36) (.01) (1.17)
Effect of repurchase of Treasury Stock................ -- --+ .05 .08
-------- -------- -------- --------
Net asset value, end of year............................ $ 15.57 $ 13.43 $ 11.13 $ 13.21
======== ======== ======== ========
Market value per share, end of year..................... $ 14.625 $ 11.625 $ 9.00 $ 10.875
======== ======== ======== ========
TOTAL INVESTMENT RETURN:**
Based on market value per share......................... 30.87% 33.20% (17.17)% 28.77%
======== ======== ======== ========
Based on net asset value per share...................... 20.60% 24.44% (15.68)% 13.94%
======== ======== ======== ========
TOTAL FUND:
RATIOS TO AVERAGE NET ASSETS:
Total expenses**........................................ .78% .79% .87% .80%
======== ======== ======== ========
Investment income-net................................... 4.98% 5.40% 5.43% 5.10%
======== ======== ======== ========
SUPPLEMENTAL DATA:
Net assets, end of year (in thousands).................. $289,993 $265,127 $238,466 $274,999
======== ======== ======== ========
Portfolio turnover...................................... 129.06% 87.69% 69.37% 116.03%
======== ======== ======== ========
Average commission rate paid++.......................... $ .0447 -- -- --
======== ======== ======== ========
</TABLE>
- ---------------
(1) The above financial information reflects the Fund's performance as a
closed-end investment company and, therefore, may not be indicative of its
performance as an open-end investment company. Capital Shares of the Fund
existing at the time of its conversion to an open-end investment company
have been classified as Class A shares.
(2) Income Shares were redeemed on July 31, 1997.
* Annualized.
** Total investment returns based on market value, which can be significantly
greater or lesser than the net asset value, may result in substantially
different returns. Total investment returns exclude the effects of sales
loads.
*** Excluding taxes on undistributed net realized long-term capital gains.
++ For fiscal years beginning on or after September 1, 1995, the Fund is
required to disclose its average commission rate per share for purchases and
sales of equity securities. The "Average commission rate paid" includes
commissions paid in foreign currencies, which have been converted into U.S.
dollars using the prevailing exchange rate on the date of the transaction.
Such conversions may significantly affect the rate shown.
+ Amount is less than $.01 per capital share.
++ Based on average shares outstanding during the period.
+++ For the six months ended December 31, 1987.
8
<PAGE> 9
<TABLE>
<CAPTION>
CLASS A SHARES(1)
----------------------------------------------------------------------------------------
FOR THE
FOR THE YEAR ENDED DECEMBER 31, YEAR ENDED
------------------------------------------------------------------------- JUNE 30,
1992 1991 1990 1989 1988 1987+++ 1987
-------- -------- -------- -------- -------- -------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
$ 9.31 $ 9.30 $ 9.30 $ 9.32 $ 9.38 $ 9.64 $ 9.63
-------- -------- -------- -------- -------- -------- --------
1.35 1.41 1.38 1.39 1.41 .65 1.31
(1.36) (1.40) (1.38) (1.41) (1.47) (.91) (1.30)
-------- -------- -------- -------- -------- -------- --------
$ 9.30 $ 9.31 $ 9.30 $ 9.30 $ 9.32 $ 9.38 $ 9.64
======== ======== ======== ======== ======== ======== ========
$ 11.25 $ 12.625 $ 10.875 $ 11.50 $ 11.50 $ 10.50 $ 12.00
======== ======== ======== ======== ======== ======== ========
2.74% 34.37% 9.23% 15.85% 27.63% (3.76)% 1.81%
======== ======== ======== ======== ======== ======== ========
15.17% 15.87% 15.50% 15.60% 15.79% 7.02% 14.65%
======== ======== ======== ======== ======== ======== ========
$ 10.91 $ 7.67 $ 10.12 $ 8.69 $ 8.49 $ 11.88 $ 12.26
-------- -------- -------- -------- -------- -------- --------
2.03 3.24 (2.45) 1.43 .20 (3.39) (.38)
(.12) -- -- -- -- -- --
.05 -- -- -- -- -- --
-------- -------- -------- -------- -------- -------- --------
$ 12.87 $ 10.91 $ 7.67 $ 10.12 $ 8.69 $ 8.49 $ 11.88
======== ======== ======== ======== ======== ======== ========
$ 9.375 $ 6.875 $ 4.25 $ 5.50 $ 4.25 $ 3.875 $ 7.125
======== ======== ======== ======== ======== ======== ========
38.11% 61.76% (22.73)% 29.41% 9.68% (45.61)% (10.76)%
======== ======== ======== ======== ======== ======== ========
19.48% 42.24% (24.21)% 16.46% 2.36% (28.54)% 3.16%
======== ======== ======== ======== ======== ======== ========
.80% .83% .86% .80% .79% .83%* .75%
======== ======== ======== ======== ======== ======== ========
6.34% 7.24% 7.39% 7.15% 7.55% 6.37%* 6.08%
======== ======== ======== ======== ======== ======== ========
$289,366 $275,045 $230,851 $264,339 $245,077 $243,073 $292,704
======== ======== ======== ======== ======== ======== ========
76.54% 54.90% 40.28% 50.47% 48.72% 23.09% 62.35%
======== ======== ======== ======== ======== ======== ========
-- -- -- -- -- -- --
======== ======== ======== ======== ======== ======== ========
</TABLE>
9
<PAGE> 10
RISK FACTORS AND SPECIAL CONSIDERATIONS
CONVERSION TO OPEN-END STATUS
On August 4, 1997, the Fund converted from a closed-end investment company
to an open-end investment company. Prior to the conversion of the Fund to
open-end status, the Fund was operated as a diversified, closed-end,
"dual-purpose" management investment company with different investment
objectives and policies from those described herein.
DERIVATIVE INVESTMENTS
The Fund may engage in transactions in certain instruments that may be
characterized as derivatives. These instruments include various types of
options, futures and options thereon, currency forwards and options thereon and
indexed securities, including inverse securities. The Fund may engage in these
transactions for hedging purposes or, in certain cases, to enhance total return.
Investments in indexed securities, including inverse securities, subject
the Fund to the risks associated with changes in the particular indices, which
risks may include the loss of amounts invested. Transactions involving options,
futures, options on futures or currency may involve the loss of an opportunity
to profit from a price movement in the underlying asset beyond certain levels or
a price increase on other portfolio assets (in the case of transactions for
hedging purposes) or expose the Fund to potential losses that exceed the amount
originally invested by the Fund in such instruments. For a further discussion of
the risks associated with these investments, see "Investment Objective and
Policies -- Description of Certain Investments," "-- Other Investment Policies
and Practices -- Portfolio Strategies Involving Options, Futures and Foreign
Exchange Transactions" and Appendix A to this Prospectus, "Investment Practices
Involving the Use of Options, Futures and Foreign Exchange."
ILLIQUID SECURITIES
The Fund may invest up to 15% of its net assets in securities that lack an
established secondary trading market or otherwise are considered illiquid.
Liquidity of a security relates to the ability to dispose easily of the security
and the price to be obtained upon disposition of the security, which may be less
than would be obtained for a comparable more liquid security. Investment of the
Fund's assets in illiquid securities may restrict the ability of the Fund to
dispose of its investments in a timely fashion and for a fair price as well as
its ability to take advantage of market opportunities. The risks associated with
illiquidity will be particularly acute in situations in which the Fund's
operations require cash, such as when the Fund redeems shares or pays dividends,
and could result in the Fund borrowing to meet short-term cash requirements or
incurring capital losses on the sale of illiquid investments. Further, issuers
whose securities are not publicly traded are not subject to the disclosure and
other investor protection requirements that would be applicable if their
securities were publicly traded. Illiquid securities may trade at a discount
from comparable, more liquid investments. In making investments in such
securities, the Fund may obtain access to material, non-public information which
may restrict the Fund's ability to conduct portfolio transactions in such
securities. In addition, the Fund may invest in privately placed securities that
may or may not be freely transferable under the laws of the applicable
jurisdiction or due to contractual restrictions on resale. See "Investment
Objective and Policies -- Description of Certain Investments -- Illiquid
Securities."
10
<PAGE> 11
NO RATING CRITERIA FOR DEBT SECURITIES
The Fund has not established any rating criteria for the debt securities in
which it may invest and such securities may not be rated at all for
creditworthiness. Securities rated in the medium to low rating categories of
nationally recognized statistical rating organizations, such as Standard &
Poor's Ratings Services ("S&P") and Moody's Investors Service, Inc. ("Moody's"),
and unrated securities of comparable quality (such lower rated and unrated
securities are referred to herein as "high yield/high risk securities" or "junk
bonds") are 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
Appendix B to this Prospectus, "Ratings of Debt Securities and Preferred Stock."
In purchasing such securities, the Fund will rely on the Manager's judgment,
analysis and experience in evaluating the creditworthiness of an issuer of such
securities. The Manager will take into consideration, among other things, the
issuer's financial resources, its sensitivity to economic conditions and trends,
its operating history, the quality of the issuer's management and regulatory
matters. The Fund does not intend to purchase debt securities that are in
default.
The market values of high yield/high risk securities, or "junk bonds," tend
to reflect individual issuer developments to a greater extent than do higher
rated securities, which react primarily to fluctuations in the general level of
interest rates. Issuers of high yield/high risk securities may be highly
leveraged and may not have available to them more traditional methods of
financing. Therefore, the risk associated with acquiring the securities of such
issuers generally is greater than is the case with higher rated securities. For
example, during an economic downturn or a sustained period of rising interest
rates, issuers of high yield/high risk securities may be more likely to
experience financial stress, especially if such issuers are highly leveraged.
During such periods, service of debt obligations also may be adversely affected
by specific issuer developments, or the issuer's inability to meet specific
projected business forecasts, or the unavailability of additional financing. The
risk of loss due to default by the issuer is significantly greater for the
holders of high yield/high risk securities because such securities may be
unsecured and may be subordinated to other creditors of the issuer.
High yield/high risk securities may have call or redemption features which
would permit an issuer to repurchase the securities from the Fund. If a call
were exercised by the issuer during a period of declining interest rates, the
Fund likely would have to replace such called securities with lower yielding
securities, thus decreasing the net investment income to the Fund and dividends
to shareholders.
The Fund may have difficulty disposing of certain high yield/high risk
securities, or "junk bonds," because there may be a thin trading market for such
securities. To the extent that a secondary trading market for high yield/high
risk securities does exist, it generally is not as liquid as the secondary
market for higher rated securities. Reduced secondary market liquidity may have
an adverse impact on market price and the Fund's ability to dispose of
particular issues when necessary to meet the Fund's liquidity needs or in
response to a specific economic event such as a deterioration in the
creditworthiness of the issuer. Reduced secondary market liquidity for certain
high yield/high risk securities also may make it more difficult for the Fund to
obtain accurate market quotations for purposes of valuing the Fund's portfolio.
Market quotations generally are available on many high yield/high risk
securities only from a limited number of dealers and may not necessarily
represent firm bids of such dealers or prices for actual sales. The Fund's
Directors, or the Manager will consider carefully the factors affecting the
market for high yield/high risk, lower rated securities in determining whether
any particular security is liquid or illiquid and whether current market
quotations are readily available.
11
<PAGE> 12
Adverse publicity and investor perceptions, which may not be based on
fundamental analysis, also may decrease the value and liquidity of high
yield/high risk securities, particularly in a thinly traded market. Factors
adversely affecting the market value of high yield/high risk securities are
likely to affect adversely the Fund's net asset value. In addition, the Fund may
incur additional expenses to the extent it is required to seek recovery upon a
default on a portfolio holding or participate in the restructuring of the
obligations.
INVESTING ON AN INTERNATIONAL BASIS
Because a substantial portion of the Fund's assets may be invested in
securities of non-U.S. issuers, an investor in the Fund should be aware of
certain risk factors and special considerations relating to international
investing, which may involve risks that are not typically associated with
investments in securities of U.S. issuers.
Specific Risks. Investing on an international basis involves certain risks
not involved in domestic investments, including fluctuations in foreign exchange
rates, future political and economic developments, different legal systems and
the possible imposition of exchange controls or other foreign governmental laws
or restrictions. Securities prices in different countries are subject to
different economic, financial, political and social factors. Since the Fund
invests heavily in securities denominated or quoted in currencies other than the
U.S. dollar, changes in foreign currency exchange rates will affect the value of
securities in the Fund and the unrealized appreciation or depreciation of
investments. Currencies of certain countries may be volatile and, therefore, may
affect the value of securities denominated in such currencies. In addition, with
respect to certain foreign countries, there is the possibility of expropriation
of assets, confiscatory taxation, difficulty in obtaining or enforcing a court
judgment, economic, political or social instability or diplomatic developments
that could affect investments in those countries. Moreover, individual foreign
economies may differ favorably or unfavorably from the U.S. economy in such
respects as growth of gross domestic product, rates of inflation, capital
reinvestment, resources, self-sufficiency and balance of payments position.
Certain foreign investments also may be subject to foreign withholding taxes.
These risks often are heightened for investments in smaller, emerging capital
markets.
As a result of these potential risks, the Manager may determine that,
notwithstanding otherwise favorable investment criteria, it may not be
practicable or appropriate to invest in a particular country. The Fund may
invest in countries in which foreign investors, including the Manager, have had
no or limited prior experience.
Public Information. Many of the foreign securities held by the Fund will
not be registered with the Commission, nor will the issuers thereof be subject
to the reporting requirements of such agency. Accordingly, there may be less
publicly available information about a foreign issuer than about a U.S. issuer
and such foreign issuers may not be subject to accounting, auditing and
financial reporting standards and requirements comparable to those of U.S.
issuers. As a result, traditional investment measurements, such as
price/earnings ratios, as used in the United States, may not be applicable to
certain smaller, emerging foreign capital markets. Foreign issuers, and issuers
in smaller, emerging capital markets in particular, may not be subject to
uniform accounting, auditing and financial reporting standards or to practices
and requirements comparable to those applicable to domestic issuers.
Trading Volume, Clearance and Settlement. Foreign financial markets, while
often growing in trading volume, have, for the most part, substantially less
volume than U.S. markets, and securities of many foreign companies are less
liquid and their prices may be more volatile than securities of comparable
domestic companies. Foreign markets also have different clearance and settlement
procedures, and in certain markets there have been times when settlements have
failed to keep pace with the volume of securities transactions,
12
<PAGE> 13
making it difficult to conduct such transactions. Further, satisfactory
custodial services for investment securities may not be available in some
countries having smaller, emerging capital markets, which may result in the Fund
incurring additional costs and delays in transporting and custodying such
securities outside such countries. Delays in settlement could result in periods
when assets of the Fund are uninvested and no return is earned thereon. The
inability of the Fund to make intended security purchases due to settlement
problems or the risk of intermediary counterparty failures could cause the Fund
to miss attractive investment opportunities. The inability to dispose of a
portfolio security due to settlement problems could result either in losses to
the Fund due to subsequent declines in the value of such portfolio security or,
if the Fund has entered into a contract to sell the security, could result in
possible liability to the purchaser.
Government Supervision and Regulation. There generally is less governmental
supervision and regulation of exchanges, brokers and issuers in foreign
countries than there is in the United States. For example, there may be no
comparable provisions under certain foreign laws to insider trading and similar
investor protection securities laws that apply with respect to securities
transactions consummated in the United States. Further, brokerage commissions
and other transaction costs on foreign securities exchanges generally are higher
than in the United States.
Depositary Receipts. The Fund may purchase sponsored or unsponsored
American Depositary Receipts ("ADRs"), European Depositary Receipts ("EDRs") and
Global Depositary Receipts ("GDRs") (collectively, "Depositary Receipts") or
other securities convertible into securities of foreign issuers. Depositary
Receipts may not necessarily be denominated in the same currency as the
underlying securities into which they may be converted. In addition, the issuers
of the securities underlying unsponsored Depositary Receipts are not obligated
to disclose material information in the United States, and, therefore, there may
be less information available regarding such issuers and there may not be a
correlation between such information and the market value of the Depositary
Receipts. Depositary Receipts also involve the risks associated with other
investments in foreign securities, as discussed above.
Restrictions on Foreign Investment. Some countries prohibit or impose
substantial restrictions on investments in their capital markets, particularly
their equity markets, by foreign entities such as the Fund. As illustrations,
certain countries require governmental approval prior to investments by foreign
persons, or limit the amount of investment by foreign persons in a particular
company, or limit the investment by foreign persons in a company to only a
specific class of securities that may have less advantageous terms than
securities of the company available for purchase by nationals. Certain countries
may restrict investment opportunities in issuers or industries deemed important
to national interests.
A number of countries have authorized the formation of closed-end
investment companies to facilitate indirect foreign investment in their capital
markets. In accordance with the Investment Company Act of 1940, as amended (the
"Investment Company Act"), the Fund may invest up to 10% of its total assets in
securities of closed-end investment companies, not more than 5% of which may be
invested in any one such company. This restriction on investments in securities
of closed-end investment companies may limit opportunities for the Fund to
invest indirectly in certain smaller capital markets. Shares of certain
closed-end investment companies may at times be acquired only at market prices
representing premiums to their net asset values. If the Fund acquires shares in
closed-end investment companies, shareholders would bear both their
proportionate share of expenses in the Fund (including investment advisory fees)
and, indirectly, the expenses of such closed-end investment companies. The Fund
also may seek, at its own cost, to create its own investment entities under the
laws of certain countries.
13
<PAGE> 14
In some countries, banks or other financial institutions may constitute a
substantial number of the leading companies or companies with the most actively
traded securities. The Investment Company Act limits the Fund's ability to
invest in any equity security of an issuer which, in its most recent fiscal
year, derived more than 15% of its revenues from "securities related
activities," as defined by the rules thereunder. These provisions may also
restrict the Fund's investments in certain foreign banks and other financial
institutions.
NON-DIVERSIFICATION
The Fund is classified as a non-diversified investment company under the
Investment Company Act, which means that the Fund is not limited by the
Investment Company Act in the proportion of its assets that may be invested in
the obligations of a single issuer. Thus, the Fund may invest a greater
proportion of its assets in the securities of a smaller number of issuers and,
as a result, will be subject to greater risk of loss with respect to its
portfolio securities. The Fund, however, intends to comply with the
diversification requirements imposed by the Internal Revenue Code of 1986, as
amended (the "Code"), for qualification as a regulated investment company. See
"Taxes" and "Investment Objective and Policies -- Investment Restrictions."
BORROWING
The Fund may borrow up to 33 1/3% of its total assets, taken at market
value, but only from banks as a temporary measure for extraordinary or emergency
purposes, including to meet redemptions (so as not to force the Fund to
liquidate securities at a disadvantageous time) or to settle securities
transactions. The Fund will not purchase securities at any time when borrowings
exceed 5% of its total assets, except (a) to honor prior commitments or (b) to
exercise subscription rights when outstanding borrowings have been obtained
exclusively for settlements of other securities transactions. The purchase of
securities while borrowings are outstanding will have the effect of leveraging
the Fund. Such leveraging increases the Fund's exposure to capital risk, and
borrowed funds are subject to interest costs that will reduce net income.
WITHHOLDING AND OTHER TAXES
Income and capital gains on securities held by the Fund may be subject to
withholding and other taxes imposed by certain jurisdictions, which would reduce
the return to the Fund on those securities. The Fund intends, unless ineligible,
to elect to "pass-through" to the Fund's shareholders the amount of foreign
taxes paid by the Fund. The taxes passed through to shareholders will be
included in each shareholder's income and could potentially be offset by either
a deduction or a credit. However, certain shareholders, including non-U.S.
shareholders, will not be entitled to the benefit of a deduction or credit with
respect to foreign taxes paid by the Fund. Non-U.S. shareholders may
nevertheless be subject to withholding tax on the foreign taxes included in
their income. Other taxes, such as transfer taxes, may be imposed on the Fund,
but would not give rise to a credit or deduction for shareholders.
FEES AND EXPENSES
The investment advisory fee (at the annual rate of 0.60% of the Fund's
average daily net assets) and other operating expenses of the Fund may be higher
than the investment advisory fees and operating expenses of other mutual funds
managed by the Manager and other investment advisers or of investment companies
investing exclusively in the securities of U.S. issuers. The investment advisory
fees and operating expenses, however, are believed by the Manager to be
comparable to expenses of open-end management investment companies that invest
on a global basis with investment objectives similar to the investment objective
of the Fund.
14
<PAGE> 15
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Fund is to seek high total return from a
combination of capital appreciation and investment income. The Fund will seek to
achieve its objective by investing primarily in a portfolio of convertible debt
securities, convertible preferred stocks and synthetic convertible securities.
Under normal circumstances, the Fund will invest at least 65% of its total
assets in convertible securities and synthetic convertible securities. The
securities in which the Fund invests may be issued by both United States and
non-United States issuers. The investment objective described in this paragraph
is a fundamental policy of the Fund and may not be changed without the approval
of the holders of a majority of the Fund's outstanding voting securities. There
can be no assurance that the investment objective of the Fund will be realized.
The convertible securities to be held by the Fund include any corporate
debt security or preferred stock that may be converted into underlying shares of
common stock. The common stock underlying convertible securities may be issued
by a different entity than the issuer of the convertible securities. Convertible
securities entitle the holder to receive interest payments paid on corporate
debt securities or the dividend preference on a preferred stock until such time
as the convertible security matures or is redeemed or until the holder elects to
exercise the conversion privilege. Synthetic convertible securities, as such
term is used herein, may be either (i) a debt security or preferred stock that
may be convertible only under certain contingent circumstances or that may pay
the holder a cash amount based on the value of shares of underlying common stock
partly or wholly in lieu of a conversion right (a "Cash-Settled Convertible") or
(ii) a combination of separate securities chosen by the Manager in order to
create the economic characteristics of a convertible security, i.e., a fixed
income security paired with a security with equity conversion features, such as
an option or warrant (a "Manufactured Convertible"). See "Convertible
Securities" below for additional information concerning convertible securities
and synthetic convertible securities eligible for purchase by the Fund.
The Fund believes that the characteristics of convertible securities make
them appropriate investments for an investment company seeking a high total
return from capital appreciation and investment income. These characteristics
include the potential for capital appreciation as the value of the underlying
common stock increases, the relatively high yield received from dividend or
interest payments as compared to common stock dividends and decreased risks of
decline in value relative to the underlying common stock due to their
fixed-income nature. As a result of the conversion feature, however, the
interest rate or dividend preference on a convertible security is generally less
than would be the case if the securities were issued in nonconvertible form.
Although the Fund may invest in securities denominated in any currency, it
is expected that a majority of its assets will be invested in securities that
are denominated in United States dollars, currencies of Pacific Basin countries
(such as Japan, Australia, Hong Kong and Singapore), and currencies of Western
European countries (such as the United Kingdom, Germany, the Netherlands,
Switzerland, Sweden, France, Italy, Belgium, Norway, Denmark, Austria and Spain)
and that are convertible into equity securities of United States, Pacific Basin
or Western European corporations.
Under normal circumstances, the Fund may invest up to 35% of its assets in
other types of securities, including common stock, preferred stock, options,
warrants, Long-term Equity Anticipation Securities ("LEAPS") and nonconvertible
debt securities of United States and non-United States issuers.
The Fund has established no rating criteria for the debt securities in
which it may invest and such securities may not be rated at all for
creditworthiness. Securities rated in the medium to lower rating categories of
nationally recognized statistical rating organizations and unrated securities of
comparable quality
15
<PAGE> 16
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 Appendix B to this Prospectus for additional information
regarding ratings of debt securities. In purchasing such securities, the Fund
will rely on the Manager's judgment, analysis and experience in evaluating the
creditworthiness of an issuer of such securities. The Manager will take into
consideration, among other things, the issuer's financial resources, its
sensitivity to economic conditions and trends, its operating history, the
quality of the issuer's management and regulatory matters. The Fund does not
intend to purchase debt securities that are in default or that the Manager
believes will be in default. See "Risk Factors and Special Considerations -- No
Rating Criteria for Debt Securities."
The Fund reserves the right as a temporary defensive measure to hold money
market securities of United States and non-United States issuers, or cash
(foreign currencies or United States dollars), in such proportions as, in the
opinion of the Manager, prevailing market, economic or political conditions
warrant. The Fund has established no rating criteria for money market securities
that it may hold as a defensive measure. For this purpose, investments made for
defensive purposes will be maintained only during periods in which the Manager
determines that economic or financial conditions are adverse for holding or
being fully invested in convertible and synthetic convertible securities of
United States and non-United States issuers. A portion of the portfolio normally
will be held in U.S. dollars or dollar-denominated money market securities to
provide for possible redemptions.
In evaluating proposed investments, the Manager will seek to maximize the
total return on the Fund's portfolio in terms of United States dollars. In
analyzing convertible securities, the Manager will consider both the yield on
the convertible security and the potential capital appreciation that is offered
by the underlying common stock. There can be no assurance that the Fund will
achieve its investment objective.
The table below shows the market value, by S&P rating category, of the debt
securities held by the Fund at June 30, 1997 (at which time the Fund was
operated as a closed-end investment company with different investment objectives
and policies from those described herein):
<TABLE>
<CAPTION>
% TOTAL
RATING ASSETS
-------------------------------------------------------------------- -------
<S> <C>
AAA................................................................. --
AA.................................................................. --
A................................................................... 6.47
BBB................................................................. 2.83
BB.................................................................. 1.22
B................................................................... 12.53
CCC................................................................. --
CC.................................................................. --
C................................................................... --
Not Rated*.......................................................... 4.62
Commercial Paper & U.S. Gov't....................................... 45.99
-------
73.66%
======
</TABLE>
- ---------------
* Debt securities that are not rated by S&P. Such bonds may be rated by
nationally recognized statistical rating organizations other than S&P, or may
not be rated by any of such organizations. With respect to the percentage of
the Fund's assets invested in
(footnote continued on next page)
16
<PAGE> 17
such securities, the Fund's Manager believes that .34% are of comparable quality
to obligations rated A, .93% are of comparable quality to obligations rated BBB,
1.81% are of comparable quality to obligations rated BB, .59% are of comparable
quality to obligations rated B, .75% are of comparable quality to obligations
rated CCC, .15% are of comparable quality to obligations rated C, and .05% are
of comparable quality to obligations rated D. This determination is based on the
Manager's own internal evaluation and does not necessarily reflect how such
securities would be rated by S&P if it were to rate the securities.
For a description of the above referenced ratings, see Appendix B to this
Prospectus, "Ratings of Debt Securities and Preferred Stock." The Fund has
established no rating criteria for the securities in which it may invest and
such securities may not be rated at all for creditworthiness. The above
percentages are as of June 30, 1997; the rating composition of the portfolio of
the Fund may vary over time.
CONVERTIBLE SECURITIES
Set forth below is additional information concerning convertible
securities, including synthetic convertible securities.
Convertible securities are issued and traded in a number of securities
markets. For the past several years, the principal markets have been the United
States, the Euromarket and Japan. Issuers during this period have included major
corporations domiciled in the United States, Japan, France, Switzerland, Canada
and the United Kingdom. Since the Fund will invest a substantial portion of its
assets in the United States market and the Euromarket, where convertible bonds
have been primarily denominated in the United States dollar, it is expected that
ordinarily a substantial portion of the convertible securities held by the Fund
will be denominated in United States dollars. However, the underlying equity
securities typically will be quoted in the currency of the country where the
issuer is domiciled. With respect to convertible securities denominated in a
currency different from that of the underlying equity securities, the conversion
price may be based on a fixed exchange rate established at the time the security
is issued. As a result, fluctuations in the exchange rate between the currency
in which the debt security is denominated and the currency in which the share
price is quoted will affect the value of the convertible security. As described
below, the Fund is authorized to enter into foreign currency hedging
transactions in which it may seek to reduce the effect of such fluctuations.
Apart from currency considerations, the value of convertible securities is
influenced by both the yield of nonconvertible securities of comparable issuers
and by the value of the underlying common stock. The value of a convertible
security viewed without regard to its conversion feature (i.e., strictly on the
basis of its yield) is sometimes referred to as its "investment value." To the
extent interest rates change, the investment value of the convertible security
typically will fluctuate. However, at the same time, the value of the
convertible security will be influenced by its "conversion value," which is the
market value of the underlying common stock that would be obtained if the
convertible security were converted. Conversion value fluctuates directly with
the price of the underlying common stock. If, because of a low price of the
common stock the conversion value is substantially below the investment value of
the convertible security, the price of the convertible security is governed
principally by its investment value.
To the extent the conversion value of a convertible security increases to a
point that approximates or exceeds its investment value, the price of the
convertible security will be influenced principally by its conversion value. A
convertible security will sell at a premium over the conversion value to the
extent investors place value on the right to acquire the underlying common stock
while holding a fixed-income security. The yield and conversion premium of
convertible securities issued in Japan and the Euromarket are frequently
determined at levels that cause the conversion value to affect their market
value more than the securities' investment value.
17
<PAGE> 18
Holders of convertible securities generally have a claim on the assets of
the issuer prior to the common stockholders but may be subordinated to other
debt securities of the same issuer. A convertible security may be subject to
redemption at the option of the issuer at a price established in the charter
provision, indenture or other governing instrument pursuant to which the
convertible security was issued. If a convertible security held by the Fund is
called for redemption, the Fund will be required to redeem the security, convert
it into the underlying common stock or sell it to a third party. Certain
convertible debt securities may provide a put option to the holder which
entitles the holder to cause the security to be redeemed by the issuer at a
premium over the stated principal amount of the debt security under certain
circumstances.
As indicated above, synthetic convertible securities may include either
Cash-Settled Convertibles or Manufactured Convertibles. Cash-Settled
Convertibles are instruments that are created by the issuer and have the
economic characteristics of traditional convertible securities but may not
actually permit conversion into the underlying equity securities in all
circumstances. As an example, a private company may issue a Cash-Settled
Convertible that is convertible into common stock only if the company
successfully completes a public offering of its common stock prior to maturity.
Manufactured Convertibles are created by the Manager by combining separate
securities that possess one of the two principal characteristics of a
convertible security, i.e., fixed income ("fixed income component") or a right
to acquire equity securities ("convertibility component"). The fixed income
component is achieved by investing in nonconvertible fixed income securities,
such as nonconvertible bonds, preferred stocks and money market instruments. The
convertibility component is achieved by investing in call options, warrants,
LEAPS, or other securities with equity conversion features ("equity features")
granting the holder the right to purchase a specified quantity of the underlying
stocks within a specified period of time at a specified price or, in the case of
a stock index option, the right to receive a cash payment based on the value of
the underlying stock index.
A warrant is an instrument issued by a corporation that gives a holder the
right to subscribe to a specified amount of capital stock at a set price for a
specified period of time. Warrants involve the risk that the price of the
security underlying the warrant may not exceed the exercise price of the warrant
and the warrant may expire without any value. The Fund has not established any
limits on the purchase of warrants in connection with Manufactured Convertibles.
See "Other Investment Policies and Practices -- Portfolio Strategies Involving
Options, Futures and Foreign Exchange Transactions" for a discussion of call
options and stock index call options.
A Manufactured Convertible differs from traditional convertible securities
in several respects. Unlike a traditional convertible security, which is a
single security having a unitary market value, a Manufactured Convertible is
comprised of two or more separate securities, each with its own market value.
Therefore, the total "market value" of such a Manufactured Convertible is the
sum of the values of its fixed-income component and its convertibility
component.
More flexibility is possible in the creation of a Manufactured Convertible
than in the purchase of a traditional convertible security. Because many
corporations have not issued convertible securities, the Manager may combine a
fixed income instrument and an equity feature with respect to the stock of the
issuer of the fixed income instrument to create a synthetic convertible security
otherwise unavailable in the market. The Manager may also combine a fixed income
instrument of an issuer with an equity feature with respect to the stock of a
different issuer when the Manager believes such a Manufactured Convertible would
better promote the Fund's objective than alternative investments. For example,
the Manager may combine an equity feature with respect to an issuer's stock with
a fixed income security of a different issuer in the same industry
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<PAGE> 19
to diversify the Fund's credit exposure, or with a U.S. Treasury instrument to
create a Manufactured Convertible with a higher credit profile than a
traditional convertible security issued by that issuer. A Manufactured
Convertible also is a more flexible investment in that its two components may be
purchased separately and, upon purchasing the separate securities, "combined" to
create a Manufactured Convertible. For example, the Fund may purchase a warrant
for eventual inclusion in a Manufactured Convertible while postponing the
purchase of a suitable bond to pair with the warrant pending development of more
favorable market conditions.
The value of a Manufactured Convertible may respond differently to certain
market fluctuations than would a traditional convertible security with similar
characteristics. For example, in the event the Fund created a Manufactured
Convertible by combining a short-term U.S. Treasury instrument and a call option
on a stock, the Manufactured Convertible would likely outperform a traditional
convertible of similar maturity and which is convertible into that stock during
periods when Treasury instruments outperform corporate fixed income securities
and underperform during periods when corporate fixed-income securities
outperform Treasury instruments.
DESCRIPTION OF CERTAIN INVESTMENTS
Depositary Receipts. The Fund may invest in the securities of foreign
issuers in the form of Depositary Receipts or other securities convertible into
securities of foreign issuers. Depositary Receipts may not necessarily be
denominated in the same currency as the underlying securities into which they
may be converted. ADRs are receipts typically issued by an American bank or
trust company that evidence ownership of underlying securities issued by a
foreign corporation. EDRs are receipts issued in Europe that evidence a similar
ownership arrangement. GDRs are receipts issued throughout the world that
evidence a similar arrangement. Generally, ADRs, in registered form, are
designed for use in the U.S. securities markets, and EDRs, in bearer form, are
designed for use in European securities markets. GDRs are tradeable both in the
U.S. and in Europe and are designed for use throughout the world. The Fund may
invest in unsponsored Depositary Receipts. The issuers of unsponsored Depositary
Receipts are not obligated to disclose material information in the United
States, and, therefore, there may be less information available regarding such
issuers and there may not be a correlation between such information and the
market value of the Depositary Receipts.
Warrants. The Fund may invest in warrants, which are securities permitting,
but not obligating, their holder to subscribe for other securities. Warrants do
not carry with them the right to dividends or voting rights with respect to the
securities that they entitle their holders to purchase, and they do not
represent any rights in the assets of the issuer. As a result, an investment in
warrants may be considered more speculative than certain other types of
investments. In addition, the value of a warrant does not necessarily change
with the value of the underlying securities and a warrant ceases to have value
if it is not exercised prior to its expiration date.
Illiquid Securities. The Fund may invest up to 15% of its net assets in
securities that lack an established secondary trading market or otherwise are
considered illiquid. The Fund may invest in securities of issuers that are sold
in private placement transactions between the issuers and their purchasers and
that are neither listed on an exchange nor traded in other established markets.
In many cases, privately placed securities will be subject to contractual or
legal restrictions on transfer. As a result of the absence of a public trading
market, privately placed securities in turn may be less liquid or illiquid and
more difficult to value than publicly traded securities. To the extent that
privately placed securities may be resold in privately negotiated transactions,
the prices realized from the sales, due to illiquidity, could be less than those
originally paid by the Fund or less than their fair market value. In addition,
issuers whose securities are not publicly traded may not be subject to
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<PAGE> 20
the disclosure and other investor protection requirements that may be applicable
if their securities were publicly traded. If any privately placed securities
held by the Fund are required to be registered under the securities laws of one
or more jurisdictions before being resold, the Fund may be required to bear the
expenses of registration. Certain of the Fund's investments in private
placements may consist of direct investments and may include investments in
smaller, less-seasoned issuers, which may involve greater risks. These issuers
may have limited product lines, markets or financial resources, or they may be
dependent on a limited management group. In making investments in such
securities, the Fund may obtain access to material nonpublic information which
may restrict the Fund's ability to conduct portfolio transactions in such
securities.
The Fund may purchase securities that are not registered ("restricted
securities") under the Securities Act of 1933, as amended (the "Securities
Act"), but can be offered and sold to "qualified institutional buyers" under
Rule 144A under the Securities Act. The Board of Directors has determined to
treat as liquid Rule 144A securities that are either (i) freely tradeable in
their primary markets offshore or (ii) non-investment grade debt securities
which the Manager determines are as liquid as publicly-registered non-investment
grade debt securities. The Board of Directors has adopted guidelines and
delegated to the Manager the daily function of determining and monitoring
liquidity of restricted securities. The Board of Directors, however, will retain
sufficient oversight and be ultimately responsible for the determinations. Since
it is not possible to predict with assurance exactly how this market for
restricted securities sold and offered under Rule 144A will develop, the Board
of Directors will carefully monitor the Fund's investments in these securities.
This investment practice could have the effect of increasing the level of
illiquidity in the Fund to the extent that qualified institutional buyers become
for a time uninterested in purchasing these securities.
Indexed and Inverse Securities. The Fund may invest in securities the
potential return of which is based on the change in particular measurements of
value or rate (an "index"). As an illustration, the Fund may invest in a debt
security that pays interest and returns principal based on the change in the
value of a securities index or a basket of securities, or based on the relative
changes of two indices. In addition, the Fund may invest in securities the
potential return of which is based inversely on the change in an index. For
example, the Fund may invest in securities that pay a higher rate of interest
when a particular index decreases and pay a lower rate of interest (or do not
fully return principal) when the value of the index increases. If the Fund
invests in such securities, it may be subject to reduced or eliminated interest
payments or loss of principal in the event of an adverse movement in the
relevant index or indices.
Certain indexed and inverse securities may have the effect of providing
investment leverage because the rate of interest or amount of principal payable
increases or decreases at a rate that is a multiple of the changes in the
relevant index. As a consequence, the market value of such securities may be
substantially more volatile than the market values of other debt securities. The
Fund believes that indexed and inverse securities may provide portfolio
management flexibility that permits the Fund to seek enhanced returns, hedge
other portfolio positions or vary the degree of portfolio leverage with greater
efficiency than would otherwise be possible under certain market conditions.
OTHER INVESTMENT POLICIES AND PRACTICES
Portfolio Strategies Involving Options, Futures and Foreign Exchange
Transactions. The Fund is authorized to engage in certain investment practices
involving the use of options, futures and foreign exchange, which may expose the
Fund to certain risks. These investment practices and the associated risks are
described in detail in Appendix A attached to this Prospectus.
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<PAGE> 21
Portfolio Transactions. Subject to policies established by the Board of
Directors of the Fund, the Manager is primarily responsible for the execution of
the Fund's portfolio transactions. Since portfolio transactions may be effected
on foreign securities exchanges, the Fund may incur settlement delays on certain
of such exchanges. See "Risk Factors and Special Considerations." In executing
portfolio transactions, the Manager seeks to obtain the best net results for the
Fund, taking into account such factors as price (including the applicable
brokerage commissions or dealer spread), size of order, difficulty of execution,
operational facilities of the firm involved and the firm's risk in positioning a
block of securities. While the Manager generally seeks reasonably competitive
fees, commissions or spreads, the Fund does not necessarily pay the lowest fee,
commission or spread available. The Fund may invest in certain securities traded
in the over-the-counter ("OTC") market and, where possible, will deal directly
with the dealers who make a market in the securities involved except in those
circumstances where better prices and execution are available elsewhere. Such
dealers usually are acting as principal for their own account. On occasion,
securities may be purchased directly from the issuer. Such portfolio securities
are generally traded on a net basis and do not normally involve either brokerage
commissions or transfer taxes. The Fund contemplates that, consistent with its
policy of obtaining the best net results, it will place orders for transactions
with a number of brokers and dealers, including Merrill Lynch, an affiliate of
the Manager. Subject to obtaining the best price and execution, securities firms
that provide supplemental investment research to the Manager, including Merrill
Lynch, 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 and the expenses of the Manager will not necessarily be
reduced as a result of the receipt of such supplemental information. See
"Management of the Fund -- Management and Advisory Arrangements."
Under the Investment Company Act, persons affiliated with the Fund and
persons who are affiliated with such affiliated persons, including Merrill
Lynch, are prohibited from dealing with the Fund as a principal in the purchase
and sale of securities unless a permissive order allowing such transactions is
obtained from the Commission. Affiliated persons of the Fund, and affiliated
persons of such affiliated persons, may serve as the Fund's broker in
transactions conducted on an exchange and in OTC transactions conducted on an
agency basis and may receive brokerage commissions from the Fund. In addition,
the Fund may not purchase securities during the existence of any underwriting
syndicate for such securities of which Merrill Lynch is a member except pursuant
to procedures approved by the Board of Directors of the Fund that comply with
rules adopted by the Commission. To the extent Merrill Lynch is active in
distributions of securities of issuers in certain foreign countries, the Fund
may be disadvantaged in that it may not purchase securities in such
distributions or may be limited in the amount it may purchase. In addition,
consistent with the Conduct Rules of the NASD, 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. It is expected that the majority of the
shares of the Fund will be sold by Merrill Lynch. Costs associated with
transactions in foreign securities are generally higher than in the U.S.,
although the Fund will endeavor to achieve the best net results in effecting its
portfolio transactions.
The Fund anticipates that its brokerage transactions involving securities
of companies domiciled in countries other than the United States will be
conducted primarily on the principal stock exchanges of such countries.
Brokerage commissions and other transaction costs on foreign securities
exchanges are generally higher than in the United States, although the Fund will
endeavor to achieve the best net results in effecting such transactions. There
generally is less governmental supervision and regulation of foreign stock
exchanges and brokers than in the United States. See "Risk Factors and Special
Considerations."
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<PAGE> 22
The Fund's ability and decisions to purchase and sell portfolio securities
may be affected by foreign laws and regulations relating to the convertibility
and repatriation of assets.
Portfolio Turnover. Generally, the Fund does not purchase securities for
short-term trading profits. However, the Fund may dispose of securities without
regard to the time they have been held when such actions, for defensive or other
reasons, appear advisable to the Manager in light of a change in circumstances
in general market, economic or financial conditions. As a result of its
investment policies, the Fund may engage in a substantial number of portfolio
transactions. Accordingly, while the Fund anticipates that its annual portfolio
turnover rate should not exceed 100% under normal conditions, it is impossible
to predict portfolio turnover rates. 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 all 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
rate involves certain tax consequences and correspondingly greater transaction
costs in the form of dealer spreads and brokerage commissions, which are borne
directly by the Fund.
Repurchase Agreements. The Fund may invest in securities pursuant to
repurchase agreements. Under a repurchase agreement, the seller agrees, upon
entering into the contract with the Fund, to repurchase a security (typically a
security issued or guaranteed by the U.S. Government) at a mutually agreed-upon
time and price, thereby determining the yield during the term of the agreement.
This results in a fixed yield for the Fund insulated from fluctuations in the
market value of the underlying security during such period although, to the
extent the repurchase agreement is not denominated in U.S. dollars, the Fund's
return may be affected by currency fluctuations. Repurchase agreements may be
entered into only with financial institutions that (i) have, in the opinion of
the Manager, substantial capital relative to the Fund's exposure, or (ii) have
provided the Fund with a third-party guaranty or other credit enhancement. The
Fund takes possession of the underlying securities when investing in repurchase
agreements. Nevertheless, if the seller were to default on its obligation to
repurchase a security under a repurchase agreement and the market value of the
underlying security at such time was less than the Fund had paid to the seller,
the Fund would realize a loss. The Fund may not invest more than 15% of its net
assets in repurchase agreements maturing in more than seven days, together with
all other illiquid securities.
When-Issued Securities and Forward Commitment Transactions. The Fund may
purchase or sell securities that it is entitled to receive on a when-issued
basis, and it may purchase or sell securities for delayed delivery. These
transactions occur when securities are purchased or sold by the Fund with
payment and delivery taking place in the future to secure what is considered an
advantageous yield and price to the Fund at the time of entering into the
transaction. Although the Fund has not established any limit on the percentage
of its assets that may be committed in connection with such transactions, the
Fund will maintain a segregated account with its custodian of cash, cash
equivalents, U.S. Government securities or other liquid securities denominated
in U.S. dollars or non-U.S. currencies in an aggregate amount equal to the
amount of its commitments in connection with such purchase transactions.
There can be no assurance that a security purchased on a when-issued basis
or purchased or sold for delayed delivery will be issued, and the value of the
security, if issued, on the delivery date may be more or less than its purchase
price. The Fund may bear the risk of a decline in the value of such security and
may not benefit from an appreciation in the value of the security during the
commitment period.
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<PAGE> 23
Standby Commitment Agreements. The Fund, from time to time, may enter into
standby commitment agreements. Such agreements commit the Fund, for a stated
period of time, to purchase a stated amount of equity securities that may be
issued and sold to the Fund at the option of the issuer. The price of the
security is fixed at the time of the commitment. At the time of entering into
the agreement, the Fund is paid a commitment fee, regardless of whether or not
the security is ultimately issued. The Fund will enter into such agreements only
for the purpose of investing in the security underlying the commitment at a
price that is considered advantageous to the Fund. The Fund will not enter into
a standby commitment with a remaining term in excess of 45 days and presently
will limit its investment in such commitments so that the aggregate purchase
price of the securities subject to such commitments, together with the value of
portfolio securities subject to legal restrictions on resale that affect their
marketability, will not exceed 15% of its net assets taken at the time of
acquisition of such a commitment. The Fund at all times will maintain a
segregated account with its custodian of cash, cash equivalents, U.S. Government
securities or other liquid securities denominated in U.S. dollars or non-U.S.
currencies in an aggregate amount equal to the purchase price of the securities
underlying a commitment.
There can be no assurance that the securities subject to a standby
commitment will be issued, and the value of the security, if issued, on the
delivery date may be more or less than its purchase price. Since the issuance of
the security underlying the commitment is at the option of the issuer, the Fund
may bear the risk of a decline in the value of such security and may not benefit
from an appreciation in the value of the security during the commitment period.
The purchase of a security subject to a standby commitment agreement and
the related commitment fee will be recorded on the date on which the security
can reasonably be expected to be issued, and the value of the security
thereafter will be reflected in the calculation of the Fund's net asset value.
The cost basis of the security will be adjusted by the amount of the commitment
fee. In the event the security is not issued, the commitment fee will be
recorded as income on the expiration date of the standby commitment.
Lending of Portfolio Securities. The Fund may from time to time lend
securities from its portfolio with a value not exceeding 33 1/3% of its total
assets to banks, brokers and other financial institutions and receive collateral
in cash or securities issued or guaranteed by the United States Government. Such
collateral will be maintained at all times in an amount equal to at least 102%
of the current market value of the loaned securities. During the period of such
a loan, the Fund receives the income on the loaned securities and either
receives the income on the collateral or other compensation, i.e., negotiated
loan premium or fee, for entering into the loan and thereby increases its yield.
In the event that the borrower defaults on its obligation to return borrowed
securities, because of insolvency or otherwise, the Fund could experience delays
and costs in gaining access to the collateral and could suffer a loss to the
extent that the value of the collateral falls below the market value of the
borrowed securities.
Short Sales. The Fund may make short sales of securities. A short sale is a
transaction in which the Fund sells a security it does not own in anticipation
that the market price of that security may decline. The Fund expects to make
short sales both as a form of hedging to offset potential declines in long
positions in similar securities and in order to maintain portfolio flexibility.
When the Fund makes a short sale, it must borrow the security sold short
and deliver it to the broker-dealer through which it made the short sale as
collateral for its obligation to deliver the security upon conclusion of the
sale. The Fund may have to pay a fee to borrow particular securities and is
often obligated to pay over any payments received on such borrowed securities.
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<PAGE> 24
The Fund's obligation to replace the borrowed security will be secured by
collateral deposited with the broker-dealer. With respect to uncovered short
positions, the Fund will also be required to deposit similar collateral with its
custodian to the extent, if any, necessary so that the value of both collateral
deposits in the aggregate is at all times equal to at least 100% of the current
market value of the security sold short. Depending on arrangements made with the
broker-dealer from which it borrowed the security regarding payment over of any
payments received by the Fund on such security, the Fund may not receive any
payments (including interest) on its collateral deposited with such
broker-dealer.
If the price of the security sold short increases between the time of the
short sale and the time the Fund replaces the borrowed security, the Fund will
incur a loss; conversely, if the price declines, the Fund will realize a gain.
Any gain will be decreased, and any loss increased, by the transaction costs
described above. Although the Fund's gain is limited to the price at which it
sold the security short, its potential loss is theoretically unlimited.
The Fund will not make a short sale if, after giving effect to such sale,
the market value of all securities sold short exceeds 25% of the value of its
total assets or the Fund's aggregate short sales of a particular class of
securities exceeds 25% of the outstanding securities of that class. The Fund may
also make short sales "against the box" without respect to such limitations. In
this type of short sale, at the time of the sale, the Fund owns or has the
immediate and unconditional right to acquire at no additional cost the identical
security.
INVESTMENT RESTRICTIONS
The Fund's investment activities are subject to further restrictions that
are described in the Statement of Additional Information. Investment
restrictions and policies that are fundamental policies 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 (a) 67% of the shares represented at a meeting at which more
than 50% of the outstanding shares are represented or (b) more than 50% of the
outstanding shares). Among its fundamental policies, the Fund may not invest
more than 25% of its total assets, taken at market value at the time of each
investment, in the securities of issuers in any particular industry (excluding
the U.S. Government and its agencies and instrumentalities). Investment
restrictions and policies that are non-fundamental policies may be changed by
the Board of Directors without shareholder approval. As a non-fundamental
policy, the Fund may not borrow money or pledge its assets, except that the Fund
(a) may borrow from a bank as a temporary measure for extraordinary or emergency
purposes or to meet redemptions in amounts not exceeding 33 1/3% (taken at
market value) of its total assets and pledge its assets to secure such
borrowings, (b) may obtain such short-term credit as may be necessary for the
clearance of purchases and sales of portfolio securities and (c) may purchase
securities on margin to the extent permitted by applicable law. (However, at the
present time, applicable law prohibits the Fund from purchasing securities on
margin.) (The deposit or payment by the Fund of initial or variation margin in
connection with financial futures contracts or options transactions is not
considered to be the purchase of a security on margin.) The purchase of
securities while borrowings are outstanding will have the effect of leveraging
the Fund. Such leveraging or borrowing increases the Fund's exposure to capital
risk, and borrowed funds are subject to interest costs which will reduce net
income.
As a non-fundamental policy, the Fund will not invest in securities that
cannot readily be resold because of legal or contractual restrictions or that
are not otherwise readily marketable, including repurchase agreements maturing
in more than seven days, if, regarding all such securities, more than 15% of its
net assets taken at market value would be invested in such securities.
Notwithstanding the foregoing, the Fund may
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<PAGE> 25
purchase without regard to this limitation securities that are not registered
under the Securities Act, but that can be offered and sold to "qualified
institutional buyers" under Rule 144A under the Securities Act, provided that
the Fund's Board of Directors continuously determines, based on the trading
markets for the specific Rule 144A security, that it is liquid. The Board of
Directors may adopt guidelines and delegate to the Manager the daily function of
determining and monitoring liquidity of restricted securities. The Board has
determined that securities which are freely tradeable in their primary market
outside of the United States should be deemed liquid. The Board, however, will
retain sufficient oversight and be ultimately responsible for the
determinations.
Non-Diversified Status. The Fund is classified as non-diversified within
the meaning of the Investment Company Act, which means that the Fund is not
limited by such Act in the proportion of its assets that it may invest in
securities of a single issuer. The Fund's investments will be limited, however,
in order to qualify for the special treatment afforded "regulated investment
companies" under the Code. See "Taxes." To qualify, the Fund will comply with
certain requirements, including limiting its 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. A fund that elects to be
classified as "diversified" under the Investment Company Act must satisfy the
foregoing 5% and 10% requirements with respect to 75% of its total assets. To
the extent that the Fund assumes large positions in the securities of a small
number of issuers, the Fund's net asset value may fluctuate to a greater extent
than that of a diversified company as a result of changes in the financial
condition or in the market's assessment of the issuers, and the Fund may be more
susceptible to any single economic, political or regulatory occurrence than a
diversified company.
For purposes of the diversification requirements set forth above with
respect to regulated investment companies, and to the extent required by the
Commission, the Fund, as non-fundamental policy, will consider securities issued
or guaranteed by the government of any one foreign country as the obligations of
a single issuer.
MANAGEMENT OF THE FUND
DIRECTORS
The Directors of the Fund consist of six individuals, five of whom are not
"interested persons" of the Fund as defined in the Investment Company Act. The
Directors are responsible for the overall supervision of the operations of the
Fund and perform the various duties imposed on the directors or trustees of
investment companies by the Investment Company Act.
The Directors are:
ARTHUR ZEIKEL* -- President of the Manager and its affiliate, FAM;
President and Director of Princeton Services, Inc. ("Princeton Services");
Executive Vice President of ML & Co.; and Director of the Distributor.
JAMES H. BODURTHA -- Director and Executive Vice President, The China
Business Group, Inc.
HERBERT I. LONDON -- John M. Olin Professor of Humanities, New York
University.
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<PAGE> 26
ROBERT R. MARTIN -- Former Chairman, Kinnard Investments, Inc.
JOSEPH L. MAY -- Attorney in private practice.
ANDRE F. PEROLD -- Professor, Harvard Business School.
- ---------------
* Interested person, as defined in the Investment Company Act, of the Fund.
MANAGEMENT AND ADVISORY ARRANGEMENTS
The Manager acts as the manager for the Fund and provides the Fund with
investment management services. The Manager is owned and controlled by ML & Co.,
a financial services holding company and the parent of Merrill Lynch. The
Manager or FAM acts as the investment adviser for more than 140 registered
investment companies. The Manager also offers portfolio management and portfolio
analysis services to individuals and institutions. As of June 30, 1997, the
Manager and FAM had a total of approximately $256.6 billion in investment
company and other portfolio assets under management, including accounts of
certain affiliates of the Manager. The principal business address of the Manager
is 800 Scudders Mill Road, Plainsboro, New Jersey 08536.
The Fund has entered into an investment advisory agreement with the Manager
(the "Management Agreement"). The Manager also served as the Fund's Manager
prior to the conversion of the Fund from a closed-end investment company to an
open-end investment company. The Management Agreement, which includes certain
provisions to accommodate the conversion of the Fund from a closed-end
investment company to an open-end investment company, was approved by the Fund's
Board of Directors on September 27, 1996 and by shareholders on January 16,
1997. Unless earlier terminated as described below, the Management Agreement
will remain in effect until July 31, 1999 and thereafter, if approved at least
annually (a) by the Directors or by a majority of the outstanding shares of the
Fund and (b) by a majority of the Directors who are not parties to such contract
or interested persons (as defined in the Investment Company Act) of any such
party. Such contract is not assignable and may be terminated without penalty on
60 days' written notice at the option of either party thereto or by the vote of
the shareholders of the Fund. The Management Agreement provides that, subject to
the direction of the Board of Directors of the Fund, the Manager is responsible
for the actual management of the Fund's portfolio. The responsibility for making
decisions to buy, sell or hold a particular security rests with the Manager,
subject to review by the Board of Directors.
The Manager provides the portfolio manager for the Fund who considers
analyses from various sources (including brokerage firms with which the Fund
does business), makes the necessary decisions, and places orders for
transactions accordingly. The Manager is also obligated to perform certain
administrative and management services for the Fund and is obligated to provide
all of the office space, facilities, equipment and personnel necessary to
perform its duties under the Management Agreement.
The Fund pays the Manager a monthly fee at the annual rate of 0.60% of the
average daily net assets of the Fund. For the fiscal year ended December 31,
1996 (during which period the Fund operated as a closed-end investment company),
the investment advisory fee paid by the Fund to the Manager aggregated
$1,695,738 (based upon average net assets of approximately $280.7 million).
Daniel A. Luchansky is the Portfolio Manager of the Fund. Mr. Luchansky has
been a Vice President of the Manager since 1991. Mr. Luchansky is responsible
for the day-to-day management of the Fund's investment portfolio.
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<PAGE> 27
The Manager has also entered into a sub-advisory agreement (the
"Sub-Advisory Agreement") with Merrill Lynch Asset Management U.K. Limited
("MLAM U.K."), an indirect, wholly owned subsidiary of ML & Co. and an affiliate
of the Manager, pursuant to which the Manager pays MLAM U.K. a fee for providing
investment advisory services to the Manager with respect to the Fund in an
amount to be determined from time to time by the Manager and MLAM U.K. but in no
event in excess of the amount the Manager actually receives for providing
services to the Fund pursuant to the Management Agreement. The Sub-Advisory
Agreement was approved by the Fund's Board of Directors on September 27, 1996
and by shareholders on January 16, 1997. Unless earlier terminated as described
below, the Sub-Advisory Agreement will remain in effect until July 31, 1999 and
thereafter, if approved at least annually (a) by the Directors or by a majority
of the outstanding shares of the Fund and (b) by a majority of the Directors who
are not parties to such contract or interested persons (as defined in the
Investment Company Act) of any such party. Such contract is not assignable and
may be terminated without penalty on 60 days' written notice at the option of
either party thereto or by the vote of the shareholders of the Fund. MLAM U.K.
has offices at Milton Gate, 1 Moor Lane, London EC2Y 9HA, England.
The Management Agreement obligates the Fund to pay certain expenses
incurred in its operations including, among other things, the investment
advisory fees, legal and audit fees, registration fees, unaffiliated Directors'
fees and expenses, custodian and transfer fees, accounting and pricing costs and
certain of the costs of printing proxies, shareholder reports, prospectuses and
statements of additional information distributed to shareholders. Accounting
services are provided to the Fund by the Manager and the Fund reimburses the
Manager for its costs in connection with such services. For the fiscal year
ended December 31, 1996, the Fund reimbursed the Manager $99,274 for accounting
services. For the fiscal year ended December 31, 1996, the ratio of total
expenses to average net assets, excluding taxes on undistributed net realized
long-term capital gains, was 0.78%. During such period, however, the Fund was
operated as a closed-end investment company and, consequently, such ratio may
not necessarily be indicative of the amounts of future expenses of the Fund.
CODE OF ETHICS
The Board of Directors of the Fund has adopted a Code of Ethics under Rule
17j-l of the Investment Company Act which incorporates the Code of Ethics of the
Manager (together, the "Codes"). The Codes significantly restrict the personal
investing activities of all employees of the Manager and, as described below,
impose additional, more onerous, restrictions on fund investment personnel.
The Codes require that all employees of the Manager preclear any personal
securities investment (with limited exceptions, such as government securities).
The preclearance requirement and associated procedures are designed to identify
any substantive prohibition or limitation applicable to the proposed investment.
The substantive restrictions applicable to all employees of the Manager include
a ban on acquiring any securities in a "hot" initial public offering and a
prohibition from profiting on short-term trading in securities. In addition, no
employee may purchase or sell any security which at the time is being purchased
or sold (as the case may be), or to the knowledge of the employee is being
considered for purchase or sale, by any fund advised by the Manager.
Furthermore, the Codes provide for trading "blackout periods" which prohibit
trading by investment personnel of the Fund within periods of trading by the
Fund in the same (or equivalent) security (15 or 30 days depending upon the
transaction).
27
<PAGE> 28
TRANSFER AGENCY SERVICES
Merrill Lynch Financial Data Services, Inc. (the "Transfer Agent"), which
is a subsidiary of ML & Co., acts as the Fund's Transfer Agent pursuant to a
Transfer Agency, Dividend Disbursing Agency and Shareholder Servicing Agency
Agreement (the "Transfer Agency Agreement"). Pursuant to the Transfer Agency
Agreement, the Transfer Agent is responsible for the issuance, transfer and
redemption of shares and the opening and maintenance of shareholder accounts.
Pursuant to the Transfer Agency Agreement, the Fund pays the Transfer Agent an
annual fee of up to $11.00 per Class A or Class D account and up to $14.00 per
Class B or Class C account and is entitled to reimbursement for certain
transaction charges and out-of-pocket expenses incurred by the Transfer Agent
under the Transfer Agency Agreement. Pursuant to 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.
PURCHASE OF SHARES
The Distributor, an affiliate of the Manager, FAM and Merrill Lynch, acts
as the distributor of the shares of the Fund. Shares of the Fund are offered
continuously for sale by the Distributor and other eligible securities dealers
(including Merrill Lynch). Shares of the Fund may be purchased from securities
dealers or by mailing a purchase order directly to the Transfer Agent. The
minimum initial purchase is $1,000 and the minimum subsequent purchase is $50,
except that for retirement plans, the minimum initial purchase is $100 and the
minimum subsequent purchase is $1, and for participants in certain fee-based
programs, the minimum initial purchase is $500 and the minimum subsequent
purchase is $50. Different minimums, may apply to purchases made through the
Merrill Lynch Blueprint(SM) Program. See "Purchase of Shares -- Merrill Lynch
Blueprint(SM) Program" in the Statement of Additional Information.
The Fund offers its shares in four classes, at a public offering price
equal to the next determined net asset value per share plus sales charges that
are imposed either at the time of purchase or on a deferred basis, depending
upon the class of shares selected by the investor under the Merrill Lynch Select
Pricing(SM) System, as described below. The applicable offering price for
purchase orders is based upon the net asset value of the Fund next determined
after receipt of the purchase order by the Distributor. As to purchase orders
received by securities dealers prior to the close of business on the New York
Stock Exchange ("NYSE") (generally, 4:00 p.m., New York time), which includes
orders received after the close of business on the previous day, the applicable
offering price will be based on the net asset value determined as of 15 minutes
after the close of business on the NYSE on that day, provided the Distributor in
turn receives the order from the securities dealer prior to 30 minutes after the
close of business on the NYSE on that day. If the purchase orders are not
received by the Distributor prior to 30 minutes after the close of business on
the NYSE, such orders shall be deemed received on the next business day. 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 Distributor or the Fund. Neither the Distributor nor the
dealers are permitted to withhold placing orders to benefit themselves by a
price change. Merrill Lynch may charge its customers a processing fee (presently
$5.35) to confirm a sale of shares to such customers. Purchases made directly
through the Fund's Transfer Agent are not subject to the processing fee.
28
<PAGE> 29
The Fund issues four classes of shares under the Merrill Lynch Select
Pricing(SM) System, which permits each investor to choose the method of
purchasing shares that the investor believes is most beneficial given the amount
of the purchase, the length of time the investor expects to hold the shares and
other relevant circumstances. Shares of Class A and Class D are sold to
investors choosing the initial sales charge alternatives and shares of Class B
and Class C are sold to investors choosing the deferred sales charge
alternatives. Investors should determine whether under their particular
circumstances it is more advantageous to incur an initial sales charge or to
have the entire initial purchase price invested in the Fund with the investment
thereafter being subject to a CDSC and ongoing distribution fees. A discussion
of the factors that investors should consider in determining the method of
purchasing shares under the Merrill Lynch Select Pricing(SM) System is set forth
under "Merrill Lynch Select Pricing(SM) System" on page 3.
Each Class A, Class B, Class C and Class D share of the Fund represents an
identical interest in the investment portfolio of the Fund and has the same
rights, except that Class B, Class C and Class D shares bear the expenses of the
ongoing account maintenance fees, and Class B and Class C shares bear the
expenses of the ongoing distribution fees and the additional incremental
transfer agency costs resulting from the deferred sales charge arrangements. The
CDSCs, distribution fees and account maintenance fees that are imposed on Class
B and Class C shares, as well as the account maintenance fees that are imposed
on Class D shares, will be imposed directly against those classes and not
against all assets of the Fund and, accordingly, such charges will not affect
the net asset value of any other class or have any impact on investors choosing
another sales charge option. Dividends paid by the Fund for each class of shares
will be calculated in the same manner at the same time and will differ only to
the extent that account maintenance and distribution fees and any incremental
transfer agency costs relating to a particular class are borne exclusively by
that class. Class B, Class C and Class D shares each have exclusive voting
rights with respect to the Rule 12b-1 distribution plan adopted with respect to
such class pursuant to which account maintenance and/or distribution fees are
paid (except that Class B shareholders may vote upon any material changes to
expenses charged under the Class D Distribution Plan). See "Distribution Plans"
below. Each class has different exchange privileges. See "Shareholder
Services -- Exchange Privilege."
Investors should understand that the purpose and function of the initial
sales charges with respect to Class A and Class D shares are the same as those
of the deferred sales charges and distribution fees with respect to Class B and
Class C shares in that the sales charges and distribution fees, if any,
applicable to each class provide for the financing of the distribution of the
shares of the Fund. The distribution-related revenues paid with respect to a
class will not be used to finance the distribution expenditures of another
class. Sales personnel may receive different compensation for selling different
classes of shares. Investors are advised that only Class A and Class D shares
may be available for purchase through securities dealers, other than Merrill
Lynch, which are eligible to sell shares.
29
<PAGE> 30
The following table sets forth a summary of the distribution arrangements
for each class of shares under the Merrill Lynch Select Pricing(SM) System.
<TABLE>
<S> <C> <C> <C> <C> <C> <C>
- ------------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------
ACCOUNT
MAINTENANCE DISTRIBUTION
CLASS SALES CHARGE(1) FEE FEE CONVERSION FEATURE
----------------------------------------------------------------------------------------------------------
A Maximum 5.25% initial sales
charge(2)(3) No No No
----------------------------------------------------------------------------------------------------------
B CDSC for a period of four years,
at a rate of 4.0% during the
first year, decreasing 1.0% B shares convert to
annually to 0.0%(4) 0.25% 0.75% D shares automatically
after approximately
eight years(5)
----------------------------------------------------------------------------------------------------------
C 1.0% CDSC for one year(6) 0.25% 0.75% No
----------------------------------------------------------------------------------------------------------
D Maximum 5.25% initial sales
charge(3) 0.25% No No
----------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
- ---------------
(1) Initial sales charges are imposed at the time of purchase as a percentage of
the offering price. CDSCs may be imposed if the redemption occurs within the
applicable CDSC time period. The charge will be assessed on an amount equal
to the lesser of the proceeds of redemption or the cost of the shares being
redeemed.
(2) Offered only to eligible investors. See "Initial Sales Charge
Alternatives -- Class A and Class D Shares -- Eligible Class A Investors."
(3) Reduced for purchases of $25,000 or more and waived for purchases of Class A
shares by certain retirement plans and participants in connection with
certain fee-based programs. Class A and Class D share purchases of
$1,000,000 or more may not be subject to an initial sales charge but instead
may be subject to a 1.0% CDSC if redeemed within one year. Such CDSC may be
waived in connection with certain fee-based programs. A 0.75% sales charge
for 401(k) purchases over $1,000,000 will apply.
(4) The CDSC may be modified in connection with certain fee-based programs.
(5) The conversion period for dividend reinvestment shares and the conversion
and holding periods for certain retirement plans are modified. Also, Class B
shares of certain other MLAM-advised mutual funds into which exchanges may
be made have a ten-year conversion period. If Class B shares of the Fund are
exchanged for Class B shares of another MLAM-advised mutual fund, the
conversion period applicable to the Class B shares acquired in the exchange
will apply, and the holding period for the shares exchanged will be tacked
onto the holding period for the shares acquired.
(6) The CDSC may be waived in connection with certain fee-based programs.
30
<PAGE> 31
INITIAL SALES CHARGE ALTERNATIVES -- CLASS A AND CLASS D SHARES
Investors choosing the initial sales charge alternatives who are eligible
to purchase Class A shares should purchase Class A shares rather than Class D
shares because there is an account maintenance fee imposed on Class D shares.
The public offering price of Class A and Class D shares for purchasers
choosing the initial sales charge alternative is the next determined net asset
value plus varying sales charges (i.e., sales loads), as set forth below:
<TABLE>
<CAPTION>
SALES CHARGE SALES CHARGE
AS PERCENTAGE AS PERCENTAGE* DISCOUNT TO
OF THE OF THE NET SELECTED DEALERS
OFFERING AMOUNT AS PERCENTAGE OF
AMOUNT OF PURCHASE PRICE INVESTED THE OFFERING PRICE
- ------------------------------------------------- ------------- -------------- ------------------
<S> <C> <C> <C>
Less than $25,000................................ 5.25% 5.54% 5.00%
$25,000 but less than $50,000.................... 4.75 4.99 4.50
$50,000 but less than $100,000................... 4.00 4.16 3.75
$100,000 but less than $250,000.................. 3.00 3.09 2.75
$250,000 but less than $1,000,000................ 2.00 2.04 1.80
$1,000,000 and over**............................ 0.00 0.00 0.00
</TABLE>
- ---------------
* Rounded to the nearest one-hundredth percent.
** The initial sales charge may be waived on Class A and Class D purchases of
$1,000,000 or more and on Class A share purchases by certain retirement plan
investors and participants in connection with certain fee-based programs. If
the sales charge is waived in connection with a purchase of $1,000,000 or
more, such purchases may be subject to a CDSC of 1.0% if the shares are
redeemed within one year after purchase. Such CDSC may be waived in
connection with certain fee-based programs. The charge will be assessed on an
amount equal to the lesser of the proceeds of redemption or the cost of the
shares being redeemed. A sales charge of 0.75% will be charged on purchases
of $1 million or more of Class A or Class D shares by certain
employer-sponsored retirement or savings plans.
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. The
proceeds from the account maintenance fees are used to compensate Merrill Lynch
for providing continuing account maintenance activities.
Eligible Class A Investors. Class A shares are offered to a limited group
of investors and also will be issued upon reinvestment of dividends on
outstanding Class A shares. Investors that currently own Class A shares of the
Fund in a shareholder account, including participants in the Merrill Lynch
Blueprint(SM) program, are entitled to purchase additional Class A shares of the
Fund in that account. Certain employer-sponsored retirement or savings plans,
including eligible 401(k) plans, may purchase Class A shares at net asset value
provided such plans meet the required minimum number of eligible employees or
required amount of assets advised by MLAM or any of its affiliates. Class A
shares are available at net asset value to corporate warranty insurance reserve
fund programs and U.S. branches of foreign banking institutions provided that
the program or branch has $3 million or more initially invested in MLAM-advised
mutual funds. Also eligible to purchase Class A shares at net asset value are
participants in certain investment programs including 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 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
31
<PAGE> 32
subsidiaries and their directors and employees and to members of the Boards of
MLAM-advised investment companies, including the Fund. Certain persons who
acquired shares of certain MLAM-advised closed-end funds in their initial
offerings who wish to reinvest the net proceeds from a sale of their closed-end
fund shares of common stock in shares of the Fund also may purchase Class A
shares of the Fund if certain conditions set forth in the Statement of
Additional Information are met (for closed-end funds that commenced operations
prior to October 21, 1994). In addition, Class A shares of the Fund and certain
other MLAM-advised mutual funds are offered at net asset value to shareholders
of Merrill Lynch Senior Floating Rate Fund, Inc. and, if certain conditions set
forth in the Statement of Additional Information are met, to shareholders of
Merrill Lynch Municipal Strategy Fund, Inc. and Merrill Lynch High Income
Municipal Bond Fund, Inc. who wish to reinvest the net proceeds from a sale of
certain of their shares of common stock pursuant to a tender offer conducted by
such funds in shares of the Fund and certain other MLAM-advised mutual funds.
Until September 4, 1997, former holders of Income Shares of the Fund, all
of which were redeemed prior to the Fund's conversion to open-end status on
August 4, 1997, may purchase Class A shares of the Fund at net asset value
without any front-end sales charge.
Reduced Initial Sales Charges. No sales charges are imposed upon Class A
and Class D shares issued as a result of the automatic reinvestment of dividends
or capital gains distributions. Class A and Class D sales charges also may be
reduced under a Right of Accumulation and a Letter of Intention. Class A shares
are offered at net asset value to certain eligible Class A investors as set
forth above under "Eligible Class A Investors." See "Shareholder
Services -- Fee-Based Programs."
Provided applicable threshold requirements are met, either Class A or Class
D shares are offered at net asset value to Employee Access(SM) Accounts
available through authorized employers. Class A shares are offered at net asset
value to shareholders of Merrill Lynch Senior Floating Rate Fund, Inc., and
subject to certain conditions, Class A and Class D shares are offered at net
asset value to shareholders of Merrill Lynch Municipal Strategy Fund, Inc. and
Merrill Lynch High Income Municipal Bond Fund, Inc., who wish to reinvest in
shares of the Fund the net proceeds from a sale of certain of their shares of
common stock pursuant to tender offers conducted by those funds.
Class D shares are offered at net asset value, without a sales charge, to
an investor who has a business relationship with a Merrill Lynch Financial
Consultant, if certain conditions set forth in the Statement of Additional
Information are met. Class D shares may be offered at net asset value in
connection with the acquisition of assets of other investment companies.
Class D shares are offered with reduced sales charges and, in certain
circumstances, at net asset value, to participants in the Merrill Lynch
Blueprint(SM) Program.
Additional information concerning these reduced initial sales charges is
set forth in the Statement of Additional Information.
DEFERRED SALES CHARGE ALTERNATIVES -- CLASS B AND CLASS C SHARES
Investors choosing the deferred sales charge alternatives should consider
Class B shares if they intend to hold their shares for an extended period of
time and Class C shares if they are uncertain as to the length of time they
intend to hold their assets in MLAM-advised mutual funds.
The public offering price of Class B and Class C shares for investors
choosing the deferred sales charge alternatives is the next determined net asset
value per share without the imposition of a sales charge at the
32
<PAGE> 33
time of purchase. As discussed below, Class B shares are subject to a four year
CDSC, which declines each year, while Class C shares are subject only to a one
year 1.0% CDSC. On the other hand, approximately eight years after Class B
shares are issued, such Class B shares, together with shares issued upon
dividend reinvestment with respect to those shares, are automatically converted
into Class D shares of the Fund and thereafter will be subject to lower
continuing fees. See "Conversion of Class B Shares to Class D Shares" below.
Both Class B and Class C shares are subject to an account maintenance fee of
0.25% of net assets and distribution fees of 0.75% of net assets as discussed
below under "Distribution Plans." The proceeds from the account maintenance fees
are used to compensate Merrill Lynch for providing continuing account
maintenance activities.
Class B and Class C shares are sold without an initial sales charge so that
the Fund will receive the full amount of the investor's purchase payment.
Merrill Lynch compensates its financial consultants for selling Class B and
Class C shares at the time of purchase from its own funds. See "Distribution
Plans" below.
Proceeds from the CDSC and the distribution fee are paid to the Distributor
and are used in whole or in part by the Distributor to defray the expenses of
dealers (including Merrill Lynch) related to providing distribution related
services to the Fund in connection with the sale of the Class B and Class C
shares, such as the payment of compensation to financial consultants for selling
Class B and Class C shares from the dealers' own funds. The combination of the
CDSC and the ongoing distribution fee facilitates the ability of the Fund to
sell the Class B and Class C shares without a sales charge being deducted at the
time of purchase. Approximately eight years after issuance, Class B shares will
convert automatically into Class D shares of the Fund, which are subject to an
account maintenance fee but no distribution fee; Class B shares of certain other
MLAM-advised mutual funds into which exchanges may be made convert into Class D
shares automatically after approximately ten years. If Class B shares of the
Fund are exchanged for Class B shares of another MLAM-advised mutual fund, the
conversion period applicable to the Class B shares acquired in the exchange will
apply, and the holding period for the shares exchanged will be tacked onto the
holding period for the shares acquired.
Imposition of the CDSC and the distribution fee on Class B and Class C
shares is limited by the NASD asset-based sales charge rule. See "Limitations on
the Payment of Deferred Sales Charges" below. The proceeds from the ongoing
account maintenance fee are used to compensate Merrill Lynch for providing
continuing account maintenance activities. Class B shareholders of the Fund
exercising the exchange privilege described under "Shareholder
Services -- Exchange Privilege" will continue to be subject to the Fund's CDSC
schedule if such schedule is higher than the CDSC schedule relating to the Class
B shares acquired as a result of the exchange.
Contingent Deferred Sales Charges -- Class B Shares. Class B shares that
are redeemed within four years of purchase may be subject to a CDSC at the rates
set forth below charged as a percentage of the dollar amount subject thereto.
The charge will be assessed on an amount equal to the lesser of the proceeds of
redemption or the cost of the shares being redeemed. Accordingly, no CDSC will
be imposed on increases in net asset value above the initial purchase price. In
addition, no charge will be assessed on shares derived from reinvestment of
dividends or capital gains distributions.
33
<PAGE> 34
The following table sets forth the rates of the Class B CDSC:
<TABLE>
<CAPTION>
CLASS B
CDSC AS A
YEAR SINCE PERCENTAGE OF
PURCHASE DOLLAR AMOUNT
PAYMENT MADE SUBJECT TO CHARGE
------------------------------------------------------------- -----------------
<S> <C>
0-1.......................................................... 4.0%
1-2.......................................................... 3.0%
2-3.......................................................... 2.0%
3-4.......................................................... 1.0%
4 and thereafter............................................. None
</TABLE>
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. Therefore, it will be assumed that the redemption
is first of shares held for over four years or shares acquired pursuant to
reinvestment of dividends or distributions and then of shares held longest
during the four-year period. The charge will not be applied to dollar amounts
representing an increase in the net asset value since the time of purchase. A
transfer of shares from a shareholder's account to another account will be
assumed to be made in the same order as a redemption.
To provide an example, assume an investor purchased 100 Class B shares at
$10 per share (at a cost of $1,000) and in the third year after purchase, the
net asset value per share is $12 and, during such time, the investor has
acquired 10 additional shares through dividend reinvestment. If at such time the
investor makes his or her first redemption of 50 shares (proceeds of $600), 10
shares will not be subject to the CDSC because of dividend reinvestment. With
respect to the remaining 40 shares, the CDSC is applied only to the original
cost of $10 per share and not to the increase in net asset value of $2 per
share. Therefore, $400 of the $600 redemption proceeds will be charged at a rate
of 2.0% (the applicable rate in the third year after purchase).
The Class B CDSC is waived on redemptions of shares in connection with
certain post-retirement withdrawals from an Individual Retirement Account
("IRA") or other retirement plan or following death or disability (as defined in
the Code) of a shareholder. The Class B CDSC also is waived on redemptions of
shares by certain eligible 401(a) and eligible 401(k) plans and in connection
with certain group plans placing orders through the Merrill Lynch Blueprint(SM)
Program. The CDSC is also waived for any Class B shares that are purchased by
eligible 401(a) or eligible 401(k) plans that are rolled over into a Merrill
Lynch or Merrill Lynch Trust Company custodied IRA and held in such account at
the time of redemption. The Class B CDSC is also waived for any Class B shares
purchased within eligible Employee Access(SM) Accounts. The Class B CDSC is also
waived for any Class B shares that are purchased by a Merrill Lynch rollover IRA
that was funded by a rollover from a terminated 401(k) plan managed by the MLAM
Private Portfolio Group and held in such account at the time of redemption.
Additional information concerning the waiver of the Class B CDSC is set forth in
the Statement of Additional Information. The terms of the CDSC may be modified
in connection with certain fee-based programs. See "Shareholder
Services -- Fee-Based Programs."
Contingent Deferred Sales Charges -- Class C Shares. Class C shares that
are redeemed within one year after purchase may be subject to a 1.0% CDSC
charged as a percentage of the dollar amount subject thereto. The charge will be
assessed on an amount equal to the lesser of the proceeds of redemption or the
cost of the shares being redeemed. Accordingly, no Class C CDSC will be imposed
on increases in net asset value above the initial purchase price. In addition,
no Class C CDSC will be assessed on shares derived from reinvestment
34
<PAGE> 35
of dividends or capital gains distributions. The Class C CDSC may be waived in
connection with certain fee-based programs. See "Shareholder
Services -- Fee-Based Programs."
In determining whether a Class C CDSC is applicable to a redemption, the
calculation will be determined in the manner that results in the lowest possible
rate being charged. Therefore, it will be assumed that the redemption is first
of shares held for over one year or shares acquired pursuant to reinvestment of
dividends or distributions and then of shares held longest during the one-year
period. The charge will not be applied to dollar amounts representing an
increase in the net asset value since the time of purchase. A transfer of shares
from a shareholder's account to another account will be assumed to be made in
the same order as a redemption.
Conversion of Class B Shares to Class D Shares. After approximately eight
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 0.25% of net assets but are not subject to the
distribution fee that is borne by Class B shares. Automatic conversion of Class
B shares into Class D shares will occur at least once each month (on the
"Conversion Date") on the basis of the relative net asset values of the shares
of the two classes on the Conversion Date, without the imposition of any sales
load, fee or other charge. Conversion of Class B shares to Class D shares will
not be deemed a purchase or sale of the shares for Federal income tax purposes.
In addition, shares purchased through reinvestment of dividends on Class B
shares also will convert automatically to Class D shares. The Conversion Date
for dividend reinvestment shares will be calculated taking into account the
length of time the shares underlying such dividend reinvestment shares were
outstanding. If at a Conversion Date the conversion of Class B shares to Class D
shares of the Fund in a single account will result in less than $50 worth of
Class B shares being left in the account, all of the Class B shares of the Fund
held in the account on the Conversion Date will be converted to Class D shares
of the Fund.
Share certificates for Class B shares of the Fund to be converted must be
delivered to the Transfer Agent at least one week prior to the Conversion Date
applicable to those shares. In the event such certificates are not received by
the Transfer Agent at least one week prior to the Conversion Date, the related
Class B shares will convert to Class D shares on the next scheduled Conversion
Date after such certificates are delivered.
In general, Class B shares of equity MLAM-advised mutual funds will convert
approximately eight years after initial purchase, and Class B shares of taxable
and tax-exempt fixed income MLAM-advised mutual funds will convert approximately
ten years after initial purchase. If, during the Conversion Period, a
shareholder exchanges Class B shares with an eight-year Conversion Period for
Class B shares with a ten-year Conversion Period, or vice versa, the Conversion
Period applicable to the Class B shares acquired in the exchange will apply, and
the holding period for the shares exchanged will be tacked onto the holding
period for the shares acquired.
The Conversion Period is modified for shareholders who purchased Class B
shares through certain retirement plans that qualified for a waiver of the CDSC
normally imposed on purchases of Class B shares ("Class B Retirement Plans").
When the first share of any MLAM-advised mutual fund purchased by a Class B
Retirement Plan has been held for ten years (i.e., ten years from the date the
relationship between MLAM-advised mutual funds and the Class B Retirement Plan
was established), all Class B shares of all MLAM-advised mutual funds held in
that Class B Retirement Plan will be converted into Class D shares of the
appropriate funds. Subsequent to such conversion, that Class B Retirement Plan
will be sold Class D shares of the appropriate funds at net asset value per
share.
35
<PAGE> 36
The Conversion Period also may be modified for retirement plan investors
who participate in certain fee-based programs. See "Shareholder
Services -- Fee-Based Programs."
DISTRIBUTION PLANS
The Fund has adopted separate distribution plans for Class B, Class C and
Class D shares pursuant to Rule 12b-1 under the 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 Class
B and Class C Distribution Plans provide for the payment of account maintenance
fees and distribution fees, and the Class D Distribution Plan provides for the
payment of account maintenance fees.
The Distribution Plans for Class B, Class C and Class D shares each provide
that the Fund pays the Distributor an account maintenance fee relating to the
shares of the relevant class, accrued daily and paid monthly, at the annual rate
of 0.25% of the average daily net assets of the Fund attributable to shares of
the relevant class in order to compensate the Distributor and Merrill Lynch
(pursuant to a sub-agreement) in connection with account maintenance activities.
The Distribution Plans for Class B and Class C shares each provide that the
Fund also pays the Distributor a distribution fee relating to the shares of the
relevant class, accrued daily and paid monthly, at the annual rate of 0.75% of
the average daily net assets of the Fund attributable to the shares of the
relevant class in order to compensate the Distributor and Merrill Lynch
(pursuant to a sub-agreement) for providing shareholder and distribution
services, and bearing certain distribution-related expenses of the Fund,
including payments to financial consultants for selling Class B and Class C
shares of the Fund. The Distribution Plans relating to Class B and Class C
shares are designed to permit an investor to purchase Class B and Class C shares
through dealers without the assessment of an initial sales charge and at the
same time permit the dealer to compensate its financial consultants in
connection with the sale of the Class B and Class C shares. In this regard, the
purpose and function of the ongoing distribution fees and the CDSC are the same
as those of the initial sales charge with respect to the Class A and Class D
shares of the Fund in that the deferred sales charges provide for the financing
of the distribution of the Fund's Class B and Class C shares.
The payments under the Distribution Plans are based on a percentage of
average daily net assets attributable to the shares regardless of the amount of
expenses incurred and, accordingly, distribution-related revenues from the
Distribution Plans may be more or less than distribution-related expenses.
Information with respect to the distribution-related revenues and expenses is
presented to the Directors for their consideration in connection with their
deliberations as to the continuance of the Class B and Class C Distribution
Plans. This information is presented annually as of December 31 of each year on
a "fully allocated accrual" basis and quarterly on a "direct expense and
revenue/cash" basis. On the fully allocated accrual basis, revenues consist of
the account maintenance fees, distribution fees, the CDSCs and certain other
related revenues, and expenses consist of financial consultant compensation,
branch office and regional operation center selling and transaction processing
expenses, advertising, sales promotion and marketing expenses, corporate
overhead and interest expense. On the direct expense and revenue/cash basis,
revenues consist of the account maintenance fees, distribution fees and CDSCs
and the expenses consist of financial consultant compensation.
The Fund has no obligation with respect to distribution and/or account
maintenance-related expenses incurred by the Distributor and Merrill Lynch in
connection with the Class B, Class C and Class D shares, and there is no
assurance that the Directors of the Fund will approve the continuance of the
Distribution Plans from year to year. However, the Distributor intends to seek
annual continuation of the Distribution Plans. In
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their review of the Distribution Plans, the Directors will be asked to take into
consideration expenses incurred in connection with the account maintenance
and/or distribution of each class of shares separately. The initial sales
charges, the account maintenance fee, the distribution fee and/or the CDSCs
received with respect to one class will not be used to subsidize the sale of
shares of another class. Payments of the distribution fee on Class B shares will
terminate upon conversion of those Class B shares into Class D shares as set
forth under "Deferred Sales Charge Alternatives -- Class B and Class C
Shares -- Conversion of Class B Shares to Class D Shares."
LIMITATIONS ON THE PAYMENT OF DEFERRED SALES CHARGES
The maximum sales charge rule in the Conduct Rules of the NASD imposes a
limitation on certain asset-based sales charges such as the distribution fee and
the CDSC borne by the Class B and Class C shares but not the account maintenance
fee. The maximum sales charge rule is applied separately to each class. As
applicable to the Fund, the maximum sales charge rule limits the aggregate of
distribution fee payments and CDSCs payable by the Fund to (1) 6.25% of eligible
gross sales of Class B shares and Class C shares, computed separately (defined
to exclude shares issued pursuant to dividend reinvestments and exchanges) plus
(2) interest on the unpaid balance for the respective class, computed
separately, at the prime rate plus 1% (the unpaid balance being the maximum
amount payable minus amounts received from the payment of the distribution fee
and the CDSC). In connection with the Class B shares, the Distributor has
voluntarily agreed to waive interest charges on the unpaid balance in excess of
0.50% of eligible gross sales. Consequently, the maximum amount payable to the
Distributor (referred to as the "voluntary maximum") in connection with the
Class B shares is 6.75% of eligible gross sales. The Distributor retains the
right to stop waiving the interest charges at any time. To the extent payments
would exceed the voluntary maximum, the Fund will not make further payments of
the distribution fee with respect to Class B shares, and any CDSCs will be paid
to the Fund rather than to the Distributor; however, the Fund will continue to
make payments of the account maintenance fee. In certain circumstances the
amount payable pursuant to the voluntary maximum may exceed the amount payable
under the NASD formula. In such circumstances payments in excess of the amount
payable under the NASD formula will not be made.
REDEMPTION OF SHARES
The Fund is required to redeem for cash all shares of the Fund on 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 on redemption all dividends
declared through the date of redemption. The value of shares at the time of
redemption may be more or less than the shareholder's cost, depending on the
market value of the securities held by the Fund at such time.
REDEMPTION
A shareholder wishing to redeem shares may do so by tendering the shares
directly to the Fund's Transfer Agent, Merrill Lynch Financial Data Services,
Inc., P.O. Box 45289, Jacksonville, Florida 32232-5289. Redemption requests
delivered other than by mail should be delivered to Merrill Lynch Financial Data
Services, Inc., 4800 Deer Lake Drive East, Jacksonville, Florida 32246-6484.
Proper notice of redemption in the case of shares deposited with the Transfer
Agent may be accomplished by a written letter requesting
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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 or on the certificate, as the case may be. The signature(s) on the
redemption request must be guaranteed by an "eligible guarantor institution"
(including, for example, Merrill Lynch branches and certain other financial
institutions) as such term is defined in Rule 17Ad-15 under the Securities
Exchange Act of 1934, as amended, the existence and validity of which may be
verified by the Transfer Agent through the use of industry publications.
Notarized signatures are not sufficient. In certain instances, the Transfer
Agent may require additional documents such as, but not limited to, trust
instruments, death certificates, appointments as executor or administrator, or
certificates of corporate authority. For shareholders redeeming directly with
the Transfer Agent, payments will be mailed within seven days of receipt of a
proper notice of redemption.
At various times, the Fund may be requested to redeem shares for which it
has not yet received good payment. 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, or certified check drawn on a United States bank) has been
collected for the purchase of such shares. Normally, this delay will not exceed
10 days.
REPURCHASE
The Fund also will repurchase shares through a shareholder's listed
securities dealer. The Fund will normally accept orders to repurchase shares by
wire or telephone from dealers for their customers at the net asset value next
computed after receipt of the order by the dealer, provided that the request for
repurchase is received by the dealer prior to the regular close of business on
the NYSE (generally, 4:00 p.m., New York time) on the day received and is
received by the 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.
These repurchase arrangements are for the convenience of shareholders and
do not involve a charge by the Fund (other than any applicable CDSC in the case
of Class B or Class C shares). However, securities firms which do not have
selected dealer agreements with the Distributor may impose a 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. Repurchases made directly through the Fund's 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 affect adversely
shareholders seeking redemption through the repurchase procedure. However, a
shareholder whose order for repurchase is rejected by the Fund may redeem shares
as set forth above.
Redemption payments will be made within seven days of the proper tender of
the certificates, if any, and stock power or letter requesting redemption, in
each instance with signatures guaranteed as noted above.
REINSTATEMENT PRIVILEGE -- CLASS A AND CLASS D SHARES
Shareholders who have redeemed their Class A or Class D shares have a
privilege to reinstate their accounts by purchasing Class A or Class D shares,
as the case may be, of the Fund at net asset value without a sales charge up to
the dollar amount redeemed. The reinstatement privilege may be exercised by
sending a
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notice of exercise along with a check for the amount to be reinstated to the
Transfer Agent within 30 days after the date the request for redemption was
accepted by the Transfer Agent or the Distributor. Alternatively, the
reinstatement privilege may be exercised through the investor's Merrill Lynch
Financial Consultant within 30 days after the date the request was accepted by
the Transfer Agent or the Distributor. The reinstatement will be made at the net
asset value per share next determined after the notice of reinstatement is
received and cannot exceed the amount of the redemption proceeds.
SHAREHOLDER SERVICES
The Fund offers a number of shareholder services and investment plans
described below, which are designed to facilitate investment in shares of the
Fund. Certain of such services are not available to investors who place orders
for the Fund through the Merrill Lynch Blueprint(SM) Program. Full details as to
each of such services, copies of the various plans described below and
instructions as to how to participate in the various plans and services, or 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.
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 quarterly statements will serve as transaction
confirmations for automatic investment purchases and the reinvestment of
ordinary income dividends and long-term capital gain distributions. These
statements will also show any other activity in the account since the preceding
statement. Shareholders will receive separate transaction confirmations for each
purchase or sale transaction other than automatic investment purchases and the
reinvestment of ordinary income dividends and long-term capital gains
distributions. Shareholders may make additions to their Investment Accounts at
any time by mailing a check directly to the Transfer Agent. Shareholders may
also maintain their accounts through Merrill Lynch. Upon the transfer of shares
out of a Merrill Lynch brokerage account, an Investment Account in the
transferring shareholder's name may be opened automatically at the Transfer
Agent.
Shareholders considering transferring their Class A or Class D shares from
Merrill Lynch to another brokerage firm or financial institution should be aware
that, if the firm to which the Class A or Class D shares are to be transferred
will not take delivery of shares of the Fund, a shareholder either must redeem
the Class A or Class D shares (paying any applicable CDSC) so that the cash
proceeds can be transferred to the account at the new firm or such shareholder
must continue to maintain an Investment Account at the Transfer Agent for those
Class A or Class D shares. Shareholders interested in transferring their Class B
or Class C shares from Merrill Lynch and who do not wish to have an Investment
Account maintained for such shares at the Transfer Agent may request their new
brokerage firm to maintain such shares in an account registered in the name of
the brokerage firm for the benefit of the shareholder at the Transfer Agent. If
the new brokerage firm is willing to accommodate the shareholder in this manner,
the shareholder must request that he or she be issued certificates for such
shares and then must turn the certificates over to the new firm for
re-registration as described in the preceding sentence. Shareholders considering
transferring a tax-deferred retirement account such as an IRA from Merrill Lynch
to another brokerage firm or financial institution should be aware that, if the
firm to which the retirement account is to be transferred will not take delivery
of shares of the Fund, a shareholder either must redeem the shares (paying any
applicable CDSC) so that the cash proceeds can be
39
<PAGE> 40
transferred to the account at the new firm, or such shareholder must continue to
maintain a retirement account at Merrill Lynch for those shares.
AUTOMATIC REINVESTMENT OF DIVIDENDS AND CAPITAL GAINS DISTRIBUTIONS
All dividends and capital gains distributions are reinvested automatically
in full and fractional shares of the Fund, without a sales charge, at the net
asset value per share next determined after the close of business on the NYSE on
the ex-dividend date of such dividend or distribution. A shareholder may at any
time, by written notification to Merrill Lynch if the shareholder's account is
maintained with Merrill Lynch or by written notification or by telephone
(1-800-MER-FUND) to the Transfer Agent if the shareholder's account is
maintained with the Transfer Agent, elect to have subsequent dividends or
capital gains distributions, or both, paid in cash, rather than reinvested, in
which event payment will be mailed on or about the payment date. Cash payments
also can be directly deposited to the shareholder's bank account. No CDSC will
be imposed upon redemption of shares issued as a result of the automatic
reinvestment of dividends or capital gains distributions.
SYSTEMATIC WITHDRAWAL PLANS
A Class A or Class D shareholder may elect to receive systematic withdrawal
payments from his or her Investment Account in the form of payments by check or
through automatic payment by direct deposit to his or her bank account on either
a monthly or quarterly basis. Alternatively, a Class A or Class D shareholder
whose shares are held within a CMA(R), CBA(R) or Retirement Account may elect to
have shares redeemed on a monthly, bimonthly, quarterly, semiannual or annual
basis through the Systematic Redemption Program, subject to certain conditions.
AUTOMATIC INVESTMENT PLANS
Regular additions of Class A, Class B, Class C and Class D shares may be
made to an investor's Investment Account by pre-arranged charges of $50 or more
to his or her regular bank account. Investors who maintain CMA(R) or CBA(R)
accounts may arrange to have periodic investments made in the Fund in their
CMA(R) or CBA(R) accounts or in certain related accounts in amounts of $100 or
more through the CMA(R) or CBA(R) Automated Investment Program.
EXCHANGE PRIVILEGE
U.S. shareholders of each class of shares of the Fund each have an exchange
privilege with certain other MLAM-advised mutual funds. There is currently no
limitation on the number of times a shareholder may exercise the exchange
privilege. The exchange privilege may be modified or terminated in accordance
with the rules of the Commission.
Under the Merrill Lynch Select Pricing(SM) System, Class A shareholders may
exchange Class A shares of the Fund for Class A shares of a second MLAM-advised
mutual fund if the shareholder holds any Class A shares of the second fund in
the account in which the exchange is made at the time of the exchange or is
otherwise eligible to purchase Class A shares of the second fund. If the Class A
shareholder wants to exchange Class A shares for shares of a second MLAM-advised
mutual fund, and the shareholder does not hold Class A shares of the second fund
in his or her account at the time of the exchange and is not otherwise eligible
to acquire Class A shares of the second fund, the shareholder will receive Class
D shares of the second fund as a result of the exchange. Class D shares also may
be exchanged for Class A shares of a second MLAM-advised
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<PAGE> 41
mutual fund at any time as long as, at the time of the exchange, the shareholder
holds Class A shares of the second fund in the account in which the exchange is
made or is otherwise eligible to purchase Class A shares of the second fund.
Exchanges of Class A and Class D shares are made on the basis of the
relative net asset values per Class A or Class D share, respectively, plus an
amount equal to the difference, if any, between the sales charge previously paid
on the Class A or Class D shares being exchanged and the sales charge payable at
the time of the exchange on the shares being acquired.
Class B, Class C and Class D shares are exchangeable with shares of the
same class of other MLAM-advised mutual funds.
Shares of the Fund that are subject to a CDSC are exchangeable on the basis
of relative net asset value per share without the payment of any CDSC that might
otherwise be due upon redemption of the shares of the Fund. For purposes of
computing the CDSC that may be payable upon a disposition of the shares acquired
in the exchange, the holding period for the previously owned shares of the Fund
is "tacked" to the holding period for the newly acquired shares of the other
fund.
Class A, Class B, Class C and Class D shares also are exchangeable for
shares of certain MLAM-advised money market funds specifically designated as
available for exchange by holders of Class A, Class B, Class C or Class D
shares. The period of time that Class A, Class B, Class C or Class D shares are
held in a money market fund, however, will not count toward satisfaction of the
holding period requirement for reduction of any CDSC imposed on such shares, if
any, and, with respect to Class B shares, toward satisfaction of the Conversion
Period.
Class B shareholders of the Fund exercising the exchange privilege will
continue to be subject to the Fund's CDSC schedule if such schedule is higher
than the CDSC schedule relating to the new Class B shares. In addition, Class B
shares of the Fund acquired through use of the exchange privilege will be
subject to the Fund's CDSC schedule if such schedule is higher than the CDSC
schedule relating to the Class B shares of the MLAM-advised mutual fund from
which the exchange has been made.
Exercise of the exchange privilege is treated as a sale of the exchanged
shares and a purchase of the acquired shares for Federal income tax purposes.
For further information, see "Shareholder Services -- Exchange Privilege" in the
Statement of Additional Information.
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 that 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
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<PAGE> 42
may involve the imposition of initial or deferred sales charges and distribution
and account maintenance fees) in order for the investment not to be subject to
Program fees. Additional information regarding a specific Program (including
charges and limitations on transferability applicable to shares that may be held
in such Program) is available in such Program's client agreement and from
Merrill Lynch Investor Services at (800) MER-FUND or (800) 637-3863.
TAXES
The Fund intends to continue to qualify 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 on the part of its net ordinary income and net realized capital gains
which it distributes to Class A, Class B, Class C and Class D shareholders
(together, the "shareholders"). The Fund intends to distribute substantially all
of such income.
Dividends paid by the Fund from its ordinary income or from an excess of
net short-term capital gains over net long-term capital losses (together
referred to hereafter as "ordinary income dividends") are taxable to
shareholders as ordinary income. Distributions made from an excess of net
long-term capital gains over net short-term capital losses (including gains or
losses from certain transactions in warrants, futures and options) ("capital
gain dividends") are taxable to shareholders as long-term capital gains,
regardless of the length of time the shareholder has owned Fund shares. Any loss
upon the sale or exchange of Fund shares held for six months or less, however,
will be treated as long-term capital loss to the extent of any capital gain
dividends received by the shareholder. Distributions in excess of the Fund's
earnings and profits will first reduce the adjusted tax basis of a holder's
shares and, after such adjusted tax basis is reduced to zero, will constitute
capital gains to such holder (assuming the shares are held as a capital asset).
Dividends are taxable to shareholders even though they are reinvested in
additional shares of the Fund. Not later than 60 days after the close of its
taxable year, the Fund will provide its shareholders with a written notice
designating the amounts of any ordinary income dividends or capital gain
dividends. A portion of the Fund's ordinary income dividends may be eligible for
the dividends received deduction allowed to corporations under the Code if
certain requirements are met. 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.
Ordinary income dividends paid to shareholders who are nonresident aliens
or foreign entities will be subject to a 30% U.S. 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 advisers concerning the applicability of the U.S. withholding tax.
Dividends and interest received by the Fund may give rise to withholding
and other taxes imposed by foreign countries. Tax conventions between certain
countries and the United States may reduce or eliminate such taxes. Shareholders
may be able to claim U.S. foreign tax credits with respect to such taxes,
subject to certain conditions and limitations contained in the Code. For
example, certain retirement accounts cannot claim foreign tax credits on
investments in foreign securities held in the Fund. If more than 50% in value of
the Fund's total assets at the close of its taxable year consists of securities
of foreign corporations, the Fund will be eligible, and intends, to file an
election with the Internal Revenue Service pursuant to which
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<PAGE> 43
shareholders of the Fund will be required to include their proportionate shares
of such withholding taxes in their U.S. income tax returns as gross income,
treat such proportionate shares as taxes paid by them, and deduct such
proportionate shares in computing their taxable incomes or, alternatively, use
them as foreign tax credits against their U.S. income taxes. No deductions for
foreign taxes, however, may be claimed by noncorporate shareholders who do not
itemize deductions. A shareholder that is a nonresident alien individual or a
foreign corporation may be subject to U.S. withholding tax on the income
resulting from the Fund's election described in this paragraph but may not be
able to claim a credit or deduction against such U.S. tax for the foreign taxes
treated as having been paid by such shareholder. The Fund will report annually
to its shareholders the amount per share of such withholding taxes.
Under certain provisions of the Code, some shareholders may be subject to a
31% withholding tax on ordinary income dividends, 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 Fund or who, to the Fund's knowledge, have furnished
an incorrect number. When establishing an account, an investor must certify
under penalty of perjury that such number is correct and that such investor is
not otherwise subject to backup withholding.
The Fund may invest up to 10% of its total assets in securities of other
investment companies. If the Fund purchases shares of an investment company (or
similar investment entity) organized under foreign law, the Fund will be treated
as owning shares in a passive foreign investment company ("PFIC") for U.S.
Federal income tax purposes. The Fund may be subject to U.S. Federal income tax,
and additional tax in the nature of interest (the "interest charge"), on a
portion of the distributions from such a company and on gain from the
disposition of the shares of such a company (collectively referred to as "excess
distributions"), even if such excess distributions are paid by the Fund as a
dividend to its shareholders. The Fund may be eligible to make an election with
respect to certain PFICs in which it owns shares that will allow it to avoid the
taxes on excess distributions. However, such election may cause the Fund to
recognize income in a particular year in excess of the distributions received
from such PFICs. Alternatively, under proposed regulations the Fund would be
able to elect to "mark to market" at the end of each taxable year all shares
that it holds in PFICs. If it made this election, the Fund would recognize as
ordinary income any increase in the value of such shares. Unrealized losses,
however, would not be recognized. By making the mark-to-market election, the
Fund could avoid imposition of the interest charge with respect to its
distributions from PFICs, but in any particular year might be required to
recognize income in excess of the distributions it received from PFICs and its
proceeds from dispositions of PFIC stock.
Under Code Section 988, foreign currency gains or losses from certain debt
instruments, from certain forward contracts, from futures contracts that are not
"regulated futures contracts" and from unlisted options will generally be
treated as ordinary income or loss. Such Code Section 988 gains or losses will
generally increase or decrease the amount of the Fund's investment company
taxable income available to be distributed to shareholders as ordinary income.
Additionally, if Code Section 988 losses exceed other investment company taxable
income during a taxable year, the Fund would not be able to make any ordinary
income dividend distributions, and all or a portion of distributions made before
the losses were realized but in the same taxable year would be recharacterized
as a return of capital to shareholders, thereby reducing the basis of each
shareholder's Fund shares and resulting in a capital gain for any shareholder
who received a distribution greater than such shareholder's tax basis in Fund
shares (assuming the shares were held as a capital asset).
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<PAGE> 44
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 on the exchanged shares reduces any sales charge the
shareholder would have owed upon the purchase of the new shares in the absence
of the exchange privilege. Instead, such sales charge will be treated as an
amount paid for the new shares.
A loss realized on a sale or exchange of shares of the Fund will be
disallowed if other Fund shares are acquired (whether through the automatic
reinvestment of dividends or otherwise) within a 61-day period beginning 30 days
before and ending 30 days after the date that the shares are disposed of. In
such a case, the basis of the shares acquired will be adjusted to reflect the
disallowed loss.
Upon conversion of the Fund to open-end status, Capital Shares were
designated Class A shares. Holders of Class A shares should be aware that they
will receive their proportionate share of both the Fund's taxable ordinary
income and capital gains. The highest marginal tax rate currently applicable to
ordinary income is 39.6% while the highest marginal tax rate currently
applicable to capital gains is 28%.
The foregoing is a general and abbreviated summary of the applicable
provisions of the Code and Treasury regulations presently in effect. For the
complete provisions, reference should be made to the pertinent Code sections and
the Treasury regulations promulgated thereunder. The Code and the Treasury
regulations are subject to change by legislative, judicial or administrative
action either prospectively or retroactively.
Ordinary income and capital gain dividends may also be subject to state and
local taxes.
Certain states exempt from state income taxation dividends paid by RICs
that are derived from interest on U.S. Government obligations. State law varies
as to whether dividend income attributable to U.S. Government obligations is
exempt from state income tax.
Shareholders are urged to consult their tax advisers regarding specific
questions as to Federal, foreign, state or local taxes. Foreign investors should
consider applicable foreign taxes in their evaluation of an investment in the
Fund.
PERFORMANCE DATA
From time to time the Fund may include its average annual total return and
yield for various specified time periods in advertisements or information
furnished to present or prospective shareholders. Average annual total return is
computed separately for Class A, Class B, Class C and Class D shares in
accordance with formulas specified by the Commission.
Average annual total return quotations for the specified periods will be
computed by finding the average annual compounded rates of return (based on net
investment income and any realized and unrealized capital gains or losses on
portfolio investments over such periods) that would equate the initial amount
invested to the redeemable value of such investment at the end of each period.
Average annual total return will be computed assuming all dividends and
distributions are reinvested and taking into account all applicable recurring
and nonrecurring expenses, including any CDSC that would be applicable to a
complete redemption of the
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investment at the end of the specified period in the case of Class B and Class C
shares and the maximum front-end sales charge in the case of Class A and Class D
shares. Dividends paid by the Fund with respect to all shares, to the extent any
dividends are paid, will be calculated in the same manner at the same time on
the same day and will be in the same amount, except that account maintenance and
distribution charges and any incremental transfer agency costs relating to each
class of shares will be borne exclusively by that class. The Fund will include
performance data for all classes of shares of the Fund in any advertisement or
information including performance data of the Fund.
The Fund also may quote annual total return and aggregate total return
performance data for various specified time periods. Such data will be
calculated substantially as described above, except that (1) the rates of return
calculated will not be average annual rates, but rather, actual annual,
annualized or aggregate rates of return and (2) the maximum applicable sales
charges will not be included with respect to actual annual or annualized rates
of return calculations. Aside from the impact on the performance data
calculations of including or excluding the maximum applicable sales charges,
actual annual or annualized total return data generally will be lower than
average annual total return data since the average annual rates of return
reflect compounding; aggregate total return data generally will be higher than
average annual total return data since the aggregate rates of return reflect
compounding over a longer period of time. In advertisements distributed to
investors whose purchases are subject to waiver of the CDSC in the case of Class
B and Class C shares (such as investors in certain retirement plans) or to
reduced sales loads in the case of Class A and Class D shares, the performance
data may take into account the reduced, and not the maximum, sales charge or may
not take into account the CDSC and therefore may reflect greater total return
since, due to the reduced sales charges or waiver of the CDSC, a lower amount of
expenses is deducted. See "Purchase of Shares." The Fund's total return may be
expressed either as a percentage or as a dollar amount in order to illustrate
such total return on a hypothetical $1,000 investment in the Fund at the
beginning of each specified period.
Total return figures are based on the Fund's historical performance and are
not intended to indicate future performance. The Fund's total return will vary
depending on market conditions, the securities comprising the Fund's portfolio,
the Fund's operating expenses and the amount of realized and unrealized net
capital gains or losses during the period. The value of an investment in the
Fund will fluctuate and an investor's shares, when redeemed, may be worth more
or less than their original cost.
On occasion, the Fund may compare its performance to that of the Standard &
Poor's 500 Index, The Financial Times/Standard & Poor's Actuarial World Indices,
the Morgan Stanley Capital International Indices, the Dow Jones Industrial
Average or performance data published by Lipper Analytical Services, Inc. and
Morningstar Publications, Inc., Money Magazine, U.S. News & World Report,
Business Week, CDA Investment Technology, Inc., Forbes Magazine, Fortune
Magazine or other industry publications. From time to time, the Fund may include
the Fund's risk-adjusted performance ratings assigned by Morningstar
Publications, Inc. in advertisements or supplemental sales literature. As with
other performance data, performance comparisons should not be considered
representative of the Fund's relative performance for any future period.
ADDITIONAL INFORMATION
DIVIDENDS AND DISTRIBUTIONS
It is the Fund's intention to distribute substantially all of its net
investment income, if any. Dividends from such net investment income will be
paid at least annually. All net realized long- or short-term capital
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gains, if any, will be distributed as dividends to the Fund's shareholders at
least annually. 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 "Additional Information -- Determination of Net
Asset Value." Dividends will be reinvested automatically in shares of the Fund
at net asset value without a sales charge. However, a shareholder whose account
is maintained at the Transfer Agent or whose account is maintained through
Merrill Lynch may elect in writing to receive any such dividends or
distributions or both in cash. Dividends and distributions are taxable to
shareholders as discussed below whether they are reinvested in shares of the
Fund or received in cash. From time to time, the Fund may declare a special
distribution at or about the end of the calendar year in order to comply with
Federal tax requirements that certain percentages of its ordinary income and
capital gains be distributed during the calendar year.
Gains or losses attributable to certain foreign currency transactions may
increase or decrease the amount of the Fund's income available for distribution
to shareholders. If such losses exceed other ordinary income during a taxable
year, (a) the Fund would not be able to make any ordinary income dividend
distributions and (b) all or a portion of distributions made before the losses
were realized but in the same taxable year would be recharacterized as returns
of capital to shareholders, rather than as ordinary income dividends, thereby
reducing each shareholder's tax basis in his or her Fund shares for Federal
income tax purposes and resulting in a capital gain for any shareholder who
received a distribution greater than the shareholder's tax basis in Fund shares
(assuming that the shares were held as a capital asset). For a detailed
discussion of the Federal tax considerations relevant to foreign currency
transactions, see "Additional Information -- Taxes."
DETERMINATION OF NET ASSET VALUE
The net asset value of shares of all classes of the Fund is determined by
the Manager once daily, 15 minutes after the close of business on the NYSE
(generally, 4:00 p.m. New York time), on each day during which the NYSE is open
for trading or on such other day that there is sufficient trading in portfolio
securities that the net asset value of the Fund's shares may be materially
affected. Any assets or liabilities initially expressed in terms of non-U.S.
dollar currencies are translated into U.S. dollars at the prevailing market
rates as quoted by one or more banks or dealers on the day of valuation. The net
asset value per share is computed by dividing the sum of the value of the
securities held by the Fund plus any cash or other assets (including interest
and dividends accrued but not yet received) minus all liabilities (including
accrued expenses) by the total number of shares outstanding at such time,
rounded to the nearest cent. Expenses, including the investment advisory fees
payable to the Manager and any account maintenance and/or distribution fees
payable to the Distributor, are accrued daily.
The per share net asset value of Class A shares generally will be higher
than the per share net asset value of shares of other classes, reflecting the
daily expense accruals of the account maintenance, distribution and higher
transfer agency fees applicable with respect to the Class B and Class C shares
and the daily expense accruals of the account maintenance fees applicable with
respect to Class D shares; moreover, the per share net asset value of Class D
shares generally will be higher than the per share net asset value of Class B
and Class C shares, reflecting the daily expense accruals of the distribution
and higher transfer agency fees applicable with respect to Class B and Class C
shares. It is expected, however, that the per share net asset value of the four
classes will tend to converge (although not necessarily meet) immediately after
the payment of dividends or distributions, which will differ by approximately
the amount of the expense accrual differentials between the classes.
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Portfolio securities that are traded on stock exchanges are valued at the
last sale price (regular way) on the exchange on which such securities are
traded, as of the close of business on the day the securities are being valued
or, lacking any sales, at the last available bid price. In cases where
securities are traded on more than one exchange, the securities are valued on
the exchange designated by or under the authority of the Board of Directors as
the primary market. Securities traded in the OTC market are valued at the last
available bid price in the OTC market prior to the time of valuation. Securities
that are traded both in the OTC market and on a stock exchange are valued
according to the broadest and most representative market. When the Fund writes
an option, the amount of the premium received is recorded on the books of the
Fund as an asset and an equivalent liability. The amount of the liability is
subsequently valued to reflect the current market value of the option written,
based upon the last sale price in the case of exchange-traded options or, in the
case of options traded in the OTC market, the last asked price. Options
purchased by the Fund are valued at their last sale price in the case of
exchange-traded options or, in the case of options traded in the OTC market, the
last bid price. Any assets or liabilities expressed in terms of foreign
currencies are translated into U.S. dollars at the prevailing market rates as
obtained from one or more dealers. Other investments, including futures
contracts and related options, are valued at market value. Securities and assets
for which market quotations are not readily available are valued at fair value
as determined in good faith by or under the direction of the Board of Directors
of the Fund. Such valuations and procedures will be reviewed periodically by the
Board of Directors.
ORGANIZATION OF THE FUND
The Fund was incorporated under Maryland law on May 24, 1985 as a
closed-end investment company. On February 13, 1997, the shareholders of the
Fund voted to convert the Fund to an open-end investment company. Amended and
Restated Articles of Incorporation, effective as of August 4, 1997, (i) convert
the Fund to an open-end investment company, (ii) rename the Fund "Merrill Lynch
Convertible Fund, Inc." and (iii) increase the authorized capital stock from
30,000,000 shares, par value $.10 per share, to 400,000,000 shares of Common
Stock, par value $.10 per share. The shares of Common Stock are divided into
four classes designated Class A, Class B, Class C and Class D Common Stock, each
consisting of 100,000,000 shares. Shares of Class A, Class B, Class C and Class
D Common Stock represent an interest in the same assets of the Fund and are
identical in all respects except that Class B, Class C and Class D shares bear
certain expenses related to the account maintenance associated with such shares,
and Class B and Class C shares bear certain expenses related to distribution of
such shares. Each class has exclusive voting rights with respect to matters
relating to account maintenance and distribution expenditures, as applicable.
See "Purchase of Shares." The Directors of the Fund may classify and reclassify
the unissued shares of the Fund into additional classes of Common Stock at a
future date.
Shareholders are entitled to one vote for each share held and fractional
votes for fractional shares held and will vote on the election of Directors and
any other matter submitted to a shareholder vote. The Fund does not intend to
hold meetings of shareholders in any year in which the Investment Company Act
does not require shareholders to act upon any of the following matters: (i)
election of Directors; (ii) approval of an investment advisory agreement; (iii)
approval of a distribution agreement; and (iv) ratification of selection of
independent accountants. Also, the by-laws of the Fund require that a special
meeting of shareholders be held upon the written request of at least 25% of the
outstanding shares of the Fund entitled to vote at such meeting, if they comply
with applicable Maryland law. Voting rights for Directors are not cumulative.
Shares issued are fully paid and non-assessable and have no preemptive rights.
Shares have the conversion rights described in
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this Prospectus. Each share of Common Stock is entitled to participate equally
in dividends and distributions declared by the Fund and in the net assets of the
Fund upon liquidation or dissolution after satisfaction of outstanding
liabilities except, as noted above, the Class B, Class C and Class D shares bear
certain additional expenses.
SHAREHOLDER REPORTS
Only one copy of each shareholder report and certain shareholder
communications will be mailed to each identified shareholder regardless of the
number of accounts such shareholder has. If a shareholder wishes to receive
separate copies of each report and communication for each of the shareholder's
related accounts the shareholder should notify in writing:
Merrill Lynch Financial Data Services, Inc.
P.O. Box 45289
Jacksonville, Florida 32232-5289
The written notification should include the shareholder's name, address,
tax identification number and Merrill Lynch and/or mutual fund account numbers.
If you have any questions regarding this, please call your Merrill Lynch
Financial Consultant or Merrill Lynch Financial Data Services, Inc. at
800-637-3863.
SHAREHOLDER INQUIRIES
Shareholder inquiries may be addressed to the Fund at the address or
telephone number set forth on the cover page of this Prospectus.
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APPENDIX A
INVESTMENT PRACTICES INVOLVING THE USE OF OPTIONS, FUTURES AND FOREIGN EXCHANGE
The Fund is authorized to engage in certain investment practices involving
the use of options, futures and foreign exchange, as described below. Such
instruments, which may be regarded as derivatives, are referred to collectively
herein as "Strategic Instruments."
OPTIONS ON SECURITIES AND SECURITIES INDICES
Purchasing Options. The Fund is authorized to purchase put options on
securities held in its portfolio or securities indices the performance of which
is substantially correlated with securities held in its portfolio. When the Fund
purchases a put option, in consideration for an upfront payment (the "option
premium"), the Fund acquires a right to sell to another party specified
securities owned by the Fund at a specified price (the "exercise price") on or
before a specified date (the "expiration date"), in the case of an option on
securities, or to receive from another party a payment based on the amount a
specified securities index declines below a specified level on or before the
expiration date, in the case of an option on a securities index. The purchase of
a put option limits the Fund's risk of loss in the event of a decline in the
market value of the portfolio holdings underlying the put option prior to the
option's expiration date. In the event the market value of the portfolio
holdings underlying the put option increases rather than decreases, however, the
Fund will lose the option premium and will consequently realize a lower return
on the portfolio holdings than would have been realized without the purchase of
the put.
The Fund is also authorized to purchase call options on securities it
intends to purchase or securities indices the performance of which substantially
correlates with the performance of the types of securities it intends to
purchase. When the Fund purchases a call option, in consideration for the option
premium, the Fund acquires a right to purchase from another party specified
securities at the exercise price on or before the expiration date, in the case
of an option on securities, or to receive from another party a payment based on
the amount a specified securities index increases beyond a specified level on or
before the expiration date, in the case of an option on a securities index. The
purchase of a call option may protect the Fund from having to pay more for a
security as a consequence of increases in the market value for the security
during a period when the Fund is contemplating its purchase, in the case of an
option on a security, or attempting to identify specific securities in which to
invest in a market the Fund believes to be attractive, in the case of an option
on an index (an "anticipatory hedge"). In the event the Fund determines not to
purchase a security underlying a call option, however, the Fund may lose the
entire option premium.
The Fund may also purchase call options in connection with the creation of
Manufactured Convertibles and is also authorized to purchase put or call options
in connection with closing out put or call options it has previously sold.
Writing Options. The Fund is authorized to write (i.e., sell) call options
on securities held in its portfolio or securities indices the performance of
which is substantially correlated with securities held in its portfolio. When
the Fund writes a call option, in return for an option premium, the Fund gives
another party the right to buy specified securities owned by the Fund at the
exercise price on or before the expiration date, in the case of an option on
securities, or agrees to pay to another party an amount based on any gain in a
specified securities index beyond a specified level on or before the expiration
date, in the case of an option on a securities index.
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The Fund may write call options to earn income, through the receipt of option
premiums. In the event the party to which the Fund has written an option fails
to exercise its rights under the option because the value of the underlying
securities is less than the exercise price, the Fund will partially offset any
decline in the value of the underlying securities through the receipt of the
option premium and will realize a greater return than would have been realized
on the underlying securities alone. By writing a call option, however, the Fund
limits its ability to sell the underlying securities, and gives up the
opportunity to profit from any increase in the value of the underlying
securities beyond the exercise price, while the option remains outstanding.
The Fund may also write put options on securities or securities indices.
When the Fund writes a put option, in return for an option premium, the Fund
gives another party the right to sell to the Fund a specified security at the
exercise price on or before the expiration date, in the case of an option on a
security, or agrees to pay to another party an amount on any decline in a
specified securities index below a specified level on or before the expiration
date, in the case of an option on a securities index. The Fund may write put
options to earn income, through the receipt of option premiums. In the event the
party to which the Fund has written an option fails to exercise its right under
the option because the value of the underlying securities is greater than the
exercise price, the Fund will profit by the amount of the option premium. By
writing a put option, however, the Fund will be obligated to purchase the
underlying security at a price that may be higher than the market value of the
security at the time of exercise as long as the put option is outstanding.
Accordingly, when the Fund writes a put option it is exposed to a risk of loss
in the event the value of the underlying securities falls below the exercise
price, which loss potentially may substantially exceed the amount of option
premium received by the Fund for writing the put option. The Fund will write a
put option on a security or a securities index only if the Fund is using the put
as an anticipatory hedge or is writing the put in connection with trading
strategies involving combinations of options, for example, the sale and purchase
of options with identical expiration dates on the same security or index but
different exercise prices (a technique called a "spread").
The Fund is also authorized to sell call or put options in connection with
closing out call or put options it has previously purchased.
Other than with respect to closing transactions, the Fund will only write
call or put options that are "covered." A call or put option will be considered
covered if the Fund has segregated assets with respect to such option in the
manner described in "Risk Factors in Options, Futures and Currency Instruments"
below. A call option will also be considered covered if the Fund owns the
securities it would be required to deliver upon exercise of the option (or, in
the case of an option on a securities index, securities which substantially
replicate the performance of such index) or owns a call option, warrant or
convertible instrument which is immediately exercisable for, or convertible
into, such security.
Types of Options. The Fund may engage in transactions in options on
securities or securities indices on exchanges and in the over-the-counter
("OTC") markets. In general, exchange-traded options have standardized exercise
prices and expiration dates and require the parties to post margin against their
obligations, and the performance of the parties' obligations in connection with
such options is guaranteed by the exchange or a related clearing corporation.
OTC options have more flexible terms negotiated between the buyer and the
seller, but generally do not require the parties to post margin and are subject
to greater risk of counterparty default. See "Additional Risk Factors of OTC
Transactions; Limitations on the Use of OTC Strategic Investments" below.
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FUTURES
The Fund may engage in transactions in futures and options thereon. Futures
are standardized, exchange-traded contracts which obligate a purchaser to take
delivery, and a seller to make delivery, of a specific amount of a commodity at
a specified future date at a specified price. No price is paid upon entering
into a futures contract. Rather, upon purchasing or selling a futures contract
the Fund is required to deposit collateral ("margin") equal to a percentage
(generally less than 10%) of the contract value. Each day thereafter until the
futures position is closed, the Fund will pay additional margin representing any
loss experienced as a result of the futures position the prior day or be
entitled to a payment representing any profit experienced as a result of the
futures position the prior day.
The sale of a futures contract for hedging purposes limits the Fund's risk
of loss through a decline in the market value of portfolio holdings correlated
with the futures contract prior to the futures contract's expiration date. In
the event the market value of the portfolio holdings correlated with the futures
contract increases rather than decreases, however, the Fund will realize a loss
on the futures position and a lower return on the portfolio holdings than would
have been realized without the purchase of the futures contract.
The purchase of a futures contract as an anticipatory hedge may protect the
Fund from having to pay more for securities as a consequence of increases in the
market value for such securities during a period when the Fund was attempting to
identify specific securities in which to invest in a market the Fund believes to
be attractive. In the event that such securities decline in value or the Fund
determines not to complete an anticipatory hedge transaction in a futures
contract, however, the Fund may realize a loss relating to the futures position.
The Fund will limit transactions in futures and options on futures to the
extent necessary to prevent the Fund from being deemed a "commodity pool" under
regulations of the Commodity Futures Trading Commission.
FOREIGN EXCHANGE TRANSACTIONS
The Fund may engage in spot and forward foreign exchange transactions and
currency swaps, purchase and sell options on currencies and purchase and sell
currency futures and related options thereon (collectively, "Currency
Instruments") predominantly for purposes of hedging against the decline in the
value of currencies in which its portfolio holdings are denominated against the
United States dollar.
Forward foreign exchange transactions are OTC contracts to purchase or sell
a specified amount of a specified currency or multinational currency unit at a
price and future date set at the time of the contract. Spot foreign exchange
transactions are similar but require current, rather than future, settlement.
The Fund will enter into foreign exchange transactions predominantly for
purposes of hedging either a specific transaction or a portfolio position. The
Fund may enter into a foreign exchange transaction for purposes of hedging a
specific transaction by, for example, purchasing a currency needed to settle a
security transaction or selling a currency in which the Fund has received or
anticipates receiving a dividend or distribution. The Fund may enter into a
foreign exchange transaction for purposes of hedging a portfolio position by
selling forward a currency in which a portfolio position of the Fund is
denominated or by purchasing a currency in which the Fund anticipates acquiring
a portfolio position in the near future. The Fund may also hedge portfolio
positions through currency swaps, which are transactions in which one currency
is simultaneously bought for a second currency on a spot basis and sold for the
second currency on a forward basis.
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The Fund may also hedge against the decline in the value of a currency
against the United States dollar through use of currency futures or options
thereon. Currency futures are similar to forward foreign exchange transactions
except that futures are standardized, exchange-traded contracts. See "Futures"
above.
The Fund may also hedge against the decline in the value of a currency
against the United States dollar through the use of currency options. Currency
options are similar to options on securities, but in consideration for an option
premium the writer of a currency option is obligated to sell (in the case of a
call option) or purchase (in the case of a put option) a specified amount of a
specified currency on or before the expiration date for a specified amount of
another currency. The Fund may engage in transactions in options on currencies
either on exchanges or OTC markets. See "Types of Options" above and "Additional
Risk Factors of OTC Transactions; Limitations on the Use of OTC Strategic
Instruments" below.
Although it is expected that the Fund will engage in transactions in
Currency Instruments predominantly for hedging purposes, the Fund may also
speculate in Currency Instruments in order to seek to enhance its total return.
To the extent that the Fund enters into a transaction in a Currency Instrument
for hedging purposes, the Fund will not hedge a currency in excess of the
aggregate market value of the securities which it owns (including receivables
for unsettled securities sales), or has committed to or anticipates purchasing,
which are denominated in such currency. The Fund may, however, hedge a currency
by entering into a transaction in a Currency Instrument denominated in a
currency other than the currency being hedged (a "cross-hedge"). The Fund will
only enter into a cross-hedge if the Manager believes that (i) there is a
demonstrable high correlation between the currency in which the cross-hedge is
denominated and the currency being hedged and (ii) executing a cross-hedge
through the currency in which the cross-hedge is denominated will be
significantly more cost-effective or provide substantially greater liquidity
than executing a similar hedging transaction by means of the currency being
hedged. To the extent that the Fund enters into a transaction in a Currency
Instrument for speculative purposes, the Fund may lose its entire investment or,
under certain circumstances, may be exposed to potential losses which
substantially exceed its original investment.
Risk Factors in Hedging Foreign Currency Risks. While the Fund's use of
Currency Instruments to effect 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. Moreover, although Currency Instruments will
be used with the intention of hedging against adverse currency movements,
transactions in Currency Instruments involve the risk that anticipated currency
movements will not be accurately predicted and that the Fund's hedging
strategies will be ineffective. To the extent that the Fund hedges against
anticipated currency movements which do not occur, the Fund may realize losses,
and lower its total return, as the result of its hedging transactions.
Furthermore, the Fund will only engage in hedging activities from time to time
and may not be engaging in hedging activities when movements in currency
exchange rates occur. It may not be possible for the Fund to hedge against
currency exchange rate movements, even if correctly anticipated, in the event
that (i) the currency exchange rate movement is so generally anticipated that
the Fund is not able to enter into a hedging transaction at an effective price
or (ii) the currency exchange rate movement relates to a market with respect to
which Currency Instruments are not available (such as certain developing
markets) and it is not possible to engage in effective foreign currency hedging.
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RISK FACTORS IN OPTIONS, FUTURES AND CURRENCY INSTRUMENTS
Use of Strategic Instruments for hedging purposes involves the risk of
imperfect correlation in movements in the value of the Strategic Instruments and
the value of the instruments being hedged. If the value of the Strategic
Instruments moves more or less than the value of the hedged instruments the Fund
will experience a gain or loss which will not be completely offset by movements
in the value of the hedged instruments.
The Fund intends to enter transactions involving Strategic Instruments only
if there appears to be a liquid secondary market for such instruments or, in the
case of illiquid instruments traded in OTC transactions, such instruments
satisfy the criteria set forth below under "Additional Risk Factors of OTC
Transactions; Limitations on the Use of OTC Strategic Instruments." However,
there can be no assurance that, at any specific time, either a liquid secondary
market will exist for a Strategic Instrument or the Fund will otherwise be able
to sell such instrument at an acceptable price. It may therefore not be possible
to close a position in a Strategic Instrument without incurring substantial
losses, if at all.
Certain transactions in Strategic Instruments (e.g., forward foreign
exchange transactions, futures transactions, sales of put options) may expose
the Fund to potential losses which exceed the amount originally invested by the
Fund in such instruments. When the Fund engages in such a transaction, the Fund
will deposit in a segregated account at its custodian liquid securities with a
value at least equal to the Fund's exposure, on a mark-to-market basis, to the
transaction (as calculated pursuant to requirements of the Securities and
Exchange Commission). Such segregation will ensure that the Fund has assets
available to satisfy its obligations with respect to the transaction, but will
not limit the Fund's exposure to loss.
ADDITIONAL RISK FACTORS OF OTC TRANSACTIONS; LIMITATIONS ON THE USE OF OTC
STRATEGIC INSTRUMENTS
Certain Strategic Instruments traded in OTC markets, including OTC options,
may be substantially less liquid than other instruments in which the Fund may
invest. The absence of liquidity may make it difficult or impossible for the
Fund to sell such instruments promptly at an acceptable price. The absence of
liquidity may also make it more difficult for the Fund to ascertain a market
value for such instruments. The Fund will therefore acquire illiquid OTC
instruments (i) if the agreement pursuant to which the instrument is purchased
contains a formula price at which the instrument may be terminated or sold or
(ii) for which the Manager anticipates the Fund can receive on each business day
at least two independent bids or offers, unless a quotation from only one dealer
is available, in which case that dealer's quotation may be used.
The staff of the Securities and Exchange Commission has taken the position
that purchased OTC options and the assets underlying written OTC options are
illiquid securities. The Fund has therefore adopted an investment policy
pursuant to which it will not purchase or sell OTC options (including OTC
options on futures contracts) if, as a result of such transactions, the sum of
the market value of OTC options currently outstanding which are held by the
Fund, the market value of the securities underlying OTC call options currently
outstanding which have been sold by the Fund and margin deposits on the Fund's
outstanding OTC options exceeds 15% of the total assets of the Fund, taken at
market value, together with all other assets of the Fund which are deemed to be
illiquid or are otherwise not readily marketable. However, if an OTC option is
sold by the Fund to a dealer in U.S. government securities recognized as a
"primary dealer" by the Federal Reserve Bank of New York and the Fund has the
unconditional contractual right to repurchase such OTC option at a predetermined
price, then the Fund will treat as illiquid such amount of the underlying
securities as
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is equal to the repurchase price less the amount by which the option is
"in-the-money" (i.e., current market value of the underlying security minus the
option's exercise price).
Because Strategic Instruments traded in OTC markets are not guaranteed by
an exchange or clearing corporation and generally do not require payment of
margin, to the extent that the Fund has unrealized gains in such instruments or
has deposited collateral with its counterparty the Fund is at risk that its
counterparty will become bankrupt or otherwise fail to honor its obligations.
The Fund will attempt to minimize the risk that a counterparty will become
bankrupt or otherwise fail to honor its obligations by engaging in transactions
in Strategic Instruments traded in OTC markets only with financial institutions
which have substantial capital or which have provided the Fund with a
third-party guaranty or other credit enhancement.
ADDITIONAL LIMITATIONS ON THE USE OF STRATEGIC INSTRUMENTS
The Fund may not use any Strategic Instrument to gain exposure to an asset
or class of assets that it would be prohibited from purchasing directly by its
investment restrictions, except that the Fund may use Strategic Instruments to
gain investment exposure to natural resources-based commodities indices.
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APPENDIX B
RATINGS OF DEBT SECURITIES AND PREFERRED STOCK
DESCRIPTION OF MOODY'S INVESTORS SERVICE, INC. ("MOODY'S") CORPORATE 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 edge." Interest payments are protected by a large or by an
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be visualized
are most unlikely to impair the fundamentally strong position of such
issues.
Aa Bonds which are rated Aa are judged to be of high quality by all standards.
Together with the Aaa group they comprise what are generally known as high
grade bonds. They are rated lower than the best bonds because margins of
protection may not be as large as in Aaa securities or fluctuation of
protective elements may be of greater amplitude or there may be other
elements present which make the long-term risks appear somewhat larger than
in Aaa securities.
A Bonds which are rated A possess many favorable investment attributes and
are to be considered as upper medium grade obligations. Factors giving
security to principal and interest are considered adequate, but elements
may be present which suggest a susceptibility to impairment sometime in the
future.
Baa Bonds which are rated Baa are considered as medium grade obligations,
i.e., they are neither highly protected nor poorly secured. Interest
payments 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 therefore 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 desirable
investments. 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: Moody's may apply numerical modifiers 1, 2 and 3 in each generic
rating classification from AA through B in its corporate bond rating system. The
modifier 1 indicates that the security ranks in the higher
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end of its generic rating categories, the modifier 2 indicates a mid-range
ranking; and the modifier 3 indicates that the issue ranks in the lower end of
its generic rating category.
DESCRIPTION OF MOODY'S COMMERCIAL PAPER RATINGS
The term "commercial paper" as used by Moody's means promissory obligations
not having an original maturity in excess of nine months. Moody's makes no
representations as to whether such commercial paper is by any other definition
"commercial paper" or is exempt from registration under the Securities Act of
1933, as amended.
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 makes no representation that such obligations are
exempt from registration under the Securities Act of 1933, nor does it represent
that any specific note is a valid obligation of a rated issuer or issued in
conformity with any applicable law. Moody's employs the following three
designations, all judged to be investment grade, to indicate the relative
repayment capacity of rated issuers:
Issuers rated PRIME-1 (or related supporting institutions) have a superior
capacity for repayment of short-term promissory obligations. PRIME-1 repayment
capacity will normally be evidenced by the following characteristics:
-- Leading market positions in well established industries
-- High rates of return on funds employed
-- Conservative capitalization structures with moderate reliance on debt
and ample asset protection
-- Broad margins in earnings coverage of fixed financial charges and high
internal cash generation
-- Well established access to a range of financial markets and assured
sources of alternate liquidity.
Issuers rated PRIME-2 (or related supporting institutions) have a strong
capacity for repayment of short-term promissory obligations. This will normally
be evidenced by many of the characteristics cited above but to a lesser degree.
Earnings trends and coverage ratios, while sound, will be more subject to
variation. Capitalization characteristics, while still appropriate, may be more
affected by external conditions. Ample alternate liquidity is maintained.
Issuers rated PRIME-3 (or related supporting institutions) have an
acceptable capacity for repayment of short-term promissory obligations. The
effects of industry characteristics and market composition may be more
pronounced. Variability in earnings and profitability may result in changes in
the level of debt protection measurements and the requirement for relatively
high financial leverage. Adequate alternate liquidity is maintained.
Issuers rated NOT PRIME do not fall within any of the Prime rating
categories.
If an issuer represents to Moody's that its Commercial Paper obligations
are supported by the credit of another entity or entities, then the name or
names of such supporting entity or entities are listed within parentheses
beneath the name of the issuer, or there is a footnote referring the reader to
another page for the name or names of the supporting entity or entities. In
assigning ratings to such issuers, Moody's evaluates the financial strength of
the indicated affiliated corporations, commercial banks, insurance companies,
foreign
56
<PAGE> 57
governments or other entities, but only as one factor in the total rating
assessment. Moody's makes no representation and gives no opinion on the legal
validity or enforceability of any support arrangement. You are cautioned to
review with your counsel any questions regarding particular support
arrangements.
DESCRIPTION OF MOODY'S PREFERRED STOCK RATINGS
Because of the fundamental differences between preferred stocks and bonds,
a variation of the bond rating symbols is being used in the quality ranking of
preferred stocks. The symbols, presented below, are designed to avoid comparison
with bond quality in absolute terms. It should always be borne in mind that
preferred stocks occupy a junior position to bonds within a particular capital
structure and that these securities are rated within the universe of preferred
stocks.
Preferred stock rating symbols and their definitions are as follows:
aaa An issue which is rated "aaa" is considered to be a top-quality preferred
stock. This rating indicates good asset protection and the least risk of
dividend impairment within the universe of preferred stocks.
aa An issue which is rated "aa" is considered a high-grade preferred stock.
This rating indicates that there is reasonable assurance that earnings and
asset protection will remain relatively well maintained in the foreseeable
future.
a An issue which is rated "a" is considered to be an upper-medium grade
preferred stock. While risks are judged to be somewhat greater than in the
"aaa" and "aa" classifications, earnings and asset protection are,
nevertheless, expected to be maintained at adequate levels.
baa An issue which is rated "baa" is considered to be medium grade, neither
highly protected nor poorly secured. Earnings and asset protection appear
adequate at present but may be questionable over any great length of time.
ba An issue which is rated "ba" is considered to have speculative elements and
its future cannot be considered well assured. Earnings and asset protection
may be very moderate and not well safeguarded during adverse periods.
Uncertainty of position characterizes preferred stocks in this class.
b An issue which is rated "b" generally lacks the characteristics of a
desirable investment. Assurance of dividend payments and maintenance of
other terms of the issue over any long period of time may be small.
caa An issue which is rated "caa" is likely to be in arrears on dividend
payments. This rating designation does not purport to indicate the future
status of payments.
ca An issue which is rated "ca" is speculative in a high degree and is likely
to be in arrears on dividends with little likelihood of eventual payment.
c This is the lowest rated class of preferred or preference stock. Issues so
rated can be regarded as having extremely poor prospects of ever attaining
any real investment standing.
Note: Moody's may apply numerical modifiers 1, 2 and 3 in each rating
classification from "aa" through "b" in its preferred stock rating system. The
modifier 1 indicates that the security ranks in the higher end of its generic
rating category, the modifier 2 indicates a mid-range ranking; and the modifier
3 indicates that the issue ranks in the lower end of its generic rating
category.
57
<PAGE> 58
DESCRIPTION OF STANDARD & POOR'S RATINGS SERVICES ("STANDARD & POOR'S")
CORPORATE DEBT RATINGS
A Standard & Poor's corporate or municipal rating is a current assessment
of the creditworthiness of an obligor with respect to a specific obligation.
This assessment may take into consideration obligors such as guarantors,
insurers, or lessees.
The debt rating is not a recommendation to purchase, sell or hold a
security, inasmuch as it does not comment as to market price or suitability for
a particular investor.
The ratings are based on current information furnished by the issuer or
obtained by Standard & Poor's from other sources it considers reliable. Standard
& Poor's does not perform an audit in connection with any rating and may, on
occasion, rely on unaudited financial information. The ratings may be changed,
suspended or withdrawn as a result of changes in, or unavailability of, such
information, or for other reasons.
The ratings are based, in varying degrees, on the following considerations:
(1) likelihood of default-capacity and willingness of the obligor as to the
timely payment of interest and repayment of principal in accordance with the
terms of the obligation, (2) nature of and provisions of the obligation; and (3)
protection afforded by, and relative position of, the obligation in the event of
bankruptcy, reorganization or other arrangement under the laws of bankruptcy and
other laws affecting creditors' rights.
AAA Debt rated AAA has the highest rating assigned by Standard & Poor's.
Capacity to pay interest and repay principal is extremely strong.
AA Debt rated AA has, a very strong capacity to pay interest and repay
principal and differs from the higher rated issues only in small degree.
A Debt rated A has a strong capacity to pay interest and repay principal
although it is somewhat more susceptible to the adverse effects of changes
in circumstances and economic conditions than debt in higher rated
categories.
BBB Debt rated BBB is regarded as having an adequate capacity to pay interest
and repay principal. Whereas it normally exhibits adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal
for debt in this category than for debt in higher rated categories.
Debt rated BB, B, CCC, CC and C is regarded, on balance, as having
predominantly speculative characteristics with respect to capacity to pay
interest and repay principal in accordance with the terms of the obligation. BB
indicates the lowest degree of speculation and C the highest degree of
speculation. While such debt will likely have some quality and protective
characteristics, these are outweighed by large uncertainties or major risk
exposures to adverse conditions.
BB Debt rated BB has less near-term vulnerability to default than other
speculative issues. However, it faces major ongoing uncertainties or
exposure to adverse business, financial or economic conditions which could
lead to inadequate capacity to meet timely interest and principal
payments. The BB rating category is also used for debt subordinated to
senior debt that is assigned an actual or implied BBB- rating.
58
<PAGE> 59
B Debt rated B has a greater vulnerability to default but presently has the
capacity to meet interest payments and principal repayments. Adverse
business, financial or economic conditions would likely impair capacity or
willingness to pay interest and repay principal.
The B rating category is also used for debt subordinated to senior debt
that is assigned an actual or implied BB or BB- rating.
CCC Debt rated CCC has a current identifiable vulnerability to default, and is
dependent upon favorable business, financial and economic conditions to
meet timely payments of interest and repayment of principal. In the event
of adverse business, financial or economic conditions, it is not likely to
have the capacity to pay interest and repay principal.
The CCC rating category is also used for debt subordinated to senior debt
that is assigned an actual or implied B or B- rating.
CC The rating CC is typically applied to debt subordinated to senior debt
which is assigned an actual or implied CCC rating.
C The rating C is typically applied to debt subordinated to senior debt
which is assigned an actual or implied CCC-debt rating. The C rating may
be used to cover a situation where a bankruptcy petition has been filed
but debt service payments are continued.
CI The rating CI is reserved for income bonds on which no interest is being
paid.
D Debt rated D is in payment default. The D rating category is also used
when interest payments or principal repayments are not made on the date
due even if the applicable grace period has not expired, unless Standard &
Poor's believes that such payments will be made during such grace period.
The D rating also will be used upon the filing of a bankruptcy petition if
debt service payments are jeopardized.
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 with the major
ratings categories.
Provisional ratings: The letter "p" indicates that the rating is
provisional. A provisional rating assumes the successful completion of the
project being financed by the debt being rated and indicates that payment of
debt service requirements is largely or entirely dependent upon the successful
and timely completion of the project. This rating, however, while addressing
credit quality subsequent to completion of the project, makes no comment on the
likelihood or risk of default upon failure of such completion. The investor
should exercise judgment with respect to such likelihood and risk.
L The letter "L" indicates that the rating pertains to the principal amount
of those bonds to the extent that the underlying deposit collateral is
insured by the Federal Savings & Loan Insurance Corp. or the Federal
Deposit Insurance Corp. and interest is adequately collateralized.
* Continuance of the rating is contingent upon Standard & Poor's receipt of
an executed copy of the escrow agreement or closing documentation confirming
investments and cash flows.
NR Indicates that no public rating has been requested, that there is
insufficient information on which to base a rating, or that Standard & Poor's
does not rate a particular type of obligation as a matter of policy.
59
<PAGE> 60
Debt Obligations of Issuers outside the United States and its territories
are rated on the same basis as domestic corporate and municipal issues. The
ratings measure the creditworthiness of the obligor but do not take into account
currency exchange and related uncertainties.
Bond Investment Quality Standards: Under present commercial bank
regulations issued by the Comptroller of the Currency, bonds rated in the top
four categories ("AAA", "AA", "A", "BBB", commonly known as "investment grade"
ratings) are generally regarded as eligible for bank investment. In addition,
the laws of various states governing legal investments may impose certain
ratings or other standards for obligations eligible for investment by savings
banks, trust companies, insurance companies and fiduciaries generally.
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 four categories, ranging from "A-1" for the
highest quality obligations to "D" for the lowest. These categories are as
follows:
A-1 This highest category indicates that the degree of safety regarding timely
payment is strong. Those issues determined to possess extremely strong
safety characteristics are denoted with a plus (+) sign designation.
A-2 Capacity for timely payment on issues with this designation is
satisfactory. However, the relative degree of safety is not as high as for
issues designated "A-1."
A-3 Issues carrying this designation have a satisfactory capacity for timely
payment. They are, however, somewhat more vulnerable to the adverse effects
of changes in circumstances than obligations carrying the higher
designations.
B Issues rated "B" are regarded as having only speculative capacity for
timely payment.
C This rating is assigned to short-term debt obligations with a doubtful
capacity for payment.
D Debt rated "D" is in payment default. The "D" rating category is used when
interest payments or principal payments are not made on the date due, even
if the applicable grace period has not expired, unless Standard & Poor's
believes that such payments will be made during such grace period.
A commercial paper rating is not a recommendation to purchase or sell a
security. The ratings are based on current information furnished to Standard &
Poor's by the issuer or obtained from other sources it considers reliable. The
ratings may be changed, suspended, or withdrawn as a result of changes in or
unavailability of such information.
DESCRIPTION OF STANDARD & POOR'S PREFERRED STOCK RATINGS
A Standard & Poor's preferred stock rating is an assessment of the capacity
and willingness of an issuer to pay preferred stock dividends and any applicable
sinking fund obligations. A preferred stock rating differs from a bond rating
inasmuch as it is assigned to an equity issue, which issue is intrinsically
different from, and subordinated to, a debt issue. Therefore, to reflect this
difference, the preferred stock rating symbol will normally not be higher than
the bond rating symbol assigned to, or that would be assigned to, the senior
debt of the same issuer.
60
<PAGE> 61
The preferred stock ratings are based on the following considerations:
I. Likelihood of payment-capacity and willingness of the issuer to
meet the timely payment of preferred stock dividends and any applicable
sinking fund requirements in accordance with the terms of the obligation.
II. Nature of, and provisions of, the issue.
III. Relative position of the issue in the event of bankruptcy,
reorganization, or other arrangements affecting creditors' rights.
AAA This is the highest rating that may be assigned by Standard & Poor's to a
preferred stock issue and indicates an extremely strong capacity to pay
the preferred stock obligations.
AA A preferred stock issue rated "AA" also qualifies as a high-quality fixed
income security. The capacity to pay preferred stock obligations is very
strong, although not as overwhelming as for issues rated "AAA."
A An issue rated "A" is backed by a sound capacity to pay the preferred
stock obligations, although it is somewhat more susceptible to the adverse
effects of changes in circumstances and economic conditions.
BBB An issue rated "BBB" is regarded as backed by an adequate capacity to pay
the preferred stock obligations. Whereas it normally exhibits adequate
protection parameters, adverse economic conditions or changing
circumstances are more likely to lead to a weakened capacity to make
payments for a preferred stock in this category than for issues in the "A"
category.
BB B
CCC
Preferred stock rated "BB," "B," and "CCC" are regarded, on balance, as
predominately speculative with respect to the issuer's capacity to pay
preferred stock obligations. "BB" indicates the lowest degree of
speculation and "CCC" the highest degree of speculation. While such
issues will likely have some quality and protective characteristics,
these are outweighed by large uncertainties or major risk exposures to
adverse conditions.
CC The rating "CC" is reserved for a preferred stock issue in arrears on
dividends or sinking fund payments but that is currently paying.
C A preferred stock rated "C" is a non-paying issue.
D A preferred stock rated "D" is a non-paying issue with the issuer in
default on debt instruments.
NR indicates that no rating has been requested, that there is insufficient
information on which to base a rating, or that Standard & Poor's does not rate a
particular type of obligation as a matter of policy.
PLUS (+) or MINUS (-): To provide more detailed indications of preferred
stock quality, 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.
The preferred stock ratings are not a recommendation to purchase or sell a
security, inasmuch as market price is not considered in arriving at the rating.
Preferred stock ratings are wholly unrelated to Standard & Poor's earnings and
dividend rankings for common stocks.
The ratings are based on current information furnished to Standard & Poor's
by the issuer, and 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.
61
<PAGE> 62
[This page is intentionally left blank.]
<PAGE> 63
MERRILL LYNCH CONVERTIBLE FUND, INC. -- AUTHORIZATION FORM (PART 1)
- --------------------------------------------------------------------------------
NOTE: THIS FORM MAY NOT BE USED FOR PURCHASES THROUGH THE MERRILL LYNCH
BLUEPRINT(SM) PROGRAM. YOU MAY REQUEST A MERRILL LYNCH BLUEPRINT(SM)
PROGRAM APPLICATION BY CALLING TOLL FREE (800) 637-3766.
- --------------------------------------------------------------------------------
1. SHARE PURCHASE APPLICATION
I, being of legal age, wish to purchase: (choose one)
[ ] Class A shares [ ] Class B shares [ ] Class C shares [ ] Class D
shares
of Merrill Lynch Convertible Fund, Inc., and establish an Investment Account as
described in the Prospectus. In the event that I am not eligible to purchase
Class A shares, I understand that Class D shares will be purchased.
Basis for establishing an Investment Account:
A. I enclose a check for $________ payable to Merrill Lynch Financial
Data Services, Inc. as an initial investment (minimum $1,000). I understand
that this purchase will be executed at the applicable offering price next to
be determined after this Application is received by you.
B. I already own shares of the following Merrill Lynch mutual funds that
would qualify for the Right of Accumulation as outlined in the Statement of
Additional Information: Please list all funds. (Use a separate sheet of
paper if necessary.)
1.------------------------------------ 4.-------------------------------------
2.------------------------------------ 5.-------------------------------------
3.------------------------------------ 6.-------------------------------------
Name---------------------------------------------------------------------------
First Name Initial Last Name
Name of Co-Owner (if any)------------------------------------------------------
First Name Initial Last Name
Address------------------------------------------------------------------------
- --------------------------------- Date---------------------------------
(Zip Code)
Occupation-------------------- Name and Address of Employer-------------------
- --------------------------------------- -------------------------------------
Signature of Owner Signature of Co-Owner (if any)
(In the case of co-owner, a joint tenancy with right of survivorship will be
presumed unless otherwise specified.)
- --------------------------------------------------------------------------------
2. DIVIDEND AND CAPITAL GAIN DISTRIBUTION OPTIONS
Ordinary Income Dividends
- ------------------------------------- -------------------------------------
Select [ ] Reinvest Select [ ] Reinvest
One: [ ] Cash One: [ ] Cash
- ------------------------------------- --------------------------------------
If no election is made, dividends and capital gains will be automatically
reinvested at net asset value without a sales charge.
IF CASH, SPECIFY HOW YOU WOULD LIKE YOUR DISTRIBUTIONS PAID TO YOU: [ ] Check
or [ ] Direct Deposit to bank account
IF DIRECT DEPOSIT TO BANK ACCOUNT IS SELECTED, PLEASE COMPLETE BELOW:
I hereby authorize payment of dividend and capital gain distributions by direct
deposit to my bank account and, if necessary, debit entries and adjustments for
any credit entries made to my account in accordance with the terms I have
selected on the Merrill Lynch Convertible Fund, Inc. Authorization Form.
SPECIFY TYPE OF ACCOUNT (CHECK ONE) [ ] CHECKING [ ] SAVINGS
Name on your account----------------------------------------------------------
Bank Name---------------------------------------------------------------------
Bank Number------------------------ Account Number-----------------------------
Bank Address-------------------------------------------------------------------
I AGREE THAT THIS AUTHORIZATION WILL REMAIN IN EFFECT UNTIL I PROVIDE WRITTEN
NOTIFICATION TO MERRILL LYNCH FINANCIAL DATA SERVICES, INC. AMENDING OR
TERMINATING THIS SERVICE.
Signature of Depositor--------------------------------------------------------
Signature of Depositor Date
(if joint account, both must sign)
NOTE: IF DIRECT DEPOSIT TO BANK ACCOUNT IS SELECTED, YOUR BLANK, UNSIGNED CHECK
MARKED "VOID" OR A DEPOSIT SLIP FROM YOUR SAVINGS ACCOUNT SHOULD ACCOMPANY THIS
APPLICATION.
- --------------------------------------------------------------------------------
<PAGE> 64
MERRILL LYNCH CONVERTIBLE FUND, INC.--AUTHORIZATION FORM (PART 1)--(CONTINUED)
- --------------------------------------------------------------------------------
3. SOCIAL SECURITY NUMBER OR TAXPAYER IDENTIFICATION NUMBER
------------------------------------------------------
Social Security Number or Taxpayer Identification Number
Under penalty of perjury, I certify (1) that the number set forth above is
my correct Social Security Number or Taxpayer Identification Number and (2) that
I am not subject to backup withholding (as discussed in the Prospectus under
"Taxes") either because I have not been notified that I am subject thereto as a
result of a failure to report all interest or dividends, or the Internal Revenue
Service ("IRS") has notified me that I am no longer subject thereto.
INSTRUCTION: YOU MUST STRIKE OUT LANGUAGE IN (2) ABOVE IF YOU HAVE BEEN
NOTIFIED THAT YOU ARE SUBJECT TO BACKUP WITHHOLDING DUE TO UNDER-REPORTING AND
IF YOU HAVE NOT RECEIVED A NOTICE FROM THE IRS THAT BACKUP WITHHOLDING HAS BEEN
TERMINATED. THE UNDERSIGNED AUTHORIZES THE FURNISHING OF THIS CERTIFICATION TO
OTHER MERRILL LYNCH SPONSORED MUTUAL FUNDS.
- ------------------------------------- ---------------------------------------
SIGNATURE OF OWNER SIGNATURE OF CO-OWNER (IF ANY)
- --------------------------------------------------------------------------------
4. LETTER OF INTENTION -- CLASS A AND D SHARES ONLY (See terms and conditions in
the Statement of Additional Information)
Dear Sir/Madam:
, 19
-----------------------------------------------
Date of Initial Purchase
Although I am not obligated to do so, I intend to purchase shares of Merrill
Lynch Convertible Fund, Inc. or any other investment company with an initial
sales charge or deferred sales charge for which Merrill Lynch Funds Distributor,
Inc. acts as distributor over the next 13 month period which will equal or
exceed:
[ ] $25,000 [ ] $50,000 [ ] $100,000 [ ] $250,000 [ ] $1,000,000
Each purchase will be made at the then reduced offering price applicable to
the amount checked above, as described in the Merrill Lynch Convertible Fund,
Inc. Prospectus.
I agree to the terms and conditions of this Letter of Intention. I hereby
irrevocably constitute and appoint Merrill Lynch Funds Distributor, Inc., my
attorney, with full power of substitution, to surrender for redemption any or
all shares of Merrill Lynch Convertible Fund, Inc. held as security.
By
- -------------------------------------------------------------------
Signature of Owner
- -------------------------------------------------------------------
Signature of Co-Owner (if registered in joint names, both must sign)
In making purchases under this letter, the following are the related
accounts on which reduced offering prices are to apply:
(1) Name
-----------------------------------------------------------------------
Account Number
-----------------------------------------------------------------
(2) Name
-----------------------------------------------------------------------
Account Number
-----------------------------------------------------------------
- --------------------------------------------------------------------------------
5. FOR DEALER ONLY
Branch Office, Address, Stamp.
This form when completed should be mailed to:
Merrill Lynch Convertible Fund, Inc.
c/o Merrill Lynch Financial Data Services, Inc.
P.O. Box 45289
Jacksonville, FL 32232-5289
We hereby authorize Merrill Lynch Funds Distributor, Inc. to act as our agent in
connection with transactions under this authorization form and agree to notify
the Distributor of any purchases or sales made under a Letter of Intention,
Automatic Investment Plan or Systematic Withdrawal Plan. We guarantee the
shareholder's signature.
- ---------------------------------------------------------
Dealer Name and Address
By
-------------------------------------------------------
Authorized Signature of Dealer
- ------------------------- -----------------------------
Branch-Code F/C No. F/C Last Name
- -------------------------
Dealer's Customer A/C No.
64
<PAGE> 65
MERRILL LYNCH CONVERTIBLE FUND, INC. -- AUTHORIZATION FORM (PART 2)
=============================================================================
NOTE: THIS FORM IS REQUIRED TO APPLY FOR THE SYSTEMATIC WITHDRAWAL OR
AUTOMATIC INVESTMENT PLANS ONLY.
=============================================================================
LAST NAME
1. ACCOUNT REGISTRATION
(Please Print)
Name of Owner _______________________________________________________________
First Name Initial Last Name
Name of Co-Owner (if any)____________________________________________________
First Name Initial Last Name
Address _________________________________
_________________________________________
(Zip Code)
_________________________________________
Social Security No.
or Taxpayer Identification No.
Account Number __________________________
(if existing account)
=============================================================================
2. SYSTEMATIC WITHDRAWAL PLAN -- CLASS A AND D SHARES ONLY (See terms and
conditions in the Statement of Additional Information)
MINIMUM REQUIREMENTS: $10,000 for monthly disbursements, $5,000 for
quarterly, of [ ] Class A or [ ] Class D shares in Merrill Lynch Convertible
Fund, Inc. at cost or current offering price. Withdrawals to be made either
(check one) [ ] Monthly on the 24th day of each month, or [ ] Quarterly on the
24th day of March, June, September and December. If the 24th falls on a
weekend or holiday, the next succeeding business day will be utilized. Begin
systematic withdrawal on ________, or as soon as possible thereafter.
(month)
SPECIFY HOW YOU WOULD LIKE YOUR WITHDRAWAL PAID TO YOU (CHECK ONE): [ ]
$ or [ ] % of the current value of [ ] Class A or [ ] Class D shares
in the account.
SPECIFY WITHDRAWAL METHOD: [ ] check or [ ] direct deposit to bank account
(check one and complete part (a) or (b) below):
DRAW CHECKS PAYABLE (CHECK ONE)
(a) I hereby authorize payment by check
[ ] as indicated in Item 1.
[ ] to the order of _____________________________________________________
Mail to (check one)
[ ] the address indicated in Item 1.
[ ] Name (Please Print) _________________________________________________
Address _____________________________________________________________________
Signature of Owner ______________________________ Date ______________
Signature of Co-Owner (if any) _______________________________________
(B) I HEREBY AUTHORIZE PAYMENT BY DIRECT DEPOSIT TO MY BANK ACCOUNT AND, IF
NECESSARY, DEBIT ENTRIES AND ADJUSTMENTS FOR ANY CREDIT ENTRIES MADE TO MY
ACCOUNT. I AGREE THAT THIS AUTHORIZATION WILL REMAIN IN EFFECT UNTIL I PROVIDE
WRITTEN NOTIFICATION TO MERRILL LYNCH FINANCIAL DATA SERVICES, INC. AMENDING OR
TERMINATING THIS SERVICE.
Specify type of account (check one): [ ] checking [ ] savings
Name on your Account ________________________________________________________
Bank Name ___________________________________________________________________
Bank Number ______________________________ Account Number __________________
Bank Address ________________________________________________________________
Signature of Owner __________________________________________________________
Signature of Depositor ____________________________ Date ___________________
Signature of Depositor ______________________________________________________
(if joint account, both must sign)
NOTE: IF DIRECT DEPOSIT IS ELECTED, YOUR BLANK, UNSIGNED CHECK MARKED "VOID" OR
A DEPOSIT SLIP FROM YOUR SAVINGS ACCOUNT SHALL ACCOMPANY THIS APPLICATION.
65
<PAGE> 66
MERRILL LYNCH CONVERTIBLE FUND, INC. -- AUTHORIZATION FORM (PART
2) -- (CONTINUED)
==============================================================================
3. APPLICATION FOR AUTOMATIC INVESTMENT PLAN
I hereby request that Merrill Lynch Financial Data Services, Inc. draw an
automated clearing house ("ACH") debit on my checking account described below
each month to purchase: (choose one)
[ ] Class A shares [ ] Class B shares [ ] Class C shares
[ ] Class D shares
of Merrill Lynch Convertible Fund, Inc., subject to the terms set forth below.
In the event that I am not eligible to purchase Class A shares, I understand
that Class D shares will be purchased.
MERRILL LYNCH FINANCIAL DATA
SERVICES, INC.
You are hereby authorized to draw an ACH debit each month on my bank account
for investment in Merrill Lynch Convertible Fund, Inc. as indicated below:
Amount of each check or ACH debit $ _____________________________________
Account Number __________________________________________________________
Please date and invest ACH debits on the 20th of each month beginning
_________________ or as soon as possible thereafter.
(month)
I agree that you are preparing these ACH debits voluntarily at my request
and that you shall not be liable for any loss arising from any delay in
preparing or failure to prepare any such debit. If I change banks or desire
to terminate or suspend this program, I agree to notify you promptly in
writing. I hereby authorize you to take any action to correct erroneous ACH
debits of my bank account or purchases of Fund shares including liquidating
shares of the Fund and crediting my bank account. I further agree that if a
debit is not honored upon presentation, Merrill Lynch Financial Data Services,
Inc. is authorized to discontinue immediately the Automatic Investment Plan
and to liquidate sufficient shares held in my account to offset the purchase
made with the returned dishonored debit.
_________________________ ________________________________________________
Date Signature of Depositor
________________________________________________
Signature of Depositor
(If joint account, both must sign)
AUTHORIZATION TO HONOR ACH DEBITS
DRAWN BY MERRILL LYNCH FINANCIAL
DATA SERVICES, INC.
To ______________________________________________________________________ Bank
(Investor's Bank)
Bank Address _________________________________________________________________
City _________________________________ State ______________ Zip Code _________
As a convenience to me, I hereby request and authorize you to pay and charge to
my account ACH debits drawn on my account by and payable to Merrill Lynch
Financial Data Services, Inc. I agree that your rights in respect to each such
debit shall be the same as if it were a check drawn on you and signed personally
by me. This authority is to remain in effect until revoked by me in writing.
Until you receive such notice, you shall be fully protected in honoring any such
debit. I further agree that if any such debit be dishonored, whether with or
without cause and whether intentionally or inadvertently, you shall be under no
liability.
_____________________________________ _______________________________________
Bank Account Number Signature of Depositor
(If joint account, both must sign)
NOTE: IF AUTOMATIC INVESTMENT PLAN IS ELECTED, YOUR BLANK, UNSIGNED CHECK MARKED
"VOID" SHOULD ACCOMPANY THIS APPLICATION.
66
<PAGE> 67
MANAGER
Merrill Lynch Asset Management
Administrative Offices:
800 Scudders Mill Road
Plainsboro, New Jersey 08536
Mailing Address:
P.O. Box 9011
Princeton, New Jersey 08543-9011
DISTRIBUTOR
Merrill Lynch Funds Distributor, Inc.
Administrative Offices:
800 Scudders Mill Road
Plainsboro, New Jersey 08536
Mailing Address:
P.O. Box 9081
Princeton, New Jersey 08536-9081
CUSTODIAN
The Chase Manhattan Bank
Global Securities Services
Chase MetroTech Center
Brooklyn, New York 11245
TRANSFER AGENT
Merrill Lynch Financial Data Services, Inc.
Administrative Offices:
4800 Deer Lake Drive East
Jacksonville, Florida 32246-6484
Mailing Address:
P.O. Box 45289
Jacksonville, Florida 32232-5289
INDEPENDENT AUDITORS
Deloitte & Touche LLP
117 Campus Drive
Princeton, New Jersey 08540-6400
COUNSEL
Brown & Wood LLP
One World Trade Center
New York, New York 10048-0557
<PAGE> 68
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NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS, OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS, IN CONNECTION
WITH THE OFFER CONTAINED IN THIS PROSPECTUS, AND, IF GIVEN OR MADE, SUCH OTHER
INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED
BY THE FUND, THE MANAGER OR THE DISTRIBUTOR. THIS PROSPECTUS DOES NOT CONSTITUTE
AN OFFERING IN ANY STATE IN WHICH SUCH OFFERING MAY NOT LAWFULLY BE MADE.
------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
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<S> <C>
Fee Table................................. 2
Merrill Lynch Select Pricing(SM) System... 3
Financial Highlights...................... 8
Risk Factors and Special Considerations... 10
Investment Objective and Policies......... 15
Convertible Securities.................. 17
Description of Certain Investments...... 19
Other Investment Policies and
Practices............................. 20
Investment Restrictions................. 24
Management of the Fund.................... 25
Directors............................... 25
Management and Advisory Arrangements.... 26
Code of Ethics.......................... 27
Transfer Agency Services................ 28
Purchase of Shares........................ 28
Initial Sales Charge
Alternatives -- Class A and Class D
Shares................................ 31
Deferred Sales Charge Alternatives --
Class B and Class C Shares............ 32
Distribution Plans...................... 36
Limitations on the Payment of Deferred
Sales Charges......................... 37
Redemption of Shares...................... 37
Redemption.............................. 37
Repurchase.............................. 38
Reinstatement Privilege -- Class A and
Class D Shares........................ 38
Shareholder Services...................... 39
Investment Account...................... 39
Automatic Reinvestment of Dividends and
Capital Gains Distributions........... 40
Systematic Withdrawal Plans............. 40
Automatic Investment Plans.............. 40
Exchange Privilege...................... 40
Fee-Based Programs...................... 41
Taxes..................................... 42
Performance Data.......................... 44
Additional Information.................... 45
Dividends and Distributions............. 45
Determination of Net Asset Value........ 46
Organization of the Fund................ 47
Shareholder Reports..................... 48
Shareholder Inquiries................... 48
Appendix A................................ 49
Appendix B................................ 55
Authorization Form........................ 63
Code #19010-0897
</TABLE>
(Merrill Lynch Logo)
MERRILL LYNCH
CONVERTIBLE FUND, INC.
[MLYNCH COMPASS GRAPHIC]
PROSPECTUS
August 4, 1997
Distributor:
Merrill Lynch
Funds Distributor, Inc.
This prospectus should be
retained for future reference.
<PAGE> 69
STATEMENT OF ADDITIONAL INFORMATION
MERRILL LYNCH CONVERTIBLE FUND, INC.
P.O. BOX 9011, PRINCETON, NEW JERSEY 08543-9011 - PHONE NO. (609) 282-2800
------------------------
Merrill Lynch Convertible Fund, Inc. (the "Fund") is a non-diversified,
open-end management investment company that seeks to provide shareholders with
high total return by investing primarily in a portfolio of convertible debt
securities, convertible preferred stocks and synthetic convertible securities.
Total return is the combination of capital appreciation and investment income.
The investment philosophy of the Fund is based on the belief that the
characteristics of convertible securities make them appropriate investments for
an investment company seeking a high total return from capital appreciation and
investment income. The securities in which the Fund invests may be issued by
both United States and non-United States issuers. The Fund may employ a variety
of techniques to hedge against market or currency risk or to enhance total
return. There can be no assurance that the investment objective of the Fund will
be realized.
Pursuant to the Merrill Lynch Select Pricing(SM) System, the Fund offers
four classes of shares each with a different combination of sales charges,
ongoing fees and other features. The Merrill Lynch Select Pricing(SM) System
permits an investor to choose the method of purchasing shares that the investor
believes is most beneficial given the amount of the purchase, the length of time
the investor expects to hold the shares and other relevant circumstances.
------------------------
This Statement of Additional Information of the Fund is not a prospectus
and should be read in conjunction with the prospectus of the Fund, dated August
4, 1997 (the "Prospectus"), which has been filed with the Securities and
Exchange Commission (the "Commission") and can be obtained, without charge, by
calling or by writing the Fund at the above telephone number or address. This
Statement of Additional Information has been incorporated by reference into the
Prospectus. Capitalized terms used but not defined herein have the same meanings
as in the Prospectus.
------------------------
MERRILL LYNCH ASSET MANAGEMENT -- MANAGER
MERRILL LYNCH FUNDS DISTRIBUTOR, INC.-- DISTRIBUTOR
------------------------
The date of this Statement of Additional Information is August 4, 1997.
<PAGE> 70
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Fund is to seek high total return from a
combination of capital appreciation and investment income. The Fund will seek to
achieve its objective by investing primarily in a portfolio of convertible debt
securities, convertible preferred stocks and synthetic convertible securities.
The securities in which the Fund invests may be issued by both United States and
non-United States issuers. Reference is made to "Investment Objective and
Policies" in the Prospectus for a discussion of the investment objective and
policies of the Fund.
For purposes of the Fund's investment objective, an issuer ordinarily would
be considered to be located in the country under the laws of which it is
organized or where the primary trading market of its securities is located. The
Fund, however, may consider an issuer to be located in a country, without
reference to its domicile or to the primary trading market of its securities,
when at least 50% of its non-current assets, capitalization, gross revenues or
profits in any one of the two most recent fiscal years represents (directly or
indirectly through subsidiaries) assets or activities located in such country.
The Fund also may consider a security that is denominated in a particular
country's currency to be a security of an issuer in such country without
reference to the principal trading market of the security or to the location of
its issuer. Additionally, the Fund may consider a derivative product tied to
securities of issuers located in a particular country to be the security of an
issuer in that country. The Fund also may consider investment companies to be
located in the country or countries in which they primarily make their portfolio
investments.
The securities markets of many countries at times in the past have moved
relatively independently of one another due to different economic, financial,
political and social factors. When such lack of correlation, or negative
correlation, in movements of these securities markets occurs, it may reduce risk
for the Fund's portfolio as a whole. This negative correlation also may offset
unrealized gains the Fund has derived from movements in a particular market. To
the extent the various markets move independently, total portfolio volatility is
reduced when the various markets are combined into a single portfolio. Of
course, movements in the various securities markets may be offset by changes in
foreign currency exchange rates. Exchange rates frequently move independently of
securities markets in a particular country. As a result, gains in a particular
securities market may be affected by changes in exchange rates.
While it is the policy of the Fund generally not to engage in trading for
short-term gains, the Manager will effect portfolio transactions without regard
to holding period, if, in its judgment, such transactions are advisable in light
of a change in circumstances of a particular company or within a particular
industry or in the general market, economic or financial conditions. The Fund
will, however, monitor its trading so as to comply with the requirements for the
special tax treatment afforded regulated investment companies under the Internal
Revenue Code of 1986, as amended (the "Code"). See "Taxes." 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 all
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.
For the fiscal years ended December 31, 1995 and 1996 (during which periods the
Fund operated as a closed-end investment company), the portfolio turnover rates
were 87.69% and 129.06%, respectively. The variation in portfolio turnover rates
is a result of sales of securities to enhance the Fund's liquidity in
anticipation of the redemption of Income Shares and the conversion to open-end
status, as well as strategies undertaken by the Fund to reduce its tax liability
for long-term capital gains. Higher portfolio turnover may contribute to higher
transactional costs and negative tax consequences, such as an increase in
capital gain dividends or in ordinary income dividends of
2
<PAGE> 71
accrued market discount, as well as greater difficulty meeting the requirement
for qualification as a regulated investment company that less than 30% of its
gross income be derived from the sale or other disposition of securities held
for less than three months. See "Dividends, Distributions and Taxes."
The Fund's ability and decisions to purchase or sell foreign portfolio
securities may be affected by laws or regulations relating to the convertibility
and repatriation of assets. Because the shares of the Fund are redeemable in
U.S. dollars on a daily basis on each day the Fund determines its net asset
value, the Fund intends to manage its portfolio so as to give reasonable
assurance that it will be able to obtain U.S. dollars to the extent necessary to
meet anticipated redemptions. See "Redemption of Shares." Under present
conditions, the Manager does not believe that these considerations will have any
significant effect on its portfolio strategy, although there can be no assurance
in this regard.
PORTFOLIO STRATEGIES INVOLVING OPTIONS, FUTURES AND FOREIGN EXCHANGE
TRANSACTIONS
The Fund is authorized to engage in certain investment practices involving
the use of options, futures and foreign exchange, which may expose the Fund to
certain risks. These investment practices and the associated risks are described
in detail in the Prospectus.
OTHER INVESTMENT POLICIES AND PRACTICES
Non-Diversified Status. The Fund is classified as non-diversified within
the meaning of the Investment Company Act of 1940, as amended (the "Investment
Company Act"), which means that the Fund is not limited by such Act in the
proportion of its assets that it may invest in securities of a single issuer.
The Fund's investments are limited, however, in order for the Fund to qualify as
a "regulated investment company" under the Code. See "Taxes." To qualify, the
Fund must comply with certain requirements, including limiting its 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. A fund that elects to be
classified as "diversified" under the Investment Company Act must satisfy the
foregoing 5% and 10% requirements with respect to 75% of its total assets. To
the extent that the Fund assumes large positions in the securities of a small
number of issuers, the Fund's net asset value may fluctuate to a greater extent
than that of a diversified company as a result of changes in the financial
condition or in the market's assessment of the issuers, and the Fund may be more
susceptible to any single economic, political or regulatory occurrence than a
diversified company.
When-Issued Securities and Delayed Delivery Transactions. The Fund may
purchase securities on a when-issued basis, and it may purchase or sell
securities for delayed delivery. These transactions occur when securities are
purchased or sold by the Fund with payment and delivery taking place in the
future to secure what is considered an advantageous yield and price to the Fund
at the time of entering into the transaction. Although the Fund has not
established any limit on the percentage of its assets that may be committed in
connection with such transactions, the Fund will maintain a segregated account
with its custodian of cash, cash equivalents, U.S. Government securities or
other liquid securities denominated in U.S. dollars or non-U.S. currencies in an
aggregate amount equal to the amount of its commitment in connection with such
purchase transactions.
3
<PAGE> 72
There can be no assurance that a security purchased on a when-issued basis
or purchased or sold through a forward commitment will be issued, and the value
of the security, if issued, on the delivery date may be more or less than its
purchase price. The Fund may bear the risk of a decline in the value of such
security and may not benefit from an appreciation in the value of the security
during the commitment period.
Standby Commitment Agreement. The Fund, from time to time, may enter into
standby commitment agreements. Such agreements commit the Fund, for a stated
period of time, to purchase a stated amount of equity securities which may be
issued and sold to the Fund at the option of the issuer. The price of the
security is fixed at the time of the commitment. At the time of entering into
the agreement the Fund is paid a commitment fee, regardless of whether or not
the security is ultimately issued, which is typically approximately 0.50% of the
aggregate purchase price of the security that the Fund has committed to
purchase. The Fund will enter into such agreements only for the purpose of
investing in the security underlying the commitment at a price that is
considered advantageous to the Fund. The Fund will not enter into a standby
commitment with a remaining term in excess of 45 days and presently will limit
its investment in such commitments so that the aggregate purchase price of the
securities subject to such commitments, together with the value of portfolio
securities subject to legal restrictions on resale that affect their
marketability, will not exceed 15% of its net assets taken at the time of
acquisition of such a commitment. The Fund at all times will maintain a
segregated account with its custodian of cash, cash equivalents, U.S. Government
securities or other liquid securities denominated in U.S. dollars or non-U.S.
currencies in an aggregate amount equal to the purchase price of the securities
underlying a commitment.
There can be no assurance that the securities subject to a standby
commitment will be issued, and the value of the security, if issued, on the
delivery date may be more or less than its purchase price. Since the issuance of
the security underlying the commitment is at the option of the issuer, the Fund
may bear the risk of a decline in the value of such security and may not benefit
from an appreciation in the value of the security during the commitment period.
The purchase of a security subject to a standby commitment agreement and
the related commitment fee will be recorded on the date on which the security
can reasonably be expected to be issued, and the value of the security
thereafter will be reflected in the calculation of the Fund's net asset value.
The cost basis of the security will be adjusted by the amount of the commitment
fee. In the event the security is not issued, the commitment fee will be
recorded as income on the expiration date of the standby commitment.
Repurchase Agreements. The Fund may invest in securities pursuant to
repurchase agreements. Repurchase agreements may be entered into only with
financial institutions which (i) have, in the opinion of the Manager,
substantial capital relative to the Fund's exposure, or (ii) have provided the
Fund with a third-party guaranty or other credit enhancement. Under such
agreements, the seller agrees, upon entering into the contract with the Fund, to
repurchase the security at a mutually agreed-upon time and price in a specified
currency, 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 although it may be affected by currency fluctuations. In repurchase
agreements, the prices at which the trades are conducted do not reflect accrued
interest on the underlying obligation. 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, as a purchaser, 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. ln the event of default by the seller under a
repurchase
4
<PAGE> 73
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, the rate of return to the Fund shall be dependent
upon intervening fluctuations of the market value of such securities and the
accrued interest on the securities. 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 more than 15% of its net assets in repurchase agreements
maturing in more than seven days together with all other illiquid investments.
Lending of Portfolio Securities. Subject to the investment restrictions set
forth in the Prospectus and herein, the Fund may from time to time lend
securities from its portfolio to approved borrowers and receive therefor
collateral in cash or securities issued or guaranteed by the United States
Government. Such collateral will be maintained at all times in an amount equal
to at least 102% of the current market value of the loaned securities. The
purpose of such loans is to permit the borrower to use such securities for
delivery to purchasers when such borrower has sold short. If cash collateral is
received by the Fund, it is invested in short-term money market securities, and
a portion of the yield received in respect of such investment is retained by the
Fund. Alternatively, if securities are delivered to the Fund as collateral, the
Fund and the borrower negotiate a rate for the loaned premium to be received by
the Fund for lending its portfolio securities. In either event, the total yield
on the Fund's portfolio is increased by loans of its portfolio securities. The
Fund will have the right to regain record ownership of loaned securities to
exercise beneficial rights such as voting rights, subscription rights and rights
to dividends, interest or other distributions. Such loans are terminable at any
time, and the borrower, after notice, will be required to return borrowed
securities within five business days. The Fund may pay reasonable finder's,
administrative and custodial fees in connection with such loans. With respect to
the lending of portfolio securities, there is the risk of failure by the
borrower to return the securities involved in such transactions.
INVESTMENT RESTRICTIONS
The Fund has adopted a number of fundamental and non-fundamental
restrictions and policies relating to the investment of its assets and its
activities. The fundamental policies set forth below may not be changed without
the approval of the holders of a majority of the Fund's outstanding voting
securities (which for this purpose and under the Investment Company Act means
the lesser of (i) 67% of the Fund's shares represented at a meeting at which
more than 50% of the outstanding shares of the Fund are represented or (ii) more
than 50% of the Fund's outstanding shares). The Fund may not:
1. Invest more than 25% of its assets, taken at market value at the
time of each investment, in the securities of issuers in any particular
industry (excluding the U.S. Government and its agencies and
instrumentalities). For purposes of this restriction, states,
municipalities and their political subdivisions are not considered part of
any industry.
2. Make investments for the purpose of exercising control or
management. Investments by the Fund in wholly-owned investment entities
created under the laws of certain countries will not be deemed to be the
making of investments for the purpose of exercising control or management.
5
<PAGE> 74
3. Purchase or sell real estate, except that, to the extent permitted
by applicable law, the Fund may invest in securities directly or indirectly
secured by real estate or interests therein or issued by companies which
invest in real estate or interests therein.
4. Make loans to other persons, except that the acquisition of bonds,
debentures or other corporate debt securities and investment in government
obligations, commercial paper, pass-through instruments, certificates of
deposit, bankers' acceptances and repurchase agreements and purchase and
sale contracts 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 this Statement of Additional Information, as they may
be amended from time to time.
5. Issue senior securities to the extent such issuance would violate
applicable law.
6. Borrow money, except that (i) the Fund may borrow from banks (as
defined in the Investment Company Act) in amounts up to 33 1/3% of its
total assets (including the amount borrowed), (ii) the Fund may, to the
extent permitted by applicable law, borrow up to an additional 5% of its
total assets for temporary purposes, (iii) the Fund may obtain such
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.
7. Underwrite securities of other issuers except insofar as the Fund
technically may be deemed an underwriter under the Securities Act of 1933,
as amended (the "Securities Act"), in selling portfolio securities.
8. Purchase or sell commodities or contracts on commodities, except to
the extent that the Fund may do so in accordance with applicable law and
the Fund's Prospectus and Statement of Additional Information, as they may
be amended from time to time, and without registering as a commodity pool
operator under the Commodity Exchange Act.
Under the non-fundamental investment restrictions, the Fund may not:
a. Purchase securities of other investment companies except to the
extent 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 its 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.
c. Invest in securities which cannot be readily resold because of
legal or contractual restrictions or which cannot otherwise be marketed,
redeemed or put to the issuer or a third party, if at the time of
acquisition more than 15% of its net assets would be invested in such
securities. This restriction shall not
6
<PAGE> 75
apply to securities which mature within seven days or securities which the
Board of Directors of the Fund has otherwise determined to be liquid
pursuant to applicable law. Securities purchased in accordance with Rule
144A under the Securities Act and determined to be liquid by the Board of
Directors are not subject to the limitations set forth in this investment
restriction.
d. Notwithstanding fundamental investment restriction (6) above,
borrow money or pledge its assets, except that the Fund (a) may borrow from
a bank as a temporary measure for extraordinary or emergency purposes or to
meet redemptions in amounts not exceeding 33 1/3% (taken at market value)
of its total assets and pledge its assets to secure such borrowings, (b)
may obtain such short-term credit as may be necessary for the clearance of
purchases and sales of portfolio securities and (c) may purchase securities
on margin to the extent permitted by applicable law. However, at the
present time, applicable law prohibits the Fund from purchasing securities
on margin. The deposit or payment by the Fund of initial or variation
margin in connection with financial futures contracts or options
transactions is not considered to be the purchase of a security on margin.
The purchase of securities while borrowings are outstanding will have the
effect of leveraging the Fund. Such leveraging or borrowing increases the
Fund's exposure to capital risk, and borrowed funds are subject to interest
costs which will reduce net income. The Fund will not purchase securities
while borrowings exceed 5% of its total assets.
Portfolio securities of the Fund generally may not be purchased from, sold
or loaned to the Manager or its affiliates or any of their directors, officers
or employees, acting as principal, unless pursuant to a rule or exemptive order
under the Investment Company Act.
The staff of the Commission has taken the position that purchased
over-the-counter ("OTC") options and the assets used as cover for written OTC
options are illiquid securities. Therefore, the Fund has adopted an investment
policy pursuant to which it will not purchase or sell OTC options if, as a
result of any such transaction, the sum of the market value of OTC options
currently outstanding that are held by the Fund, the market value of the
underlying securities covered by OTC call options currently outstanding that
were sold by the Fund and margin deposits on the Fund's existing OTC options on
financial futures contracts exceeds 15% of the net assets of the Fund, taken at
market value, together with all other assets of the Fund that are illiquid or
are not otherwise readily marketable. However, if the OTC option is sold by the
Fund to a primary U.S. Government securities dealer recognized by the Federal
Reserve Bank of New York and if the Fund has the unconditional contractual right
to repurchase such OTC option from the dealer at a predetermined price, then the
Fund will treat as illiquid such amount of the underlying securities as is equal
to the repurchase price less the amount by which the option is "in-the-money"
(i.e., current market value of the underlying securities minus the option's
strike price). The repurchase price with the primary dealers is typically a
formula price which is generally based on a multiple of the premium received for
the option, plus the amount by which the option is "in-the-money." This policy
as to OTC options is not a fundamental policy of the Fund and may be amended by
the Board of Directors of the Fund without the approval of the Fund's
shareholders. However, the Fund will not change or modify this policy prior to
the change or modification by the Commission staff of its position.
In addition, as a non-fundamental policy which may be changed by the Board
of Directors and to the extent required by the Commission or its staff, the Fund
will, for purposes of investment restriction (1), treat securities issued or
guaranteed by the government of any one foreign country as the obligations of a
single issuer.
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<PAGE> 76
As another non-fundamental policy, the Fund will not invest in securities
that are (a) subject to material legal restrictions on repatriation of assets or
(b) cannot be readily resold because of legal or contractual restrictions or
which are not otherwise readily marketable, including repurchase agreements and
purchase and sale contracts maturing in more than seven days, if, regarding all
such securities, more than 15% of its net assets, taken at market value would be
invested in cash securities.
Because of the affiliation of Merrill Lynch, Pierce, Fenner & Smith
Incorporated ("Merrill Lynch") with the Fund, the Fund is prohibited from
engaging in certain transactions involving such firm or its affiliates except
for brokerage transactions permitted under the Investment Company Act involving
only usual and customary commissions or transactions permitted pursuant to an
exemptive order under the Investment Company Act. See "Portfolio Transactions
and Brokerage." Without such an exemptive order, the Fund is prohibited from
engaging in portfolio transactions with Merrill Lynch or its affiliates acting
as principal and from purchasing securities in public offerings that are not
registered under the Securities Act in which such firms or any of its affiliates
participate as an underwriter or dealer.
MANAGEMENT OF THE FUND
DIRECTORS AND OFFICERS
Information about the Directors and executive officers 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 executive
officer and Director is P.O. Box 9011, Princeton, New Jersey 08543-9011.
ARTHUR ZEIKEL (65) -- President and Director(1)(2) -- President of the
Manager (which term as used herein includes its corporate predecessors) since
1977; President of Fund Asset Management, L.P. ("FAM") (which term as used
herein includes its corporate predecessors) since 1977; President and Director
of Princeton Services, Inc. ("Princeton Services") since 1993; Executive Vice
President of Merrill Lynch & Co., Inc. ("ML & Co.") since 1990; Director of
Merrill Lynch Funds Distributor, Inc. ("MLFD" or the "Distributor") since 1977.
JAMES H. BODURTHA (53) -- Director(2) -- 36 Popponesset Road, Cotuit,
Massachusetts 02635. Director and Executive Vice President, The China Business
Group, Inc. since 1996; Chairman and Chief Executive Officer, China Enterprise
Management Corporation from 1993 to 1996; Chairman, Berkshire Corporation since
1980; Partner, Squire, Sanders & Dempsey from 1980 to 1993.
HERBERT I. LONDON (58) -- Director(2) -- 113-115 University Place, New
York, New York 10003. John M. Olin Professor of Humanities, New York University
since 1993 and Professor thereof since 1980; Dean, Gallatin Division of New York
University from 1978 to 1993; Distinguished Fellow, Herman Kahn Chair, Hudson
Institute from 1984 to 1985; Trustee, Hudson Institute since 1980; Director,
Damon Corporation since 1991; Overseer, Center for Naval Analyses from 1983 to
1993; Limited Partner, Hypertech L.P. since 1996.
ROBERT R. MARTIN (70) -- Director(2) -- 513 Grand Hill, St. Paul, Minnesota
55102. Chairman and Chief Executive Officer, Kinnard Investments, Inc. from 1990
to 1993; Executive Vice President, Dain Bosworth from 1974 to 1989; Director,
Carnegie Capital Management from 1977 to 1985 and Chairman thereof in 1979;
Director, Securities Industry Association from 1981 to 1982 and Public
Securities Association from 1979 to 1980; Chairman of the Board, WTC Industries
Inc. in 1994; Trustee, Northland College since 1992.
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<PAGE> 77
JOSEPH L. MAY (68) -- Director(2) -- 424 Church Street, Suite 2000,
Nashville, Tennessee 37219. Attorney in private practice since 1984; President,
May and Athens Hosiery Mills Division, Wayne-Gossard Corporation from 1954 to
1983; Vice President, Wayne-Gossard Corporation from 1972 to 1983; Chairman, The
May Corporation (personal holding company) from 1972 to 1983; Director, Signal
Apparel Co. from 1972 to 1989.
ANDRE F. PEROLD (45) -- Director(2) -- Morgan Hall, Soldiers Field, Boston,
Massachusetts 02163. Professor, Harvard Business School since 1989 and Associate
Professor from 1983 to 1989; Trustee, The Common Fund, since 1989; Director,
Quantec Limited since 1991 and TIBCO from 1994 to 1996.
TERRY K. GLENN (56) -- Executive Vice President(1)(2) -- Executive Vice
President of the Manager and FAM since 1983; Executive Vice President and
Director of Princeton Services since 1993; President of the Distributor since
1986 and Director thereof since 1991; President of Princeton Administrators,
L.P. since 1988.
JOSEPH T. MONAGLE (49) -- Senior Vice President(1)(2) -- Senior Vice
President of the Manager and FAM since 1983; Vice President of the Manager from
1978 to 1990; Senior Vice President of Princeton Services since 1993.
VINCENT T. LATHBURY III (56) -- Vice President(1)(2) -- Vice President and
Portfolio Manager of the Manager and FAM since 1982; Vice President and Manager
of the Bond Department of INA Capital Management, Inc. from 1979 to 1982.
DANIEL A. LUCHANSKY (38) -- Vice President and Portfolio
Manager(1)(2) -- Vice President of the Manager since 1991.
BARTON A. VOGEL (61) -- Vice President(1)(2) -- Vice President of the
Manager since 1985.
DONALD C. BURKE (37) -- Vice President(1)(2) -- Vice President and Director
of Taxation of the Manager since 1990.
GERALD M. RICHARD (48) -- Treasurer(1)(2) -- Senior Vice President and
Treasurer of the Manager and FAM since 1984; Vice President of the Distributor
since 1981 and Treasurer thereof since 1984; Senior Vice President and Treasurer
of Princeton Services since 1993.
IRA P. SHAPIRO(34) -- Secretary(1)(2) -- Vice President of the Manager
since 1997; Attorney with the Manager and FAM from 1993 to 1997; attorney in
private practice prior to 1993.
- ---------------
(1) Interested person, as defined in the Investment Company Act, of the Fund.
(2) Such Director or officer is a trustee, director or officer of certain other
investment companies for which the Manager or FAM acts as investment adviser
or manager.
At July 15, 1997, the officers and Directors of the Fund as a group (14
persons) owned an aggregate of less than 1% of the outstanding shares of the
Fund. At such date, Mr. Zeikel, a Director and officer of the Fund, and the
other officers of the Fund, owned less than 1% of the outstanding shares of
common stock of ML & Co.
COMPENSATION OF DIRECTORS
The Fund pays each Director who is not affiliated with the Manager (each, a
"non-affiliated Director") a fee of $5,000 per year plus $500 per Board meeting
attended, together with such Director's actual out-of-pocket expenses relating
to attendance at meetings. The Fund also compensates each member of the Audit
and Nominating Committee (the "Committee"), which consists of the non-affiliated
Directors, a fee of
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<PAGE> 78
$1,000 per year plus $250 per Committee meeting attended. For the fiscal year
ended December 31, 1996, fees and expenses paid to the non-affiliated Directors
aggregated $45,322.
The following table sets forth for the fiscal year ended December 31, 1996
(during which period the Fund operated as a closed-end investment company),
compensation paid by the Fund to the non-affiliated Directors and, for the
calendar year ended December 31, 1996, the aggregate compensation paid by all
registered investment companies advised by MLAM or its affiliate, FAM
("MLAM/FAM-Advised Funds"), to the non-affiliated Directors.
<TABLE>
<CAPTION>
AGGREGATE
COMPENSATION
PENSION OR FROM FUND AND
RETIREMENT BENEFITS MLAM/FAM-ADVISED
COMPENSATION ACCRUED AS PART FUNDS PAID TO
NAME OF DIRECTOR FROM FUND OF FUND EXPENSES DIRECTORS(1)
------------------------------- ------------ ------------------- ----------------
<S> <C> <C> <C>
James H. Bodurtha.............. $9,000 None $148,500
Herbert I. London.............. 9,000 None 148,500
Robert R. Martin............... 9,000 None 148,500
Joseph L. May.................. 9,000 None 148,500
Andre F. Perold................ 9,000 None 148,500
</TABLE>
- ---------------
(1) The Directors serve on the boards of MLAM/FAM-Advised Funds as follows: Mr.
Bodurtha (22 registered investment companies consisting of 46 portfolios);
Mr. London (22 registered investment companies consisting of 46 portfolios);
Mr. Martin (22 registered investment companies consisting of 46 portfolios);
Mr. May (22 registered investment companies consisting of 46 portfolios);
and Mr. Perold (22 registered investment companies consisting of 46
portfolios).
MANAGEMENT AND ADVISORY ARRANGEMENTS
Reference is made to "Management of the Fund -- Management and Advisory
Arrangements" in the Prospectus for certain information concerning the
management and advisory arrangements of the Fund.
Securities may be held by, or be appropriate investments for, the Fund as
well as other funds or investment advisory clients for which the Manager or its
affiliates act as an adviser. Because of different objectives or other factors,
a particular security may be bought for one or more clients when one or more
clients are selling the same security. If purchases or sales of securities by
the Manager for the Fund or other funds for which it acts as investment adviser
or for its advisory clients arise for consideration at or about the same time,
transactions in such securities will be made, insofar as feasible, for the
respective funds and clients in a manner deemed equitable to all. To the extent
that transactions on behalf of more than one client of the Manager or its
affiliates during the same period may increase the demand for securities being
purchased or the supply of securities being sold, there may be an adverse effect
on price.
The Fund has entered into an investment advisory agreement with the Manager
(the "Management Agreement"). The Manager also served as the Fund's Manager
prior to the conversion of the Fund from a closed-end investment company to an
open-end investment company. As discussed in the Prospectus, the Manager
receives for its services to the Fund monthly compensation at the annual rate of
0.60% of the average daily net assets of the Fund. For the fiscal years ended
December 31, 1994, 1995 and 1996 (during which periods the Fund operated as a
closed-end investment company), the fees paid by the Fund to the Manager
aggregated $1,546,374, $1,570,010 and $1,695,738, respectively.
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<PAGE> 79
As described in the Prospectus, the Manager has also entered into a
sub-advisory agreement with Merrill Lynch Asset Management U.K. Limited ("MLAM
U.K.") pursuant to which MLAM U.K. provides investment advisory services to the
Manager with respect to the Fund.
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 Fund connected with investment and economic
research, trading and investment management of the Fund, as well as the fees of
all Directors of the Fund who are affiliated persons of the Manager. The Fund
pays all other expenses incurred in the operation of the Fund, including, among
other things, taxes, expenses for legal and auditing services, costs of printing
proxies, stock certificates, shareholder reports and prospectuses and statements
of additional information (except to the extent paid by the Distributor),
charges of the custodian, any sub-custodian and transfer agent, expenses of
redemption of shares, Commission fees, expenses of registering the shares under
Federal, state or foreign laws, fees and expenses of non-affiliated Directors,
accounting and pricing costs (including the daily calculation of net asset
value), insurance, interest, brokerage costs, litigation and other extraordinary
or nonrecurring expenses, and other expenses properly payable by the Fund.
Accounting services are provided to the Fund by the Manager, and the Fund
reimburses the Manager for its costs in connection with such services on a
semi-annual basis. The Distributor will pay certain promotional expenses of the
Fund incurred in connection with the offering of shares of the Fund. Certain
expenses will be financed by the Fund pursuant to distribution plans in
compliance with Rule 12b-1 under the Investment Company Act. See "Purchase of
Shares -- Distribution Plans."
The Manager is a limited partnership, the partners of which are ML & Co.
and Princeton Services. ML & Co. and Princeton Services are "controlling
persons" of the Manager as defined under the Investment Company Act because of
their ownership of its voting securities or their power to exercise a
controlling influence over its management or policies.
Duration and Termination. Unless earlier terminated as described herein,
the Management Agreement will continue in effect for a period of two years from
the date of execution and will remain in effect from year to year thereafter if
approved annually (a) by the Board of Directors or by a majority of the
outstanding shares of the Fund and (b) by a majority of the Directors 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 thereto or by the vote of the shareholders of the Fund.
PURCHASE OF SHARES
Reference is made to "Purchase of Shares" in the Prospectus for certain
information as to the purchase of Fund shares.
The Fund issues four classes of shares under the Merrill Lynch Select
Pricing(SM) System; shares of Class A and Class D are sold to investors choosing
the initial sales charge alternatives, and shares of Class B and Class C are
sold to investors choosing the deferred sales charge alternatives. Each Class A,
Class B, Class C and Class D share of the Fund represents an identical interest
in the investment portfolio of the Fund and has the same rights except that
Class B, Class C and Class D shares bear the expenses of the ongoing account
maintenance fees, and Class B and Class C shares bear the expenses of the
ongoing distribution fees and the additional incremental transfer agency costs
resulting from the deferred sales charge arrangements.
11
<PAGE> 80
Class B, Class C and Class D shares each have exclusive voting rights with
respect to the Rule 12b-1 distribution plan adopted with respect to such class
pursuant to which account maintenance and/or distribution fees are paid (except
that Class B shareholders may vote upon any material changes to expenses charged
under the Class D Distribution Plan). Each class has different exchange
privileges. See "Shareholder Services -- Exchange Privilege."
The Merrill Lynch Select Pricing(SM) System is used by more than 50
registered investment companies advised by the Manager or its affiliate, FAM.
Funds advised by the Manager or FAM that utilize the Merrill Lynch Select
Pricing(SM) System are referred to herein as "MLAM-advised mutual funds."
The Fund has entered into separate distribution agreements with the
Distributor in connection with the continuous offering of each class of shares
of the Fund (the "Distribution Agreements"). The Distribution Agreements
obligate the Distributor to pay certain expenses in connection with the offering
of each class of shares of the Fund. After the prospectuses, statements of
additional information and periodic reports have been prepared, set in type and
mailed to shareholders, the Distributor pays for the printing and distribution
of copies thereof used in connection with the offering to dealers and
prospective 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 under "Management of the Fund -- Management and Advisory
Arrangements."
INITIAL SALES CHARGE ALTERNATIVES -- CLASS A AND CLASS D 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 that, 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
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 that
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 or an investment adviser. The term "purchase" also
includes purchases by employee benefit plans not qualified under Section 401 of
the Code, including purchases of shares of the Fund by employees or by employers
on behalf of employees, by means of a payroll deduction plan or otherwise.
Purchases by such a company or non-qualified employee benefit plan will qualify
for the quantity discounts discussed above only if the Fund and the Distributor
are able to realize economies of scale in sales effort and sales related expense
by means of the company, employer or plan making the Fund's Prospectus available
to individual investors or employees and forwarding investments by such persons
to the Fund and by any such employer or plan bearing the expense of any payroll
deduction plan.
Closed-End Fund Investment Option. Class A shares of the Fund and other
MLAM-advised mutual funds ("Eligible Class A shares") are offered at net asset
value to shareholders of certain closed-end funds advised by the Manager or FAM
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
12
<PAGE> 81
of a sale of their closed-end fund shares of common stock in Eligible Class A
shares, if the conditions set forth below are satisfied. Alternatively,
closed-end fund shareholders who purchased such shares on or after October 21,
1994 and wish to reinvest the net proceeds from a sale of their closed-end fund
shares are offered Class A shares (if eligible to buy Class A shares) or Class D
shares of the Fund and other MLAM-advised mutual funds ("Eligible Class D
shares"), if the following conditions are met. First, the sale of closed-end
fund shares must be made through Merrill Lynch and the net proceeds therefrom
must be reinvested immediately in Eligible Class A or Class D shares. Second,
the closed-end fund shares must either have been acquired in the initial public
offering or be shares representing dividends from shares of common stock
acquired in such offering. Third, the closed-end fund shares must have been
continuously maintained in a Merrill Lynch securities account. Fourth, there
must be a minimum purchase of $250 to be eligible for the investment option.
Shareholders of certain MLAM-advised continuously offered closed-end funds
may reinvest at net asset value the net proceeds from a sale of certain shares
of common stock of such funds in shares of the Fund. Upon exercise of this
investment option, shareholders of Merrill Lynch Senior Floating Rate Fund, Inc.
will receive Class A shares of the Fund and shareholders of Merrill Lynch
Municipal Strategy Fund, Inc. and Merrill Lynch High Income Municipal Bond Fund,
Inc. will receive Class D shares of the Fund, except that shareholders already
owning Class A shares 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 other requirements
pertaining to the reinvestment privilege are met. In order to exercise this
investment option, a shareholder of one of the above-referenced continuously
offered closed-end funds (an "eligible fund") must sell his or her shares of
common stock of the eligible fund (the "eligible shares") back to the eligible
fund in connection with a tender offer conducted by the eligible fund and
reinvest the proceeds immediately in the designated class of shares of the Fund.
This investment option is available only with respect to eligible shares as to
which no Early Withdrawal Charge or CDSC (each as defined in the eligible fund's
prospectus) is applicable. Purchase orders from eligible fund shareholders
wishing to exercise this investment option will be accepted only on the day that
the related tender offer terminates and will be effected at the net asset value
of the designated class of the Fund on such day.
REDUCED INITIAL SALES CHARGES
Right of Accumulation. Reduced sales charges are applicable through a right
of accumulation under which eligible investors are permitted to purchase shares
of the Fund subject to an initial sales charge at the offering price applicable
to the total of (a) the public offering price of the shares then being purchased
plus (b) an amount equal to the then current net asset value or cost, whichever
is higher, of the purchaser's combined holdings of all classes of shares of the
Fund and of other MLAM-advised mutual funds. For any such right of accumulation
to be made available, the Distributor must be provided at the time of purchase,
by the purchaser or the purchaser's securities dealer, with sufficient
information to permit confirmation of qualification. Acceptance of the purchase
order is subject to such confirmation. The right of accumulation may be amended
or terminated at any time. Shares held in the name of a nominee or custodian
under pension, profit-sharing, or other employee benefit plans may not be
combined with other shares to qualify for the right of accumulation.
Letter of Intention. Reduced sales charges are applicable to purchases
aggregating $25,000 or more of the Class A or Class D shares of the Fund or of
any other MLAM-advised mutual funds made within a
13
<PAGE> 82
13-month period starting with the first purchase pursuant to a Letter of
Intention in the form provided in the Prospectus. The Letter of Intention is
available only to investors whose accounts are maintained at Merrill Lynch
Financial Data Services, Inc., the Fund's transfer agent (the "Transfer Agent").
The Letter of Intention is not available to employee benefit plans for which
Merrill Lynch provides plan participant recordkeeping services. The Letter of
Intention is not a binding obligation to purchase any amount of Class A or Class
D shares but its execution will result in the purchaser paying a lower sales
charge at the appropriate quantity purchase level. A purchase not originally
made pursuant to a Letter of Intention may be included under a subsequent Letter
of Intention executed within 90 days of such purchase if the Distributor is
informed in writing of this intent within such 90-day period. The value of Class
A and Class D shares of the Fund and of other MLAM-advised mutual funds
presently held, at cost or maximum offering price (whichever is higher), on the
date of the first purchase under the Letter of Intention, may be included as a
credit toward the completion of such Letter, but the reduced sales charge
applicable to the amount covered by such Letter will be applied only to new
purchases. If the total amount of shares purchased does not equal the amount
stated in the Letter of Intention (minimum of $25,000), the investor will be
notified and must pay, within 20 days of the expiration of such Letter, the
difference between the sales charge on the Class A or Class D shares purchased
at the reduced rate and the sales charge applicable to the sales actually
purchased through the Letter. Class A or Class D shares equal to five percent of
the intended amount will be held in escrow during the 13-month period (while
remaining registered in the name of the purchaser) for this purpose. The first
purchase under the Letter of Intention must be at least five percent of the
dollar amount of such Letter. If a purchase during the term of such Letter
otherwise would 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 reduced percentage sales charge which would be applicable to a
single purchase equal to the total dollar value of the Class A or Class D shares
then being purchased under such Letter, but there will be no retroactive
reduction of the sales charges on any previous purchase. The value of any shares
redeemed or otherwise disposed of by the purchaser prior to termination or
completion of the Letter of Intention will be deducted from the total purchases
made under such Letter. An exchange from a MLAM-advised money market fund into
the Fund that creates a sales charge will count toward completing a new or
existing Letter of Intention from the Fund.
Merrill Lynch Blueprint(SM) Program. Class D shares of the Fund are offered
to participants in the Merrill Lynch Blueprint(SM) Program ("Blueprint"). In
addition, participants in Blueprint who own Class A shares of the Fund may
purchase additional Class A shares of the Fund through Blueprint. Blueprint is
directed to small investors, group Individual Retirement Accounts ("IRAs") and
participants in certain affinity groups such as credit unions, trade
associations and benefit plans. Investors placing orders to purchase Class A or
Class D shares of the Fund through Blueprint will acquire the Class A or Class D
shares at net asset value plus a sales charge calculated in accordance with the
Blueprint sales charge schedule (i.e., up to $5,000 at 3.50% and $5,000.01 or
more at the standard sales charge rates disclosed in the Prospectus). In
addition, Class A and Class D shares of the Fund are being offered at net asset
value plus a sales charge of .50% for corporate or group IRA programs placing
orders to purchase their Class A or Class D shares through Blueprint. Services
available to Class A and Class D investors through Blueprint, including exchange
privileges, may differ from those available to other investors in Class A or
Class D shares.
Class A and Class D shares are offered at net asset value to Blueprint
participants through the Merrill Lynch Directed IRA Rollover Program ("IRA
Rollover Program") available from Merrill Lynch Business Financial Services, a
business unit of Merrill Lynch. The IRA Rollover Program is available to
custodian
14
<PAGE> 83
rollover assets from Employee Sponsored Retirement and Savings Plans (as defined
below) whose trustee and/or plan sponsor has entered into the Merrill Lynch
Directed IRA Rollover Program Service Agreement.
Orders for purchases and redemptions of Class A or Class D shares of the
Fund may be grouped for execution purposes which, in some circumstances, may
involve the execution of such orders two business days following the day such
orders are placed. The minimum initial purchase price is $100, with a $50
minimum for subsequent purchases through Blueprint. There are no minimum initial
or subsequent purchase requirements for participants who are part of an
automatic investment plan. Additional information concerning purchases through
Blueprint, including any annual fees and transaction charges, is available from
Merrill Lynch, Pierce, Fenner & Smith Incorporated, The Blueprint(SM) Program,
P.O. Box 30441, New Brunswick, New Jersey 08989-0441.
Employee Access(SM) Accounts. Provided applicable threshold requirements
are met, either Class A or Class D shares are offered at net asset value to
Employee Access(SM) Accounts available through authorized employers. The initial
minimum for such accounts is $500, except that the initial minimum for shares
purchased for such accounts pursuant to the Automatic Investment Program is $50.
Purchase Privilege of Certain Persons. Directors of the Fund, directors and
trustees of other MLAM-advised mutual funds, ML & Co. and its subsidiaries (the
term "subsidiaries," when used herein with respect to ML & Co., includes FAM,
the Manager and certain other entities directly or indirectly wholly owned and
controlled by ML & Co.) and their directors and employees, and any trust,
pension, profit-sharing or other benefit plan for such persons, may purchase
Class A shares of the Fund at net asset value.
Class D shares of the Fund are offered at net asset value, without a sales
charge, to an investor who has a business relationship with a Financial
Consultant who joined Merrill Lynch from another investment firm within six
months prior to the date of purchase by such investor, if the following
conditions are satisfied: first, the investor must advise Merrill Lynch that it
will purchase Class D shares of the Fund with proceeds from a redemption of a
mutual fund that was sponsored by the Financial Consultant's previous firm and
was subject to a sales charge either at the time of purchase or on a deferred
basis; and second, the investor also must establish that such redemption had
been made within 60 days prior to the investment in the Fund, and the proceeds
from the redemption had been maintained in the interim in cash or a money market
fund.
Class D shares of the Fund are also offered at net asset value, without a
sales charge, to an investor who has a business relationship with a Merrill
Lynch Financial Consultant and who has invested in a mutual fund sponsored by a
non-Merrill Lynch company for which Merrill Lynch has served as a selected
dealer and where Merrill Lynch has either received or given notice that such
arrangement will be terminated ("notice"), if the following conditions are
satisfied: first, the investor must purchase Class D shares of the Fund with
proceeds from a redemption of shares of such other mutual fund and the shares of
such other fund were subject to a sales charge either at the time of purchase or
on a deferred basis; and second, such purchase of Class D shares must be made
within 90 days after such notice.
Class D shares of the Fund are also offered at net asset value, without a
sales charge, to an investor who has a business relationship with a Merrill
Lynch Financial Consultant and who has invested in a mutual fund 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
15
<PAGE> 84
redemption and the proceeds from the redemption must be maintained in the
interim in cash or a money market fund.
TMA(SM) Managed Trusts. Class A shares are offered to TMA(SM) Managed
Trusts to which Merrill Lynch Trust Company provides discretionary trustee
services at net asset value.
Acquisition of Certain Investment Companies. The public offering price of
Class D shares of the Fund may be reduced to the net asset value per Class D
share in connection with the acquisition of the assets of or merger or
consolidation with a public or private investment company. The value of the
assets or company acquired in a tax-free transaction may be adjusted in
appropriate cases to reduce possible adverse tax consequences to the Fund that
might result from an acquisition of assets having net unrealized appreciation
that is disproportionately higher at the time of acquisition than the realized
or unrealized appreciation of the Fund. The issuance of Class D shares for
consideration other than cash is limited to bona fide reorganizations, statutory
mergers or other acquisitions of portfolio securities that (i) meet the
investment objective and policies of the Fund; (ii) are acquired for investment
and not for resale (subject to the understanding that the disposition of the
Fund's portfolio securities shall at all times remain within its control); and
(iii) are liquid securities, the value of which is readily ascertainable, that
are not restricted as to transfer either by law or liquidity of market (except
that the Fund may acquire through such transactions restricted or illiquid
securities to the extent the Fund does not exceed the applicable limits on
acquisition of such securities set forth under "Investment Objective and
Policies" herein).
Reductions in or exemptions from the imposition of a sales load are due to
the nature of the investors and/or the reduced sales efforts that will be needed
in obtaining such investments.
EMPLOYER-SPONSORED RETIREMENT OR SAVINGS PLANS AND CERTAIN OTHER ARRANGEMENTS
Certain employer-sponsored retirement or savings plans and certain other
arrangements may purchase Class A or Class D shares at net asset value, based on
the number of employees or number of employees eligible to participate in the
plan, the aggregate amount invested by the plan in specified investments and/or
the services provided by Merrill Lynch to the plan. Certain other plans may
purchase Class B shares with a waiver of the contingent deferred sales charge
("CDSC") upon redemption, based on similar criteria. Such Class B shares will
convert into Class D shares approximately ten years after the plan purchases the
first share of any MLAM-advised mutual fund. Minimum purchase requirements may
be waived or varied for such plans. Additional information regarding purchases
by employer-sponsored retirement or savings plans and certain other arrangements
is available toll-free from Merrill Lynch Business Financial Services at (800)
237-7777.
DISTRIBUTION PLANS
Reference is made to "Purchase of Shares -- Distribution Plans" in the
Prospectus for certain information with respect to the separate distribution
plans for Class B, Class C and Class D shares pursuant to Rule 12b-1 under the
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.
Payments of the account maintenance fees and/or distribution fees are
subject to the provisions of Rule 12b-1 under the Investment Company Act. Among
other things, each Distribution Plan provides that the Distributor shall provide
and the Directors shall review quarterly reports of the disbursement of the
account
16
<PAGE> 85
maintenance fees and/or distribution fees paid to the Distributor. In their
consideration of each Distribution Plan, the Directors must consider all factors
they deem relevant, including information as to the benefits of the Distribution
Plan to the Fund and its related class of shareholders. Each Distribution Plan
further provides that so long as the Distribution Plan remains in effect, the
selection and nomination of Directors who are not "interested persons" of the
Fund, as defined in the Investment Company Act (the "Independent Directors"),
shall be committed to the discretion of the Independent Directors then in
office. In approving each Distribution Plan in accordance with Rule 12b-1, the
Independent Directors concluded that there is a reasonable likelihood that such
Distribution Plan will benefit the Fund and its related class of shareholders.
Each Distribution Plan can be terminated at any time, without penalty, by the
vote of a majority of the Independent Directors 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 Directors,
including a majority of the Independent Directors who have no direct or indirect
financial interest in such Distribution Plan, cast in person at a meeting called
for that purpose. Rule 12b-1 further requires that the Fund preserve copies of
each Distribution Plan and any report made pursuant to such plan for a period of
not less than six years from the date of such Distribution Plan or such report,
the first two years in an easily accessible place.
LIMITATIONS ON THE PAYMENT OF DEFERRED SALES CHARGES
The maximum sales charge rule in the Conduct Rules of the National
Association of Securities Dealers, Inc. ("NASD") imposes a limitation on certain
asset-based sales charges such as the distribution fee and the CDSC borne by the
Class B and Class C shares but not the account maintenance fee. The maximum
sales charge rule is applied separately to each class. As applicable to the
Fund, the maximum sales charge rule limits the aggregate of distribution fee
payments and CDSCs payable by the Fund to (1) 6.25% of eligible gross sales of
Class B shares and Class C shares, computed separately (defined to exclude
shares issued pursuant to dividend reinvestments and exchanges), plus (2)
interest on the unpaid balance for the respective class, computed separately, at
the prime rate plus 1% (the unpaid balance being the maximum amount payable
minus amounts received from the payment of the distribution fee and the CDSC).
In connection with the Class B shares, the Distributor has voluntarily agreed to
waive interest charges on the unpaid balance in excess of 0.50% of eligible
gross sales. Consequently, the maximum amount payable to the Distributor
(referred to as the "voluntary maximum") in connection with the Class B shares
is 6.75% of eligible gross sales. The Distributor retains the right to stop
waiving the interest charges at any time. To the extent payments would exceed
the voluntary maximum, the Fund will not make further payments of the
distribution fee with respect to Class B shares, and any CDSCs will be paid to
the Fund rather than to the Distributor; however, the Fund will continue to make
payments of the account maintenance fee. In certain circumstances the amount
payable pursuant to the voluntary maximum may exceed the amount payable under
the NASD formula. In such circumstances payment in excess of the amount payable
under the NASD formula will not be made.
REDEMPTION OF SHARES
Reference is made to "Redemption of Shares" in the Prospectus for certain
information as to the redemption and repurchase of Fund shares.
17
<PAGE> 86
The right to redeem shares or to receive payment with respect to any such
redemption may be suspended for more than seven days after the tender of such
shares only for periods during which trading on the New York Stock Exchange
("NYSE") is restricted as determined by the Commission or such Exchange is
closed (other than customary weekend and holiday closings), for any period
during which an emergency exists, as defined by the Commission, as a result of
which disposal of portfolio securities or determination of the net asset value
of the Fund is not reasonably practicable, and for such other periods as the
Commission may by order permit for the protection of shareholders of the Fund.
DEFERRED SALES CHARGES -- CLASS B AND CLASS C SHARES
As discussed in the Prospectus under "Purchase of Shares -- Deferred Sales
Charge Alternatives -- Class B and Class C Shares," while Class B shares
redeemed within four years of purchase are subject to a CDSC under most
circumstances, the charge is waived (i) on redemptions of Class B shares in
certain instances, including in connection with certain post-retirement
withdrawals from an IRA or other retirement plan or (ii) on redemptions of Class
B shares following the death or disability of a Class B shareholder. Redemptions
for which the waiver applies in the case of such withdrawals are: (a) any
partial or complete redemption in connection with a tax-free distribution
following retirement under a tax-deferred retirement plan or attaining age
59 1/2 in the case of an IRA or other retirement plan, or part of a series of
equal periodic payments (not less frequently than annually) made for the life
(or life expectancy) or any redemption resulting from the tax-free return of an
excess contribution to an IRA; or (b) any partial or complete redemption
following the death or disability (as defined in 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.
Merrill Lynch Blueprint(SM) Program. Class B shares are offered to certain
participants in the Blueprint(SM) Program. Blueprint is directed to small
investors, group IRAs and participants in certain affinity groups such as trade
associations and credit unions. Class B shares of the Fund are offered through
Blueprint only to members of certain affinity groups. The CDSC is waived in
connection with purchase orders placed through Blueprint. Services, including
the exchange privilege, available to Class B investors through Blueprint,
however, may differ from those available to other Class B investors. Orders for
purchases and redemptions of Class B shares of the Fund will be grouped for
execution purposes which, in some circumstances, may involve the execution of
such orders two business days following the day such orders are placed. The
minimum initial purchase price is $100, with a $50 minimum for subsequent
purchases through Blueprint. There is no minimum initial or subsequent purchase
requirement for investors who are part of a Blueprint automatic investment plan.
Additional information concerning these Blueprint programs, including any annual
fees or transaction charges, is available from Merrill Lynch, Pierce, Fenner &
Smith Incorporated, The Blueprint(SM)Program, P.O. Box 30441, New Brunswick, New
Jersey 08989-0441.
PORTFOLIO TRANSACTIONS AND BROKERAGE
Subject to policies established by the Board of Directors of the Fund, the
Manager is primarily responsible for the execution of the Fund's portfolio
transactions and the allocation of brokerage. In executing such transactions,
the Manager seeks to obtain the best net results for the Fund, taking into
account such factors as price (including the applicable brokerage commission or
dealer spread), size of order, difficulty of execution and operational
facilities of the firm involved and the firm's risk in positioning a block of
securities.
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While the Manager generally seeks reasonably competitive commission rates, the
Fund does not necessarily pay the lowest commission or spread available. The
Fund has no obligation to deal with any broker or group of brokers in execution
of transactions in portfolio securities. Subject to obtaining the best price and
execution, brokers who provide supplemental investment research 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 the Management Agreement and the expenses of the Manager will not
necessarily be reduced as a result of the receipt of such supplemental
information. It is possible that certain supplementary investment research so
received will primarily benefit one or more other investment companies or other
accounts for which investment discretion is exercised. Conversely, the Fund may
be the primary beneficiary of the research or services received as a result of
portfolio transactions effected for such other accounts or investment companies.
In addition, consistent with the Conduct Rules of the NASD and policies
established by the Board of Directors of the Fund, 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.
The Fund does not use any particular broker or dealer, and brokers who
provide supplemental investment research to the Manager may receive orders for
transactions by the Fund. Such supplemental research services ordinarily consist
of assessments and analyses of the business or prospects of a company, industry
or economic sector. Information so received will be in addition to and not in
lieu of the services required to be performed by the Manager under the
Management Agreement. If in the judgment of the Manager the Fund will benefit
from supplemental research services, the Manager is authorized to pay brokerage
commissions to a broker furnishing such services that are in excess of
commissions that another broker may have charged for effecting the same
transaction. The expenses of the Manager will not necessarily be reduced as a
result of the receipt of such supplemental information, and the Manager may use
such information in servicing its other accounts. Whether or not a particular
broker-dealer sells shares of the Fund neither qualifies nor disqualifies such
broker-dealer to execute transactions for the Fund.
The Fund anticipates that its brokerage transactions involving securities
of companies domiciled in countries other than the United States will be
conducted primarily on the principal stock exchanges of such countries.
Brokerage commissions and other transaction costs on foreign stock exchange
transactions are generally higher than in the United States, although the Fund
will endeavor to achieve the best net results in effecting its portfolio
transactions. There is generally less governmental supervision and regulation of
foreign stock exchanges and brokers than in the United States.
Foreign equity securities may be held by the Fund in the form of American
Depositary Receipts ("ADRs"), European Depositary Receipts ("EDRs"), Global
Depositary Receipts ("GDRs") or other securities convertible into foreign equity
securities. ADRs, EDRs and GDRs may be listed on stock exchanges, or traded in
OTC markets in the United States or Europe, as the case may be. ADRs, like other
securities traded in the United States, will be subject to negotiated commission
rates.
The Fund may invest in certain securities traded in the OTC market and
intends to deal directly with the dealers who make a market in the securities
involved, except in those circumstances in which better prices and execution are
available elsewhere. Under the Investment Company Act, persons affiliated with
the Fund and persons who are affiliated with such affiliated persons are
prohibited from dealing with the Fund as principal in the purchase and sale of
securities unless a permissive order allowing such transactions is obtained from
the Commission. Since transactions in the OTC market usually involve
transactions with dealers acting as principal for their own accounts, the Fund
will not deal with affiliated persons, including Merrill Lynch and its
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affiliates, in connection with such transactions. However, an affiliated person
of the Fund may serve as its broker in OTC transactions conducted on an agency
basis provided that, among other things, the fee or commission received by such
affiliated broker is reasonable and fair compared to the fee or commission
received by non-affiliated brokers in connection with comparable transactions.
See "Investment Objective and Policies -- Investment Restrictions." For the
fiscal year ended December 31, 1994, the Fund paid aggregate commissions of
$170,953, $60,694 or 35.5% of which was paid to Merrill Lynch for effecting
36.0% of the aggregate amount of transactions in which the Fund paid brokerage
commissions. For the fiscal year ended December 31, 1995, the Fund paid
aggregate commissions of $186,888, $78,106 or 41.8% of which was paid to Merrill
Lynch for effecting 37.6% of the aggregate dollar amount of transactions in
which the Fund paid brokerage commissions. For the fiscal year ended December
31, 1996, the Fund paid aggregate commissions of $548,586, $177,752 or 32.4% of
which was paid to Merrill Lynch for effecting 33.9% of the aggregate dollar
amount of transactions in which the Fund paid brokerage commissions. During such
periods, however, the Fund operated as a closed-end investment company and,
consequently, such amounts may not necessarily be indicative of the costs of
future brokerage commissions for the Fund.
The Fund's ability and decisions to purchase or sell portfolio securities
may be affected by laws or regulations relating to the convertibility and
repatriation of assets. Because the shares of the Fund are redeemable on a daily
basis in United States dollars, the Fund intends to manage its portfolio so as
to give reasonable assurance that it will be able to obtain United States
dollars to the extent necessary to meet anticipated redemptions. Under present
conditions, it is not believed that these considerations will have any
significant effect on its portfolio strategy.
Section 11(a) of the Securities Exchange Act of 1934, as amended, generally
prohibits members of the United States national securities exchanges from
executing exchange transactions for their affiliates and institutional accounts
which they manage unless the member (i) has obtained prior express authorization
from the account to effect such transactions, (ii) at least annually furnishes
the account with 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.
The Board of Directors of the Fund has considered the possibility of
seeking to recapture for the benefit of the Fund brokerage commissions and other
expenses of possible portfolio transactions by conducting portfolio transactions
through affiliated entities. For example, brokerage commissions received by
affiliated brokers could be offset against the advisory fee paid by the Fund to
the Manager. After considering all factors deemed relevant, the Board of
Directors made a determination not to seek such recapture. The Board will
reconsider this matter from time to time.
DETERMINATION OF NET ASSET VALUE
The net asset value of the shares of the Fund will be determined by the
Manager once daily Monday through Friday, as of 15 minutes after the close of
business on the NYSE (generally, 4:00 p.m., New York time), on each day during
which the NYSE is open for trading. The NYSE is not open on New Year's Day,
Martin Luther King, Jr. Day, Presidents' Day, Good Friday, Memorial Day,
Independence Day, Labor Day,
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Thanksgiving Day and Christmas Day. Any assets or liabilities initially
expressed in terms of non-U.S. dollar currencies are translated into U.S.
dollars at the prevailing market rates as quoted by one or more banks or dealers
on the day of valuation. The Fund also will determine its net asset value on any
day in which there is sufficient trading in its portfolio securities that the
net asset value might be affected materially, but only if on any such day the
Fund is required to sell or redeem shares. 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. Expenses, including the investment advisory fees and
any account maintenance and/or distribution fees, are accrued daily. The per
share net asset value of Class B, Class C and Class D shares generally will be
lower than the per share net asset value of Class A shares, reflecting the daily
expense accruals of the account maintenance, distribution and higher transfer
agency fees applicable with respect to Class B and Class C shares and the daily
expense accruals of the account maintenance fees applicable with respect to
Class D shares; moreover, the per share net asset value of Class B and Class C
shares generally will be lower than the per share net asset value of Class D
shares, reflecting the daily expense accruals of the distribution fees and
higher transfer agency fees applicable with respect to Class B and Class C
shares of the Fund. It is expected, however, that the per share net asset value
of the four classes will tend to converge (although not necessarily meet)
immediately after the payment of dividends or distributions, which will differ
by approximately the amount of the expense accrual differentials between the
classes.
Portfolio securities that are traded on stock exchanges are valued at the
last sale price (regular way) on the exchange on which such securities are
traded, as of the close of business on the day the securities are being valued
or, lacking any sales, at the last available bid price. In cases where
securities are traded on more than one exchange, the securities are valued on
the exchange designated by or under the authority of the Board of Directors as
the primary market. Securities traded in the OTC market are valued at the last
available bid price in the OTC market prior to the time of valuation. Portfolio
securities that are traded both in the OTC market and on a stock exchange are
valued according to the broadest and most representative market. When the Fund
writes an option, the amount of the premium received is recorded on the books of
the Fund as an asset and an equivalent liability. The amount of the liability is
subsequently valued to reflect the current market value of the option written,
based upon the last sale price in the case of exchange-traded options or, in the
case of options traded in the OTC market, the last asked price. Options
purchased by the Fund are valued at their last sale price in the case of
exchange-traded options or, in the case of options traded in the OTC market, the
last bid price. Other investments, including financial futures contracts and
related options, are valued at market value. Securities and assets for which
market quotations are not readily available are valued at fair value as
determined in good faith by or under the direction of the Board of Directors of
the Fund. Such valuations and procedures will be reviewed periodically by the
Board of Directors.
Generally, trading in foreign securities, as well as U.S. Government
securities and money market instruments, is substantially completed each day at
various times prior to the close of business on the NYSE. The values of such
securities used in computing the net asset value of the Fund's shares are
determined as of such times. Foreign currency exchange rates are also generally
determined prior to the close of business on the NYSE. Occasionally, events
affecting the values of such securities and such exchange rates may occur
between the times at which they are determined and the close of business on the
NYSE that will not be reflected in the computation of the Fund's net asset
value. If events materially affecting the value of such securities occur during
such period, then these securities will be valued at their fair value as
determined in good faith by the Directors.
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SHAREHOLDER SERVICES
The Fund offers a number of shareholder services described below which are
designed to facilitate investment in its shares. Full details as to each of such
services and copies of the various plans described below can be obtained from
the Fund, the Distributor or Merrill Lynch. Certain of these services are
available only to U.S. investors.
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. The statements will serve as transaction confirmations for
automatic investment purchases and the reinvestment of ordinary income dividends
and capital gain distributions. The statements also will show any other activity
in the account since the preceding statement. Shareholders will receive separate
transaction confirmations for each purchase or sale transaction other than
automatic investment purchases, the reinvestment of ordinary income dividends
and long-term capital gain distributions. A shareholder may make additions to
his or her Investment Account at any time by mailing a check directly to the
Fund's Transfer Agent.
Share certificates are issued only for full shares and only upon the
specific request of the shareholder. Issuance of certificates representing all
or only part of the full shares in an Investment Account may be requested by
shareholders directly from the Transfer Agent.
Shareholders considering transferring their Class A or Class D shares from
Merrill Lynch to another brokerage firm or financial institution should be aware
that, if the firm to which the Class A or Class D shares are to be transferred
will not take delivery of shares of the Fund, a shareholder either must redeem
the Class A or Class D shares so that the cash proceeds can be transferred to
the account at the new firm or such shareholder must continue to maintain an
Investment Account at the Transfer Agent for those Class A or Class D shares.
Shareholders interested in transferring their Class B or Class C shares from
Merrill Lynch and who do not wish to have an Investment Account maintained for
such shares at the Transfer Agent may request their new brokerage firm to
maintain such shares in an account registered in the name of the brokerage firm
for the benefit of the shareholder. If the new brokerage firm is willing to
accommodate the shareholder in this manner, the shareholder must request that he
or she be issued certificates for the shares and then must turn the certificates
over to the new firm for re-registration as described in the preceding sentence.
Shareholders considering transferring a tax-deferred retirement account such as
an IRA from Merrill Lynch to another brokerage firm or financial institution
should be aware that, if the firm to which the retirement account is to be
transferred will not take delivery of shares of the Fund, a shareholder must
either redeem the shares (paying any applicable CDSC) so that the cash proceeds
can be transferred to the account at the new firm, or such shareholder must
continue to maintain a retirement account at Merrill Lynch for those shares. A
shareholder may make additions to his or her Investment Account at any time by
mailing a check directly to the Transfer Agent.
AUTOMATIC INVESTMENT PLANS
A U.S. shareholder may make additions to an Investment Account at any time
by purchasing Class A shares (if an eligible Class A investor as described in
the Prospectus) or Class B, Class C or Class D shares at the applicable public
offering price either through the shareholder's securities dealer, or by mail
directly to the
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<PAGE> 91
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 whereby the Fund is authorized through pre-authorized checks or
automated clearing house debits of $50 or more to charge the regular bank
account of the shareholder on a regular basis to provide systematic additions to
the Investment Account of such shareholder. 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 ($1 for retirement
accounts) through the CMA(R) or CBA(R) Automated Investment Program.
AUTOMATIC REINVESTMENT OF DIVIDENDS AND CAPITAL GAINS DISTRIBUTIONS
Unless specific instructions to the contrary are given as to the method of
payment of dividends and capital gains distributions, dividends and
distributions will be automatically reinvested in additional shares of the Fund.
Such reinvestment will be at the net asset value of shares of the Fund, without
a sales charge, as of the close of business on the NYSE on the ex-dividend date
of the dividend or distribution. Shareholders may elect in writing to receive
either their dividends or capital gains distributions, or both, in cash, in
which event payment will be mailed on or about the payment date. Cash payments
also can be directly deposited to the shareholder's bank account.
Shareholders may, at any time, notify the Transfer Agent in writing or by
telephone (1-800-MER-FUND) that they no longer wish to have their dividends
and/or capital gains distributions reinvested in shares of the Fund or vice
versa and, commencing ten days after the receipt by the Transfer Agent of such
notice, those instructions will be effected.
SYSTEMATIC WITHDRAWAL PLANS -- CLASS A AND CLASS D SHARES
A Class A or Class D shareholder may elect to make systematic withdrawals
from an Investment Account on either a monthly or quarterly basis as provided
below. Quarterly withdrawals are available for shareholders who have acquired
Class A or Class D shares of the Fund having a value, based on cost or the
current offering price, of $5,000 or more, and monthly withdrawals are available
for shareholders with Class A or Class D shares with such a value of $10,000 or
more.
At the time of each withdrawal payment, sufficient Class A or Class D
shares are redeemed from those on deposit in the shareholder's account to
provide the withdrawal payment specified by the shareholder. The shareholder may
specify either a dollar amount or a percentage of the value of his Class A or
Class D shares. Redemptions will be made at net asset value as determined at the
close of business on the NYSE (generally, 4:00 p.m., New York time) on the 24th
day of each month or the 24th day of the last month of each quarter, whichever
is applicable. If the NYSE is not open for business on such date, the Class A or
Class D shares will be redeemed at the close of business on the following
business day. The check for the withdrawal payment will be mailed, or the direct
deposit for the withdrawal payment will be made, on the next business day
following redemption. When a shareholder is making systematic withdrawals,
dividends on all Class A or Class D shares in the Investment Account are
reinvested automatically in the Fund Class A or Class D shares, respectively. A
shareholder's Systematic Withdrawal Plan may be terminated at any time, without
charge or penalty, by the shareholder, the Fund, the Transfer Agent or the
Distributor.
Withdrawal payments should not be considered as dividends, yield or income.
Each withdrawal is a taxable event. If periodic withdrawals continuously exceed
reinvested dividends, the shareholder's original
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investment may be reduced correspondingly. Purchases of additional Class A or
Class D shares concurrent with withdrawals are ordinarily disadvantageous to the
shareholder because of sales charges and tax liabilities. The Fund will not
knowingly accept purchase orders for Class A or Class D shares of the Fund from
investors who maintain a Systematic Withdrawal Plan unless such purchase is
equal to at least one year's scheduled withdrawals or $1,200, whichever is
greater. Periodic investments may not be made into an Investment Account in
which the shareholder has elected to make systematic withdrawals.
Alternatively, a Class A or Class D shareholder whose shares are held
within a CMA(R), CBA(R) or Retirement Account may elect to have shares redeemed
on a monthly, bimonthly, quarterly, semiannual or annual basis through the
CMA(R) or CBA(R) Systematic Redemption Program. The minimum fixed dollar amount
redeemable is $25. The proceeds of systematic redemptions will be posted to the
shareholder's account five business days after the date the shares are redeemed.
Monthly systematic redemptions will be made at net asset value on the first
Monday of each month; bimonthly systematic redemptions will be made at net asset
value on the first Monday of every other month; and quarterly, semiannual or
annual redemptions are made at net asset value on the first Monday of months
selected at the shareholder's option. If the first Monday of the month is a
holiday, the redemption will be processed at net asset value on the next
business day. The Systematic Redemption Program is not available if Fund shares
are being purchased within the account pursuant to the Automatic Investment
Program. For more information on the CMA(R) or CBA(R) Systematic Redemption
Program, eligible shareholders should contact their Merrill Lynch Financial
Consultant.
EXCHANGE PRIVILEGE
U.S. shareholders of each class of shares of the Fund have an exchange
privilege with certain other MLAM-advised mutual funds. Under the Merrill Lynch
Select Pricing(SM) System, Class A shareholders may exchange Class A shares of
the Fund for Class A shares of a second MLAM-advised mutual fund if the
shareholder holds any Class A shares of the second fund in the account in which
the exchange is made at the time of the exchange or is otherwise eligible to
purchase Class A shares of the second fund. If the Class A shareholder wants to
exchange Class A shares for shares of a second MLAM-advised mutual fund, but
does not hold Class A shares of the second fund in his or her account at the
time of the exchange and is not otherwise eligible to acquire Class A shares of
the second fund, the shareholder will receive Class D shares of the second fund
as a result of the exchange. Class D shares also may be exchanged for Class A
shares of a second MLAM-advised mutual fund at any time as long as, at the time
of the exchange, the shareholder holds Class A shares of the second fund in the
account in which the exchange is made or is otherwise eligible to purchase Class
A shares of the second fund. Class B, Class C and Class D shares are
exchangeable with shares of the same class of other MLAM-advised mutual funds.
For purposes of computing the CDSC that may be payable upon a disposition of the
shares acquired in the exchange, the holding period for the previously owned
shares of the Fund is "tacked" to the holding period of the newly acquired
shares of the other fund as more fully described below. Class A, Class B, Class
C and Class D shares also are exchangeable for shares of certain MLAM-advised
money market funds as follows: Class A shares may be exchanged for shares of
Merrill Lynch Ready Assets Trust, Merrill Lynch Retirement Reserves Money Fund
(available only for exchanges within certain retirement plans), Merrill Lynch
U.S.A. Government Reserves and Merrill Lynch U.S. Treasury Money Fund; Class B,
Class C and Class D shares may be exchanged for shares of Merrill Lynch
Government Fund, Merrill Lynch Institutional Fund, Merrill Lynch Institutional
Tax-Exempt Fund and Merrill Lynch Treasury Fund. Shares with a net asset value
of at least $100 are required to qualify for the exchange privilege, and any
shares utilized in an exchange must have been held by the shareholder for 15
days.
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It is contemplated that the exchange privilege may be applicable to other new
mutual funds whose shares may be distributed by the Distributor.
Exchanges of Class A or Class D shares outstanding ("outstanding Class A or
Class D shares") for Class A or Class D shares of another MLAM-advised mutual
fund ("new Class A or Class D shares") are transacted on the basis of relative
net asset value per Class A or Class D share, respectively, plus an amount equal
to the difference, if any, between the sales charge previously paid on the
outstanding Class A or Class D shares and the sales charge payable at the time
of the exchange on the new Class A or Class D shares. With respect to
outstanding Class A or Class D shares as to which previous exchanges have taken
place, the "sales charge previously paid" shall include the aggregate of the
sales charges paid with respect to such Class A or Class D shares in the initial
purchase and any subsequent exchange. Class A or Class D shares issued pursuant
to dividend reinvestment are sold on a no-load basis in each of the funds
offering Class A or Class D shares. For purposes of the exchange privilege,
Class A and 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 of the Fund generally will be
exchanged into the Class A or Class D shares of the other funds or into shares
of certain money market funds without a sales charge.
In addition, each of the funds with Class B and Class C shares outstanding
("outstanding Class B or Class C shares") offers to exchange its Class B or
Class C shares for Class B or Class C shares, respectively, of another
MLAM-advised mutual fund ("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 Class B or
Class C 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 or Class C
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 or Class C shares of the fund from which the
exchange has been made. For purposes of computing the sales load that may be
payable on a disposition of the new Class B 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 or Class C shares of the Fund for those of Merrill Lynch
Special Value Fund, Inc. ("Special Value Fund") after having held the Fund's
Class B shares for two and a half years. The 2% CDSC that generally would apply
to a redemption would not apply to the exchange. Three years later the investor
may decide to redeem the Class B shares of Special Value Fund and receive cash.
There will be no CDSC due on this redemption, since by "tacking" the two and a
half year holding period of the Fund Class B shares to the three year holding
period for the Special Value Fund Class B shares, the investor will be deemed to
have held the Special Value Fund Class B shares for more than five years.
Shareholders also may exchange shares of the Fund into shares of certain
money market funds advised by the Manager or its affiliates, but the period of
time that Class B or Class C shares are held in a money market fund will not
count towards satisfaction of the holding period requirement for purposes of
reducing the CDSC or, with respect to Class B shares, towards satisfaction of
the conversion period. However, shares of a money market fund which were
acquired as a result of an exchange for Class B or Class C shares of the Fund
may, in turn, be exchanged back into Class B or Class C shares, respectively, of
any fund offering such shares, in which event the holding period for Class B or
Class C shares of the newly acquired fund will be aggregated
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with previous holding periods for purposes of reducing the CDSC. Thus, for
example, an investor may exchange Class B shares of the Fund for shares of
Merrill Lynch Institutional Fund ("Institutional Fund") after having held the
Fund Class B shares for two and a half years and three years later decide to
redeem the shares of Institutional Fund for cash. At the time of this
redemption, the 2% CDSC that would have been due had the Class B shares of the
Fund been redeemed for cash rather than exchanged for shares of Institutional
Fund will be payable. If, instead of such redemption the shareholder exchanged
such shares for Class B shares of a fund which the shareholder continued to hold
for an additional two and a half years, any subsequent redemption would not
incur a CDSC.
Before effecting an exchange, shareholders should obtain a currently
effective prospectus of the fund into which the exchange is to be made.
To exercise the exchange privilege, a shareholder should contact his or her
Merrill Lynch Financial Consultant, who will advise the Fund of the exchange.
Shareholders of the Fund, and shareholders of other MLAM-advised mutual 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 offering of
their shares to the general public at any time and thereafter may 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.
DIVIDENDS, DISTRIBUTIONS AND TAXES
DIVIDENDS AND DISTRIBUTIONS
The Fund intends to distribute substantially all its net investment income,
if any. Dividends from such net investment income will be paid at least
annually. All net realized long- or short-term capital gains, if any, will be
distributed to the Fund's shareholders at least annually. From time to time, the
Fund may declare a special distribution at or about the end of the calendar year
in order to comply with Federal tax requirements that certain percentages of its
ordinary income and capital gains be distributed during the calendar year. If in
any fiscal year, the Fund has net income from certain foreign currency
transactions, such income will be distributed at least annually.
See "Shareholder Services -- Automatic Reinvestment of Dividends and
Capital Gains Distributions" for information concerning the manner in which
dividends and distributions may be reinvested automatically in shares of the
Fund. A shareholder whose account is maintained at the Transfer Agent or whose
account is maintained through Merrill Lynch may elect in writing to receive any
such dividends or distributions, or both, in cash. Dividends and distributions
are taxable to shareholders, as discussed below, whether they are reinvested in
shares of the Fund or received 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 with respect to such class of shares. See
"Determination of Net Asset Value."
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TAXES
The Fund intends to continue to qualify 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 on the part of its net ordinary income and net realized capital gains
that it distributes to Class A, Class B, Class C and Class D shareholders
(together, the "shareholders"). The Fund intends to distribute substantially all
of such income.
Dividends paid by the Fund from its ordinary income or from an excess of
net short-term capital gains over net long-term capital losses (together
referred to hereafter as "ordinary income dividends") are taxable to
shareholders as ordinary income. Distributions made from an excess of net
long-term capital gains over net short-term capital losses (including gains or
losses from certain transactions in warrants, futures and options) ("capital
gain dividends") are taxable to shareholders as long-term capital gains,
regardless of the length of time the shareholder has owned Fund shares. Any loss
upon the sale or exchange of Fund shares held for six months or less, however,
will be treated as long-term capital loss to the extent of any capital gain
dividends received by the shareholder. Distributions in excess of the Fund's
earnings and profits will first reduce the adjusted tax basis of a holder's
shares and, after such adjusted tax basis is reduced to zero, will constitute
capital gains to such holder (assuming the shares are held as a capital asset).
Dividends are taxable to shareholders even though they are reinvested in
additional shares of the Fund. Not later than 60 days after the close of its
taxable year, the Fund will provide its shareholders with a written notice
designating the amounts of any ordinary income dividends or capital gain
dividends. A portion of the Fund's ordinary income dividends may be eligible for
the dividends received deduction allowed to corporations under the Code, if
certain requirements are met. For this purpose, the Fund will allocate dividends
eligible for the dividends received deduction 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 stock) that is based on the gross income allocable to 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. If the Fund pays a
dividend in January that 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.
Ordinary income dividends paid to shareholders who are nonresident aliens
or foreign entities will be subject to a 30% U.S. 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 advisers concerning the applicability of the U.S. withholding tax.
Under certain provisions of the Code, some shareholders may be subject to a
31% withholding tax on ordinary income dividends, 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 Fund or who, to the Fund's knowledge, have furnished
an incorrect number. When establishing an account, an investor must certify
under penalty of perjury that such number is correct and that such investor is
not otherwise subject to backup withholding.
27
<PAGE> 96
Dividends and interest received by the Fund may give rise to withholding
and other taxes imposed by foreign countries. Tax conventions between certain
countries and the United States may reduce or eliminate such taxes. Shareholders
may be able to claim United States foreign tax credits with respect to such
taxes, subject to certain conditions and limitations contained in the Code. For
example, certain retirement accounts cannot claim foreign tax credits on
investments in foreign securities held in the Fund. If more than 50% in value of
the Fund's total assets at the close of its taxable year consists of securities
of foreign corporations, the Fund will be eligible, and intends, to file an
election with the Internal Revenue Service pursuant to which shareholders of the
Fund will be required to include their proportionate shares of such withholding
taxes in their United States income tax returns as gross income, treat such
proportionate shares as taxes paid by them, and deduct such proportionate shares
in computing their taxable incomes or, alternatively, use them as foreign tax
credits against their United States income taxes. No deductions for foreign
taxes, however, may be claimed by noncorporate shareholders who do not itemize
deductions. A shareholder that is a nonresident alien individual or a foreign
corporation may be subject to U.S. withholding tax on the income resulting from
the Fund's election described in this paragraph but may not be able to claim a
credit or deduction against such U.S. tax for the foreign taxes treated as
having been paid by such shareholder. The Fund will report annually to its
shareholders the amount per share of such withholding taxes. For this purpose,
the Fund will allocate foreign taxes and foreign source income among the Class
A, Class B, Class C and Class D shareholders according to a method similar to
that described above for the allocation of dividends eligible for the dividends
received deduction.
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 on the exchanged shares reduces any sales charge the
shareholder would have owed upon the purchase of the new shares in the absence
of the exchange privilege. Instead, such sales charge will be treated as an
amount paid for the new shares.
A loss realized on a sale or exchange of shares of the Fund will be
disallowed if other Fund shares are acquired (whether through the automatic
reinvestment of dividends or otherwise) within a 61-day period beginning 30 days
before and ending 30 days after the date that the shares are disposed of. In
such a case, the basis of the shares acquired will be adjusted to reflect the
disallowed loss.
The Code requires a RIC to pay a nondeductible 4% excise tax to the extent
the RIC does not distribute, during each calendar year, 98% of its ordinary
income, determined on a calendar year basis, and 98% of its capital gains,
determined, in general, on an October 31 year end, plus certain undistributed
amounts from previous years. While the Fund intends to distribute its income and
capital gains in the manner necessary to minimize imposition of the 4% excise
tax, there can be no assurance that sufficient amounts of the Fund's taxable
income and capital gains will be distributed to avoid entirely the imposition of
the tax. In such event, the Fund will be liable for the tax only on the amount
by which it does not meet the foregoing distribution requirements.
28
<PAGE> 97
The Fund may invest in securities rated in the medium to lower rating
categories of nationally recognized rating organizations, and in unrated
securities ("high yield/high risk securities"), as described in the Prospectus.
Some of these high yield/high risk securities may be purchased at a discount and
may therefore cause the Fund to accrue and distribute income before amounts due
under the obligations are paid. In addition, a portion of the interest payments
on such high yield/high risk securities may be treated as dividends for Federal
income tax purposes; in such case, if the issuer of such high yield/high risk
securities is a domestic corporation, dividend payments by the Fund will be
eligible for the dividends received deduction to the extent of the deemed
dividend portion of such interest payments.
The Fund may invest up to 10% of its total assets in securities of other
investment companies. If the Fund purchases shares of an investment company (or
similar investment entity) organized under foreign law, the Fund will be treated
as owning shares in a passive foreign investment company ("PFIC") for U.S.
Federal income tax purposes. The Fund may be subject to U.S. Federal income tax,
and an additional tax in the nature of interest (the "interest charge"), on a
portion of the distributions from such a company and on gain from the
disposition of the shares of such a company (collectively referred to as "excess
distributions"), even if such excess distributions are paid by the Fund as a
dividend to its shareholders. The Fund may be eligible to make an election with
respect to certain PFICs in which it owns shares that will allow it to avoid the
taxes on excess distributions. However, such election may cause the Fund to
recognize income in a particular year in excess of the distributions received
from such PFICs. Alternatively, under proposed regulations the Fund would be
able to elect to "mark to market" at the end of each taxable year all shares
that it holds in PFICs. If it made this election, the Fund would recognize as
ordinary income any increase in the value of such shares. Unrealized losses,
however, would not be recognized. By making the mark-to-market election, the
Fund could avoid imposition of the interest charge with respect to its
distributions from PFICs, but in any particular year might be required to
recognize income in excess of the distributions it received from PFICs and its
proceeds from dispositions of PFIC stock.
TAX TREATMENT OF OPTIONS AND FUTURES TRANSACTIONS
The Fund may write (i.e., sell), purchase or sell options, futures and
forward foreign exchange contracts. 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 futures
contract will be treated as sold for its fair market value on the last day of
the taxable year. Unless such contract is a forward foreign exchange contract,
or is a non-equity option or a regulated futures contract for a non-U.S.
currency for which the Fund elects to have gain or loss treated as ordinary gain
or loss under Code Section 988 (as described below), gain or loss from 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 or
currency exchange rates with respect to its investments.
A forward foreign exchange contract that is a Section 1256 contract will be
marked to market, as described above. However, the character of gain or loss
from such a contract will generally be ordinary under Code Section 988. The Fund
may, nonetheless, elect to treat the gain or loss from certain forward foreign
exchange contracts as capital. In this case, gain or loss realized in connection
with a forward foreign exchange
29
<PAGE> 98
contract that is a Section 1256 contract will be characterized as 60% long-term
and 40% short-term capital gain or loss.
Code Section 1092, which applies to certain "straddles," may affect the
taxation of the Fund's sales of securities and transactions in options, futures
and forward foreign exchange contracts and its short sales of securities. 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 options, futures and forward foreign exchange contracts and
short sales of securities.
One of the requirements for qualification as a RIC is that less than 30% of
the Fund's gross income be derived from gains from the sale or other disposition
of securities held for less than three months. Accordingly, the Fund may be
restricted in effecting closing transactions within three months after entering
into an option or futures contract.
SPECIAL RULES FOR CERTAIN FOREIGN CURRENCY TRANSACTIONS
In general, gains from "foreign currencies" and from foreign currency
options, foreign currency futures and forward foreign exchange contracts
relating to investments in stocks, securities or foreign currencies will be
qualifying income for purposes of determining whether the Fund qualifies as a
RIC. It is currently unclear, however, who will be treated as the issuer of a
foreign currency instrument or how foreign currency options, futures, or forward
foreign exchange contracts will be valued for purposes of the RIC
diversification requirements applicable to the Fund.
Under Code Section 988, special rules are provided for certain transactions
in a foreign currency other than the taxpayer's functional currency (i.e.,
unless certain special rules apply, currencies other than the U.S. dollar). In
general, foreign currency gains or losses from certain debt instruments, from
certain forward contracts, from futures contracts that are not "regulated
futures contracts" and from unlisted options will be treated as ordinary income
or loss under Code Section 988. In certain circumstances, the Fund may elect
capital gain or loss treatment for such transactions. Regulated futures
contracts, as described above, will be taxed under Code Section 1256 unless
application of Section 988 is elected by the Fund. In general, however, Code
Section 988 gains or losses will increase or decrease the amount of the Fund's
investment company taxable income available to be distributed to shareholders as
ordinary income. Additionally, if Code Section 988 losses exceed other
investment company taxable income during a taxable year, the Fund would not be
able to make any ordinary income dividend distributions, and all or a portion of
distributions made before the losses were realized but in the same taxable year
would be recharacterized as a return of capital to shareholders, thereby
reducing the basis of each shareholder's Fund shares and resulting in a capital
gain for any shareholder who received a distribution greater than such
shareholder's basis in Fund shares (assuming the shares were held as a capital
asset). These rules and the mark-to-market rules described above, however, will
not apply to certain transactions entered into by the Fund solely to reduce the
risk of currency fluctuations with respect to its investments.
The foregoing is a general and abbreviated summary of the applicable
provisions of the Code and Treasury regulations presently in effect. For the
complete provisions, reference should be made to the pertinent Code sections and
the Treasury regulations promulgated thereunder. The Code and the Treasury
regulations are subject to change by legislative, judicial or administrative
action either prospectively or retroactively.
30
<PAGE> 99
Ordinary income and capital gain dividends may also be subject to state and
local taxes.
Certain states exempt from state income taxation dividends paid by RICs
which are derived from interest on U.S. Government obligations. State law varies
as to whether dividend income attributable to U.S. Government obligations is
exempt from state income tax.
Shareholders are urged to consult their own tax advisers regarding specific
questions as to Federal, foreign, state or local taxes. Foreign investors should
consider applicable foreign taxes in their evaluation of an investment in the
Fund.
PERFORMANCE DATA
From time to time the Fund may include its average annual total return and
other total return data in advertisements or information furnished to present or
prospective shareholders. Total return figures are based on the Fund's
historical performance and are not intended to indicate future performance.
Average annual total return is 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 front-end sales charge in the case of Class A
and Class D shares and the CDSC that would be applicable to a complete
redemption of the investment at the end of the specified period in the case of
Class B and Class C shares.
The Fund also may quote annual 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 (i) as
required by the periods of the quotations, actual annual, annualized or
aggregate data, rather than average annual data, may be quoted and (ii) the
maximum applicable sales charges will not be included with respect to actual
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.
31
<PAGE> 100
Set forth in the table below is total return information for the Class A
shares of the Fund for the periods indicated.
<TABLE>
<CAPTION>
CLASS A SHARES*
---------------------------------------------
EXPRESSED AS A REDEEMABLE VALUE
PERCENTAGE BASED OF A HYPOTHETICAL
ON A HYPOTHETICAL $1,000 INVESTMENT AT
PERIOD $1,000 INVESTMENT THE END OF THE PERIOD
- --------------------------------------------------------- ----------------- ---------------------
<S> <C> <C>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURN
(INCLUDING MAXIMUM APPLICABLE SALES CHARGES)
<S> <C> <C>
One Year Ended December 31, 1996......................... 14.27% $1,142.70
Five Years Ended December 31, 1996....................... 10.30% $1,632.20
Ten Years Ended December 31, 1996........................ 5.13% $1,649.90
Inception (August 2, 1985) to December 31, 1996.......... 6.68% $2,093.60
ANNUAL TOTAL RETURN
(EXCLUDING MAXIMUM APPLICABLE SALES CHARGES)
Year Ended December 31,
1996................................................... 20.60 % $1,206.00
1995................................................... 24.44 % $1,244.40
1994................................................... (15.68)% $ 843.20
1993................................................... 13.94 % $1,139.40
1992................................................... 19.48 % $1,194.80
1991................................................... 42.24 % $1,422.40
1990................................................... (24.21)% $ 757.90
1989................................................... 16.46 % $1,164.60
1988................................................... 2.36 % $1,023.60
1987................................................... (21.34)% $ 786.60
1986................................................... 14.13 % $1,141.30
Inception (August 2, 1985) to December 31, 1985.......... 11.18 % $1,111.80
</TABLE>
<TABLE>
<CAPTION>
AGGREGATE TOTAL RETURN
(INCLUDING MAXIMUM APPLICABLE SALES CHARGES)
<S> <C> <C>
Inception (August 2, 1985) to December 31, 1996.......... 109.36% $2,093.60
</TABLE>
- ---------------
* During such periods, the Fund operated as a closed-end investment company.
Performance data information is currently unavailable for Class B, Class C and
Class D shares since Class B, Class C and Class D shares had not commenced
operations prior to the date of this Statement of Additional Information. On
August 4, 1997, the Fund converted to an open-end investment company and
shares outstanding as of that date were designated Class A. The Fund may incur
additional expenses as an open-end investment company.
In order to reflect the reduced sales charges in the case of Class A or
Class D shares or the waiver of the CDSC in the case of Class B or Class C
shares applicable to certain investors, as described under "Purchase of Shares"
and "Redemption of Shares," respectively, the total return data quoted by the
Fund in advertisements directed to such investors may take into account the
reduced, and not the maximum, sales charge or may not take into account the CDSC
and therefore may reflect greater total return since, due to the reduced sales
charges or the waiver of sales charges, a lower amount of expenses is deducted.
32
<PAGE> 101
GENERAL INFORMATION
DESCRIPTION OF SHARES
The Fund was incorporated under Maryland law on May 24, 1985 as a
closed-end investment company. On February 13, 1997, the shareholders of the
Fund voted to convert the Fund to an open-end investment company. Amended and
Restated Articles of Incorporation, effective as of August 4, 1997, (i) convert
the Fund to an open-end investment company, (ii) rename the Fund "Merrill Lynch
Convertible Fund, Inc." and (iii) increase the authorized capital stock from
30,000,000 shares, par value $.10 per share, to 400,000,000 shares of Common
Stock, par value $.10 per share. The shares of Common Stock are divided into
four classes designated Class A, Class B, Class C and Class D Common Stock, each
consisting of 100,000,000 shares. Shares of Class A, Class B, Class C and Class
D Common Stock represent an interest in the same assets of the Fund and are
identical in all respects except that the Class B, Class C and Class D shares
bear certain expenses related to the account maintenance and/or distribution of
such shares and have exclusive voting rights with respect to matters relating to
such expenditures. At the time of conversion of the Fund into an open-end
investment company, the Fund had approximately 11,653,700 Capital Shares
outstanding, all of which were reclassified into shares of Class A Common Stock
upon such conversion. The Board of Directors of the Fund may classify and
reclassify the unissued shares of the Fund into additional classes of Common
Stock at a future date.
Shareholders are entitled to one vote for each full share held and
fractional votes for fractional shares held in the election of Directors and any
other matter submitted to a shareholder vote. The Fund does not intend to hold
annual meetings of shareholders in any year in which the Investment Company Act
does not require shareholders to act upon any of the following matters: (i)
election of Directors; (ii) approval of an investment advisory agreement; (iii)
approval of a distribution agreement; and (iv) ratification of selection of
independent accountants. Also, the by-laws of the Fund require that a special
meeting of shareholders be held upon the written request of at least 25% of the
outstanding shares of the Fund entitled to vote at such meeting, if they comply
with applicable Maryland law. Voting rights for Directors are not cumulative.
Shares issued are fully paid and non-assessable and have no preemptive rights.
Redemption and conversion rights are discussed elsewhere herein and in the
Prospectus. Each share of Class B, Class C and Class D Common Stock is entitled
to participate equally in dividends and distributions declared by the Fund and
in the net assets of the Fund upon liquidation or dissolution after satisfaction
of outstanding liabilities. Stock certificates will be issued by the Transfer
Agent only on specific request. Certificates for fractional shares are not
issued in any case. Shareholders may, in accordance with Maryland law, cause a
meeting of shareholders to be held for the purpose of voting on the removal of
Directors at the request of 25% of the outstanding shares of the Fund. A
Director may be removed at a special meeting of shareholders by a vote of a
majority of the votes entitled to be cast for the election of Directors.
33
<PAGE> 102
COMPUTATION OF OFFERING PRICE PER SHARE
An illustration of the computation of the offering price for Class A shares
of the Fund based on the value of the Fund's net assets attributable to Capital
Shares and number of Capital Shares outstanding on December 31, 1996, is
calculated as set forth below. Information is not provided for Class B, Class C
or Class D shares since no shares of Class B, Class C or Class D were publicly
offered prior to the date of this Statement of Additional Information.
<TABLE>
<CAPTION>
CLASS A
------------
<S> <C>
Net Assets............................................................. $181,484,467
============
Number of Shares Outstanding........................................... 11,653,700
============
Net Asset Value Per Share (net assets divided by number of shares
outstanding)......................................................... $ 15.57
Shares Charge (5.25% of offering price (5.54% of net asset value per
share))*............................................................. .86
------------
Offering Price......................................................... $ 16.43
============
</TABLE>
- ---------------
* Rounded to the nearest one-hundredth percent; assumes maximum sales charge is
applicable.
INDEPENDENT AUDITORS
Deloitte & Touche LLP, 117 Campus Drive, Princeton, New Jersey 08540-6400,
has been selected as the independent auditors of the Fund. The selection of
independent auditors is subject to approval by the Independent Directors of the
Fund. The independent auditors are responsible for auditing the annual financial
statements of the Fund.
CUSTODIAN
The Chase Manhattan Bank, Global Securities Services, Chase MetroTech
Center, Brooklyn, New York 11245, acts as the Custodian of the Fund's assets.
Under its contract with the Fund, the Custodian is authorized, among other
things, to establish separate accounts in foreign currencies and to cause
foreign securities owned by the Fund to be held in its offices outside of the
United States and with certain foreign banks and securities depositories. The
Custodian is responsible for safeguarding and controlling the Fund's cash and
securities, handling the receipt and delivery of securities and collecting
interest and dividends on the Fund's investments.
TRANSFER AGENT
Merrill Lynch Financial Data Services, Inc., 4800 Deer Lake Drive East,
Jacksonville, Florida 32246-6484, acts as the Fund's Transfer Agent. The
Transfer Agent is responsible for the issuance, transfer and redemption of
shares and the opening, maintenance and servicing of shareholder accounts. See
"Management of the Fund -- Transfer Agency Services" in the Prospectus.
34
<PAGE> 103
LEGAL COUNSEL
Brown & Wood LLP, One World Trade Center, New York, New York 10048-0557, is
counsel for the Fund.
REPORTS TO SHAREHOLDERS
The fiscal year of the Fund ends on December 31 of each year. The Fund
sends to its shareholders at least semi-annually reports showing the Fund's
portfolio and other information. An annual report, containing financial
statements audited by independent auditors, is sent to shareholders each year.
After the end of each year, shareholders will receive Federal income tax
information regarding dividends and capital gains distributions.
ADDITIONAL INFORMATION
The Prospectus and this Statement of Additional Information do not contain
all the information set forth in the Registration Statement and the exhibits
relating thereto, which the Fund 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.
Under a separate agreement, ML & Co. has granted the Fund 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 Fund at any time or to grant the use of such name to
any other company, and the Fund 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.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
To the knowledge of the Fund, no person owned beneficially 5% or more of
the Fund's shares on July 15, 1997.
35
<PAGE> 104
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders,
Convertible Holdings, Inc.:
We have audited the accompanying statement of assets, liabilities and capital,
including the schedule of investments, of Convertible Holdings, Inc. as of
December 31, 1996, the related statements of operations for the year then ended
and changes in net assets for each of the years in the two-year period then
ended, and the financial highlights for each of the years in the five-year
period then ended. These financial statements and the financial highlights are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements and the financial highlights based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and the financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned at December
31, 1996 by correspondence with the custodian and broker. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such financial statements and financial highlights present
fairly, in all material respects, the financial position of Convertible
Holdings, Inc. as of December 31, 1996, the results of its operations, the
changes in its net assets, and the financial highlights for the respective
stated periods in conformity with generally accepted accounting principles.
Deloitte & Touche LLP
Princeton, New Jersey
February 14, 1997
36
<PAGE> 105
<TABLE>
Convertible Holdings, Inc.
Schedule of Investments as of December 31, 1996
<CAPTION>
S&P Moody's Face Value
Industry Rating Rating Amount Convertible Debentures Cost (Note 1a)
<S> <S> <S> <C> <S> <C> <C>
Automotive NR* Baa3 $ 1,900,000 Magna International Inc., 7.25% due 7/05/2005 $ 1,640,115 $ 1,906,934
Parts--1.2% BB- B1 2,000,000 Mascotech, Inc., 4.50% due 12/15/2003 1,565,000 1,640,000
------------ ------------
3,205,115 3,546,934
Computer/ Apple Computer, Inc.:
Business NR* NR* 1,750,000 6% due 6/01/2001 (d) 1,753,125 1,717,188
Equipment-- NR* NR* 3,500,000 6% due 6/01/2001 3,326,250 3,430,000
2.3% B- B2 1,500,000 Systems and Computer Technology Corp.,
6.25% due 9/01/2003 1,584,500 1,665,000
------------ ------------
6,663,875 6,812,188
Conglomerates BBB+ A3 2,500,000 Cooper Industries, Inc., 7.05%
- --3.3% due 1/01/2015 2,560,000 2,650,000
Polyphase Corporation++:
NR* NR* 1,000,000 12% due 12/01/1997 1,000,000 1,112,500
NR* NR* 2,000,000 12% due 7/01/1999 2,000,000 2,070,000
A- Ba2 3,000,000 Thermo Electron Corporation, 4.25% due
1/01/2003 3,465,000 3,682,500
------------ ------------
9,025,000 9,515,000
Defense--0.5% NR* NR* 1,000,000 Diagnostic/Retrieval Systems, Inc., 9% due
10/01/2003*** 1,000,000 1,430,000
Energy--2.4% BB+ NR* 7,000,000 USX Corp., 7% due 6/15/2017 6,250,000 6,973,750
Environmental BBB+ Baa2 3,500,000 Laidlaw Inc., 6% due 1/15/1999 4,550,000 4,672,500
- --2.6% A- NR* 3,187,000 Thermo TerraTech, Inc., 4.625% due
5/01/2003 (d) 2,891,246 2,900,170
------------ ------------
7,441,246 7,572,670
Financial NR* NR* 2,750,000 Nal Acceptance Corp., 10% due 9/12/1998++ 2,750,000 3,437,500
Services-- NR* NR* 2,500,000 Pioneer Financial Services, Inc., 6.50% due
2.4% 4/01/2003 2,500,000 3,462,500
------------ ------------
5,250,000 6,900,000
Gaming--0.1% B- B3 377,000 Argosy Gaming Company, 12% due 6/01/2001 338,885 306,784
Health Care-- B B3 14,254,000 GranCare Inc., 6.50% due 1/15/2003 14,307,675 14,610,350
8.3% B- B2 6,000,000 Integrated Health Services Inc., 6% due
1/01/2003 5,640,000 5,820,000
BBB+ Ba1 4,122,000 Quantum Health Resources, Inc., 4.75% due
10/01/2000 3,547,597 3,709,800
------------ ------------
23,495,272 24,140,150
Home Building B- B2 2,200,000 Continental Homes Holding Corp., 6.875%
- --1.5% due 11/01/2002 2,200,000 2,318,250
BB- Ba3 751,000 Toll Brothers Inc., 4.75% due 1/15/2004 627,190 762,265
B+ B1 1,500,000 US Home Corp., 4.875% due11/01/2005 1,316,875 1,327,500
------------ ------------
4,144,065 4,408,015
Insurance-- NR* NR* 1,831,000 Statesman Group, Inc. (The), 6.25% due
0.7% 5/01/2003 1,920,886 1,927,128
Machinery-- B+ B1 2,700,000 Varlen Corp., 6.50% due 6/01/2003 2,746,250 2,700,000
0.9%
</TABLE>
37
<PAGE> 106
<TABLE>
Convertible Holdings, Inc.
Schedule of Investments as of December 31, 1996 (continued)
<CAPTION>
S&P Moody's Face Value
Industry Rating Rating Amount Convertible Debentures Cost (Note 1a)
<S> <S> <S> <C> <S> <C> <C>
Medical NR* NR* $ 1,500,000 US Diagnostic Labs, Inc., 9% due $ 1,500,000 $ 1,852,500
Services--0.6% 3/31/2003 (d)
Medical NR* Ba3 250,000 Bindley Western Industries, Inc., 6.50% due
Supplies--0.1% 10/01/2002 253,750 270,000
NR* NR* 550,000 Phoenix Shannon PLC, 9.50% due 11/01/2000 (d) 550,000 68,750
------------ ------------
803,750 338,750
Oil Services NR* NR* 6,100,000 Key Energy Group Inc., 7.50% due 7/01/2003 (d) 6,447,063 7,442,000
- --3.0% BBB- Ba2 1,000,000 Nabors Industries, Inc., 5% due 5/15/2006 1,000,000 1,235,000
------------ ------------
7,447,063 8,677,000
Paper--1.0% NR* NR* 11,270,000 Kymmene Corporation, 8.25% due 11/18/2043 2,867,286 2,803,970
Printing--0.6% NR* B1 2,065,000 Graphic Industries, Inc., 7% due 5/15/2006 1,840,438 1,858,500
Real Estate NR* B3 1,500,000 Capstone Capital Trust, Inc., 10.50% due
Investment 4/01/2002 1,631,250 2,068,125
Trust--0.7%
Restaurants-- B- B3 1,000,000 Hometown Buffet Inc., 7% due 12/01/2002 1,000,000 1,027,500
0.4%
Retail Stores B- B3 1,725,000 Baby Superstore Inc., 4.875% due 10/01/2000 1,677,313 1,707,750
- --4.3% B- B3 2,475,000 Baker (J.) Inc., 7% due 6/01/2002 1,936,267 1,980,000
A+ A1 4,000,000 Home Depot, Inc., 3.25% due 10/01/2001 4,000,000 3,900,000
B+ B1 2,500,000 Pier 1 Imports, Inc., 5.75% due 10/01/2003 2,500,000 2,650,000
B- B2 3,250,000 Sports & Recreation, Inc., 4.25% due
11/01/2000 2,442,875 2,380,625
------------ ------------
12,556,455 12,618,375
Scientific NR* NR* 4,750,000 Thermo Instrument Systems Inc., 4.50% due
Equipment--1.7% 10/15/2003 (d) 4,780,000 4,845,000
Semiconductor-- NR* A3 5,250,000 Cypress Semiconductor Corporation, 3.15%
2.0% due 3/15/2001 (d) 4,840,016 5,722,500
Technology-- NR* NR* 1,000,000 Broadband Technologies, Inc., 5% due
0.3% 5/15/2001 813,750 765,000
Textiles-- B+ B1 3,806,000 Fieldcrest Cannon, Inc., 6% due
1.0% 3/15/2012 2,889,280 2,883,045
Water Treatment BB+ B2 3,000,000 US Filter Corp., 4.50% due 12/15/2001 3,000,000 3,052,500
Systems--1.1%
Total Convertible Debentures--43.0% 117,449,882 124,745,384
<CAPTION>
Shares
Held Convertible Preferred Stocks
<S> <S> <S> <C> <S> <C> <C>
Automotive BB- B1 242,600 Masco Tech, Inc., $1.20 3,643,799 3,820,950
Parts--1.3%
Banking & A Aa3 38,400 Banc One Corporation, $3.50, Series C 2,509,287 3,187,200
Finance--4.1% A- A2 60,200 Boatmen's Bancshares, Inc., $1.75 1,667,550 3,326,050
NR* A1 10,000 Jefferson Pilot Corp. (ACES) (into Nations
Bank Corp.) 725,000 910,000
BB+ NR* 89,400 Union Planters Corp., $2.00, Series E 2,818,585 4,380,600
------------ ------------
7,720,422 11,803,850
Chemicals--0.1% A A2 19,000 Atlantic Richfield Company (ARCO) (b) 473,765 408,500
Computer AA- A1 34,200 Microsoft Corp., Series A 2,731,725 2,736,000
Software--1.0%
</TABLE>
38
<PAGE> 107
<TABLE>
Convertible Holdings, Inc.
Schedule of Investments as of December 31, 1996 (continued)
<CAPTION>
S&P Moody's Face Value
Industry Rating Rating Amount Convertible Preferred Stocks Cost (Note 1a)
<S> <S> <S> <C> <S> <C> <C>
Financial A- Baa1 71,700 SunAmerica Inc. $ 2,688,750 $ 3,029,325
Services--1.0%
Funeral--0.8% BBB Baa3 25,000 SCI Finance, $3.125, Series A 1,520,250 2,353,125
Insurance--0.8% NR* NR* 2,000 Westbridge Capital Corporation, Series A 2,000,000 2,344,000
Minerals--0.9% NR* Ba1 43,150 Cyprus Amax Minerals Co., $4.00, Series A 2,312,840 2,485,440
Paper--1.5% BB+ Ba2 23,800 James River Corp. of Virginia, $3.375,
Series K 1,092,551 1,222,725
BB+ Ba2 9,400 James River Corp. of Virginia $3.50,
Series L 444,514 486,450
BB+ Ba2 85,000 James River Corp. of Virginia, Series P 1,992,600 2,677,500
------------ ------------
3,529,665 4,386,675
Precious NR* B2 217,600 Coeur d'Alene Mines Corporation 3,793,296 3,808,000
Metals--1.3%
Real Estate BBB Baa3 80,000 Merry Land & Investment Co., Inc., $2.15,
Investment Series C 2,000,000 2,110,000
Trust--3.1% BBB Baa3 40,000 Merry Land & Investment Services, Inc.,
$1.75, Series A 1,000,000 1,145,000
BBB Baa3 60,000 Public Storage Inc., $2.062 1,518,600 3,127,500
BBB+ Baa3 80,000 Security Capital Pacific Trust, Series A 2,000,000 2,450,000
------------ ------------
6,518,600 8,832,500
Restaurants-- BBB Baa2 70,000 Wendy's International, Inc., Series A 3,500,000 3,640,000
1.3%
Steel--0.6% B B1 52,000 AK Steel Holding Corp. 1,348,342 1,833,000
Technology NR* A1 30,000 Morgan Stanley Group, Inc., Series C (into cisco
0.7% Systems, Inc.) 2,006,250 1,987,500
Tobacco--1.7% NR* Ba3 748,000 RJR Nabisco Holdings, Inc., Series C 4,093,744 5,049,000
Toys--1.8% B- B3 500,000 Tyco Toys, Inc., Series C 2,500,000 5,062,500
Waste A A1 85,000 Browning-Ferris Industries, Inc. 2,500,387 2,422,500
Management--
0.8%
Total Convertible Preferred Stocks--22.8% 52,881,835 66,002,865
<CAPTION>
Common Stocks
<S> <S> <S> <C> <S> <C> <C>
Automobile Parts--0.7% 52,800 Federal Mogul Corp. 1,243,968 1,161,600
14,800 Magna International Inc., Class A 329,559 825,100
------------ ------------
1,573,527 1,986,700
Banking & Finance--0.3% 20,000 Washington Mutual Savings Bank 220,278 865,000
Cement--0.9% 79,000 Medusa Corp. 2,666,125 2,715,625
Chemicals--0.3% 40,000 Lyondell Petrochemical Company 942,400 880,000
Computer Equipment--2.9% 254,536 EMC Corporation*** (e) 5,993,635 8,431,505
Computers--0.9% 57,700 Storage Technology Corporation (e) 2,045,431 2,747,963
Electronics--2.5% 30,000 Arrow Electronics, Inc. 994,375 1,605,000
81,395 Avnet, Inc. 3,769,959 4,741,259
64,154 Rexel SA (e) 890,670 1,018,445
------------ ------------
5,655,004 7,364,704
</TABLE>
39
<PAGE> 108
<TABLE>
Convertible Holdings, Inc.
Schedule of Investments as of December 31, 1996 (continued)
<CAPTION>
Shares Value
Industry Held Common Stocks Cost (Note 1a)
<S> <C> <S> <C> <C>
Drug Distribution--0.3% 48,900 Bindley Western Industries Inc. $ 941,309 $ 947,437
Energy--0.6% 49,000 Calenergy Inc. (e) 1,079,135 1,647,625
Financial Services--0.7% 1 Nal Acceptance Corp. (Warrants) (c)++ 0 206,250
50,000 Onbancorp Inc. 1,737,500 1,856,250
------------ ------------
1,737,500 2,062,500
Food Processing--0.9% 137,800 Hudson Foods, Inc., Class A 2,044,553 2,618,200
Health Services--0.6% 15,000 Allegiance Corporation 91,946 414,375
126,500 Regency Health Services Inc. (e) 1,472,322 1,217,563
------------ ------------
1,564,268 1,631,938
Hospital Supplies--1.1% 75,000 Baxter International, Inc. 1,098,246 3,075,000
Metal Fabricating--1.7% 128,479 Trinity Industries Leasing Co. 2,974,237 4,817,962
Oil Services--0.6% 160,900 Key Energy Group Inc. (e) 1,540,282 1,890,575
Paper--1.0% 34,700 Boise Cascade Corporation 1,147,182 1,101,725
47,200 International Paper Co. 1,843,632 1,905,700
------------ ------------
2,990,814 3,007,425
Paper/Machine--1.5% 182,300 Albany International Corp., Class A (e) 3,504,705 4,215,687
Pharmaceuticals--0.2% 40,000 IVAX Corp. 636,600 410,000
Semiconductor Capital 40,000 Novellus Systems Inc. (e) 2,176,376 2,165,000
Equipment--0.7%
Semiconductors--1.3% 200,000 Integrated Device Technology, Inc. 2,542,863 2,725,000
45,400 Park Electrochemical Corporation 834,092 1,032,850
------------ ------------
3,376,955 3,757,850
Steel--0.6% 197,200 WHX Corp (e) 1,718,699 1,750,150
Technology--0.1% 18,000 BroadBand Technologies, Inc. 373,500 265,500
Telecommunications--1.1% 173,364 ICG Communications, Inc.*** (e) 2,894,332 3,055,540
Utilities--0.6% 156,286 Citizens Utilities Company (Class A) 1,691,312 1,699,607
Waste Management--1.8% 316,351 Allied Waste Industries, Inc.*** (e) 1,509,180 2,886,703
162,000 Philip Environmental Inc. (ADR) (a) (e) 1,422,146 2,349,000
------------ ------------
2,931,326 5,235,703
Total Common Stocks--23.9% 54,370,549 69,245,196
</TABLE>
40
<PAGE> 109
<TABLE>
Convertible Holdings, Inc.
Schedule of Investments as of December 31, 1996 (concluded)
<CAPTION>
Face Value
Amount Short-Term Securities Cost (Note 1a)
<S> <C> <S> <C> <C>
Commercial Paper**-- $ 4,000,000 Coca-Cola Company (The), 5.80% due
11.3% 1/17/1997 $ 3,989,044 $ 3,989,044
10,000,000 Delaware Funding Corp., 5.50% due 1/10/1997 9,984,722 9,984,722
14,672,000 General Motors Acceptance Corp., 7.50%
due 1/02/1997 14,665,887 14,665,887
4,000,000 International Securitization Corporation,
5.80% due 1/22/1997 3,985,822 3,985,822
------------ ------------
32,625,475 32,625,475
US Government & Agency 10,000,000 Federal National Mortgage Association, 5.30%
Obligations**--3.4% due 1/08/1997 9,988,222 9,988,222
Total Short-Term Securities--14.7% 42,613,697 42,613,697
Total Investments--104.4% $267,315,963 302,607,142
------------
Short Sales (Proceeds--$12,209,627)--(4.0%) (11,515,803)
Liabilities in Excess of Other Assets--(0.4%) (1,098,466)
------------
Net Assets--100.0% $289,992,873
============
<FN>
(a)American Depositary Receipts (ADR).
(b)Convertible into Lyondell Petrochemical Co.
(c)Warrants entitle the Company to purchase a predetermined number of shares of
Common Stock. The purchase price and number of shares are subject to
adjustment under certain conditions until the expiration date.
(d)These securities may be offered and sold to "qualified institutional buyers"
under rule 144A of the Securities Act of 1933.
(e)Non-income producing security.
*Not Rated.
**Commercial Paper and certain US Government & Agency Obligations are traded
on a discount basis; the interest rates shown are the discount rates paid at
the time of purchase by the Company.
***Covered Short Sales entered into as of December 31, 1996 were as follows:
<CAPTION>
Value
Shares Issue (Notes 1a & 1g)
<S> <S> <C>
241,100 Allied Waste Industries, Inc. $ (2,230,175)
73,900 Diagnostic/Retrieval Systems, Inc. (923,750)
160,800 EMC Corporation (5,326,500)
172,220 ICG Communications, Inc. (3,035,378)
Total (proceeds--$12,209,627) $(11,515,803)
============
++Restricted securities as to resale. The value of the Company's
investment in restricted securities was approximately $6,826,000,
representing 2.4% of net assets.
<CAPTION>
Acquisition Value
Issue Date Cost (Note 1a)
<S> <S> <C> <C>
Nal Acceptance Corp.,
10% due 9/12/1998 9/12/1996 $2,750,000 $3,437,500
Nal Acceptance Corp. (Warrants) 9/12/1996 0 206,250
Polyphase Corporation:
12% due 12/01/1997 12/05/1996 1,000,000 1,112,500
12% due 7/01/1999 7/05/1994 2,000,000 2,070,000
Total $5,750,000 $6,826,250
========== ==========
Ratings of issues shown have not been audited by Deloitte & Touche LLP.
See Notes to Financial Statements.
</TABLE>
41
<PAGE> 110
<TABLE>
Convertible Holdings, Inc.
Statement of Assets, Liabilities and Capital as of December 31, 1996
<S> <C> <C>
Assets:
Investments, at value (identified cost--$267,315,963) (Note 1a) $302,607,142
Cash 22,969
Deposit on short sales (Note 1g) 11,559,616
Receivables:
Interest $ 2,051,283
Securities sold 1,173,890
Dividends 405,056 3,630,229
------------
Deferred organization expenses (Note 1e) 22,259
Prepaid expenses and other assets 34,191
------------
Total assets 317,876,406
------------
Liabilities:
Common stocks, sold short, at market value (proceeds--$12,209,627) (Notes 1a & 1g) 11,515,803
Payables:
Dividends to shareholders 10,944,793
Income taxes (Note 1c) 4,841,320
Investment adviser (Note 2) 445,812 16,231,925
------------
Accrued expenses and other liabilities 135,805
------------
Total liabilities 27,883,533
------------
Net Assets $289,992,873
============
Capital (Note 5):
Income Shares:
Par value $.10 per share; 15,000,000 shares authorized; shares issued 11,653,700 $ 1,165,370
Liquidation capital in excess of par 107,214,040
------------
108,379,410
Undistributed investment income--net 128,996
------------
Net asset value, equivalent to $9.31 per share based on 11,653,700 shares
outstanding market value--$9.625) $108,508,406
Capital Shares:
Par value $.10 per share; 15,000,000 shares authorized; 11,653,700 shares issued 1,165,370
Paid-in capital in excess of par 145,690,000
------------
Total 146,855,370
------------
Accumulated realized losses on investments--net* (1,355,248)
Unrealized appreciation on investments--net 35,984,345
------------
Total 34,629,097
------------
Net asset value, equivalent to $15.57 per share based on 11,653,700 shares
outstanding (market value--$14.625) 181,484,467
------------
Net Assets $289,992,873
============
<FN>
*Net of taxes on undistributed net realized long-term capital gains (Note 1c).
See Notes to Financial Statements.
</TABLE>
42
<PAGE> 111
<TABLE>
Convertible Holdings, Inc.
Statement of Operations for the Year Ended December 31, 1996
<S> <C> <C>
Investment Income (Notes 1c & 1d):
Interest and discount earned $ 10,364,183
Dividends (net of $2,260 foreign withholding tax) 5,941,459
------------
Total income $ 16,305,642
Expenses:
Investment advisory fees (Note 2) 1,695,738
Accounting services (Note 2) 99,274
Transfer agent fees 87,085
Professional fees 69,955
Printing and shareholder reports 49,591
Directors' fees and expenses 45,322
Amortization of organization expenses (Note 1e) 38,159
Interest on securities sold short 36,292
Custodian fees 26,466
Insurance 4,958
Dividends on securities sold short 4,704
Pricing services 2,983
Listing fees 250
Other 39,726
------------
Total expenses 2,200,503
------------
Investment income--net 14,105,139
------------
Realized & Unrealized Gain (Loss) on Investments & Foreign Currency
Transactions--Net (Notes 1b, 1c, 1d & 3):
Realized gain (loss) from:
Investments--net $ 19,901,753
Income taxes on realized gain on investments (4,841,320)
Foreign currency transactions (19,719) 15,040,714
------------
Change in unrealized appreciation/depreciation on:
Investments--net 17,386,660
Foreign currency transactions (441) 17,386,219
------------ ------------
Net realized and unrealized gain on investments and foreign currency transactions 32,426,933
------------
Net Increase in Net Assets Resulting from Operations $ 46,532,072
============
See Notes to Financial Statements.
</TABLE>
43
<PAGE> 112
<TABLE>
Convertible Holdings, Inc.
Statements of Changes in Net Assets
<CAPTION>
For the Year
Ended December 31,
1996 1995
Increase (Decrease) in Net Assets:
<S> <C> <C>
Operations:
Investment income--net $ 14,105,139 $ 14,296,369
Realized gain on investments and foreign currency transactions--net 19,882,034 15,446,497
Income taxes on realized gain on investments (4,841,320) (3,631,624)
Change in unrealized appreciation/depreciation on investments and foreign currency
transactions--net 17,386,219 19,334,251
------------ ------------
Net increase in net assets resulting from operations 46,532,072 45,445,493
------------ ------------
Dividends & Distributions to Shareholders (Notes 1f & 4):
Investment income--net (14,192,493) (14,117,464)
Realized gain on investments--net (7,473,704) (4,235,374)
------------ ------------
Net decrease in net assets resulting from dividends and distributions to shareholders (21,666,197) (18,352,838)
------------ ------------
Capital Share Transactions (Note 5):
Income shares -- (192,510)
Capital shares -- (238,874)
------------ ------------
Net decrease in net assets resulting from Treasury stock transactions -- (431,384)
------------ ------------
Net Assets:
Total increase in net assets 24,865,875 26,661,271
Beginning of year 265,126,998 238,465,727
------------ ------------
End of year* $289,992,873 $265,126,998
============ ============
<FN>
*Undistributed investment income--net (Note 1h) $ 128,996 $ 223,416
============ ============
See Notes to Financial Statements.
</TABLE>
44
<PAGE> 113
<TABLE>
Convertible Holdings, Inc.
Financial Highlights
<CAPTION>
The following per share data and ratios have been derived from information
provided in the financial statements.
For the Year Ended December 31,
Increase (Decrease) in Net Asset Value: 1996++++ 1995 1994 1993 1992
<S> <C> <C> <C> <C> <C>
Income Shares:
Per Share Operating Performance:
Net asset value, beginning of year $ 9.32 $ 9.30 $ 9.30 $ 9.30 $ 9.31
-------- -------- -------- -------- --------
Investment income--net 1.21 1.23 1.19 1.20 1.35
Dividends of investment income--net (1.22) (1.21) (1.19) (1.20) (1.36)
-------- -------- -------- -------- --------
Net asset value, end of year $ 9.31 $ 9.32 $ 9.30 $ 9.30 $ 9.30
======== ======== ======== ======== ========
Market price per share, end of year $ 9.625 $ 10.00 $ 10.00 $ 10.625 $ 11.25
======== ======== ======== ======== ========
Total Investment Return:*
Based on market value per share 9.22% 13.58% 6.61% 7.20% 2.74%
======== ======== ======== ======== ========
Based on net asset value per share 13.35% 13.82% 13.28% 13.50% 15.17%
======== ======== ======== ======== ========
Capital Shares:
Per Share Operating Performance:
Net asset value, beginning of year $ 13.43 $ 11.13 $ 13.21 $ 12.87 $ 10.91
-------- -------- -------- -------- --------
Realized and unrealized gain (loss) on investments
and foreign currency transactions--net 2.78 2.66 (2.12) 1.43 2.03
Distributions of realized gain on investments--net (.64) (.36) (.01) (1.17) (.12)
Effect of repurchase of Treasury Stock -- --++ .05 .08 .05
-------- -------- -------- -------- --------
Net asset value, end of year $ 15.57 $ 13.43 $ 11.13 $ 13.21 $ 12.87
======== ======== ======== ======== ========
Market value per share, end of year $ 14.625 $ 11.625 $ 9.00 $ 10.875 $ 9.375
======== ======== ======== ======== ========
Total Investment Return:*
Based on market value per share 30.87% 33.20% (17.17%) 28.77% 38.11%
======== ======== ======== ======== ========
Based on net asset value per share 20.60% 24.44% (15.68%) 13.94% 19.48%
======== ======== ======== ======== ========
Total Fund:
Ratios to Average Net Assets:
Total expenses** .78% .79% .87% .80% .80%
======== ======== ======== ======== ========
Investment income--net 4.98% 5.40% 5.43% 5.10% 6.34%
======== ======== ======== ======== ========
Supplemental Data:
Net assets, end of year (in thousands) $289,993 $265,127 $238,466 $274,999 $289,366
======== ======== ======== ======== ========
Portfolio turnover 129.06% 87.69% 69.37% 116.03% 76.54%
======== ======== ======== ======== ========
Average commission rate paid+++ $ .0447 -- -- -- --
======== ======== ======== ======== ========
<FN>
*Total investment returns based on market value, which can be significantly
greater or lesser than the net asset value, may result in substantially
different returns. Total investment returns exclude the effects of sales
loads.
**Excluding taxes on undistributed net realized long-term capital
gains (Note 1c).
+++For fiscal years beginning on or after September 1, 1995, the Fund is
required to disclose its average commission rate per share for purchases
and sales of equity securities.
++Amount is less than $.01 per capital share.
++++Based on average shares outstanding during the period.
See Notes to Financial Statements.
</TABLE>
45
<PAGE> 114
Convertible Holdings, Inc.
Notes to Financial Statements
1. Significant Accounting Policies:
Convertible Holdings, Inc. (the "Company") is a diversified, closed-
end, "dual purpose" investment company. The following is a summary
of significant accounting policies followed by the Company.
(a) Valuation of investments--Portfolio securities which are traded only on
stock exchanges are valued at the last sale price as of the close of business
on the day the securities are being valued, or lacking any sales, at the last
available bid price. Securities traded in the over-the-counter market are
valued at the most recent bid prices as obtained from one or more dealers that
make markets in these securities. Portfolio securities which are traded both in
the over-the-counter markets and on a stock exchange are valued according to
the broadest and most representative market. Short-term securities are valued
at amortized cost, which approximates market value. Securities and assets for
which market quotations are not readily available and securities subject to
restrictions on resale are valued at fair value as determined in good faith by
or under the direction of the Board of Directors of the Company.
(b) Foreign currency transactions--Transactions denominated in foreign
currencies are recorded at the exchange rate prevailing when recognized. Assets
and liabilities denominated in foreign currencies are valued at the exchange
rate at the end of the period. Foreign currency transactions are the result of
settling (realized) or valuing (unrealized) assets or liabilities expressed in
foreign currencies into US dollars. Realized and unrealized gains or losses
from investments include the effects of foreign exchange rates on investments.
(c) Income taxes--It is the Company's policy to comply with the requirements of
the Internal Revenue Code applicable to regulated investment companies and to
distribute all of its taxable net investment income and net realized short-term
capital gains. The Company intends to retain net realized long-term capital
gains, if any, and pay taxes on such gains at the Federal tax rates applicable
to corporations. Under the applicable foreign tax law, a withholding tax may be
imposed on dividends, interest, and capital gains at various rates.
(d) Security transactions and investment income--Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Dividend income is recorded on the ex- dividend date. Interest income (including
amortization of discount) is recognized on the accrual basis. Realized gains and
losses on security transactions are determined on the identified cost basis.
(e) Deferred organization expenses--Deferred organization expenses are charged
to expense on a straight-line basis over a twelve-year period ending on July
31, 1997, the redemption date for the Income Shares.
(f) Dividends and distributions--Dividends and distributions paid by
the Company are recorded on the ex-dividend dates.
(g) Short sales--When the Company engages in a short sale, an amount equal to
the proceeds received by the Company is reflected as an asset and equivalent
liability. The amount of the liability is subsequently marked to market to
reflect the market value of the short sale. The Company maintains a segregated
account of securities and cash as collateral for the short sales. The Company
owns convertible bonds or stock of the same issuer which covers the short sale.
The Company is exposed to market risk based on the amount, if any, that the
market value of the stock exceeds proceeds received. Securities have been
borrowed from Merrill Lynch, Pierce, Fenner & Smith Inc. ("MLPF&S"), a
subsidiary of Merrill Lynch & Co., Inc.
("ML & Co."), to execute short sales.
(h) Reclassification--Generally accepted accounting principles require that
certain components of net assets be adjusted to reflect permanent differences
between financial and tax reporting. Accordingly, $8,991,012 has been
reclassified from accumulated net realized capital losses to paid-in capital
for the amount of long-term capital gains net of taxes paid and $7,066 has been
reclassified from accumulated net realized capital losses to undistributed net
investment income. These reclassifications have no effect on net assets or net
asset values per share.
46
<PAGE> 115
Convertible Holdings, Inc.
Notes to Financial Statements (continued)
2. Investment Advisory Agreement and
Transactions with Affiliates:
The Company has entered into an Investment Advisory Agreement with
Merrill Lynch Asset Management, L.P. ("MLAM"). The general partner
of MLAM is Princeton Services, Inc. ("PSI"), an indirect wholly-
owned subsidiary of ML & Co., which is the limited partner.
MLAM is responsible for the management of the Company's portfolio and provides
the necessary personnel, facilities, equipment and certain other services
necessary to the operations of the Company. For such services, the Company pays
MLAM a quarterly fee at the annual rate of 0.60% of the Company's average
weekly net assets.
The investment advisory fee is reduced by 25% for any quarter in which the
Company fails to meet the Minimum Income Rate Objective ("Objective") at the
close of any fiscal quarter.
The Objective is to obtain a minimum annualized rate of income return equal to
85% of the yield of the Value Line Convertible Index.
Accounting services are provided to the Company by MLAM at cost.
During the year ended December 31, 1996, the Company paid Merrill Lynch
Security Pricing Service, an affiliate of MLPF&S, $1,525 for security price
quotations to compute the net asset value of the Company.
Certain officers and/or directors of the Company are officers and/or directors
of MLAM, PSI, MLPF&S, and/or ML & Co.
In addition, MLPF&S received $177,752 in commissions on the execution of
portfolio security transactions for the Company for the year ended December 31,
1996.
3. Investments:
Purchases and sales of investments, excluding short-term securities, for the
year ended December 31, 1996 were $352,903,170 and $392,170,625, respectively.
Net realized and unrealized gains (losses) as of December 31, 1996 were as
follows:
Realized Unrealized
Gains (Losses) Gains (Losses)
Long-term investments $22,556,449 $35,291,179
Short-term investments 58 --
Short sales (2,654,754) 693,824
Foreign currency
transactions (19,719) (658)
----------- -----------
Total $19,882,034 $35,984,345
=========== ===========
As of December 31, 1996, net unrealized appreciation for Federal income tax
purposes aggregated $34,060,027, of which $37,018,635 related to appreciated
securities and $2,958,608 related to depreciated securities. The aggregate cost
of investments at December 31, 1996 for Federal income tax purposes was
$268,547,115.
4. Distributions:
The Company distributes its net investment income quarterly to holders of
Income Shares. Income Shares are entitled to cumulative dividends in an amount
equivalent to net investment income, with a minimum annual rate of $1.00 per
share. To the extent that any such cumulative dividend cannot be satisfied from
net investment income, it will be paid from any net realized short-term or
long-term capital gains. Capital Shares will not be entitled to receive
distributions from net investment income until 1997.
To the extent not needed to pay the Income Shares' minimum cumulative
dividends, distributions from net realized short-term capital gains, if any,
may be paid to holders of the Capital Shares in the succeeding year. The
Company will not distribute net realized long-term capital gains except to the
limited extent described above.
47
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Convertible Holdings, Inc.
Notes to Financial Statements (concluded)
5. Share Transactions:
At December 31, 1996, there were 15,000,000 shares of $.10 par value authorized
for each class. During the year ended December 31, 1996, the Company's Income
Shares and Capital Shares outstanding remained constant at 11,653,700 and
11,653,700, respectively.
As long as any Income Shares are outstanding, the Company will not issue any
additional Capital Shares or Income Shares.
On September 27, 1996, the Board of Directors authorized the redemption of the
Income Shares to take place on July 31, 1997 for $9.30 per share plus
accumulated and unpaid dividends ("liquidation value"). As a result of this
liquidation preference, the per share capital of the Income Shares is
maintained at the liquidation value plus any unpaid income dividends. After
July 31, 1997, Capital Shares will then be the sole remaining class of shares
of the Company outstanding. On February 13, 1997, the holders of Capital Shares
approved a proposal to convert the Company to an open-end investment company.
48
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- ------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
<S> <C>
Investment Objective and Policies....... 2
Portfolio Strategies Involving
Options, Futures and Foreign
Exchange Transactions............... 3
Other Investment Policies and
Practices........................... 3
Investment Restrictions............... 5
Management of the Fund.................. 8
Directors and Officers................ 8
Compensation of Directors............. 9
Management and Advisory
Arrangements........................ 10
Purchase of Shares...................... 11
Initial Sales Charge Alternatives --
Class A and Class D Shares.......... 12
Reduced Initial Sales Charges......... 13
Employer-Sponsored Retirement or
Savings Plans and Certain Other
Arrangements........................ 16
Distribution Plans.................... 16
Limitations on the Payment of Deferred
Sales Charges....................... 17
Redemption of Shares.................... 17
Deferred Sales Charges --
Class B and Class C Shares.......... 18
Portfolio Transactions and Brokerage.... 18
Determination of Net Asset Value........ 20
Shareholder Services.................... 22
Investment Account.................... 22
Automatic Investment Plans............ 22
Automatic Reinvestment of Dividends
and Capital Gains Distributions..... 23
Systematic Withdrawal Plans --
Class A and Class D Shares.......... 23
Exchange Privilege.................... 24
Dividends, Distributions and Taxes...... 26
Dividends and Distributions........... 26
Taxes................................. 27
Tax Treatment of Options and Futures
Transactions........................ 29
Special Rules for Certain Foreign
Currency Transactions............... 30
Performance Data........................ 31
General Information..................... 33
Description of Shares................. 33
Computation of Offering Price Per
Share............................... 34
Independent Auditors.................. 34
Custodian............................. 34
Transfer Agent........................ 34
Legal Counsel......................... 35
Reports to Shareholders............... 35
Additional Information................ 35
Security Ownership of Certain
Beneficial Owners................... 35
Independent Auditors' Report............ 36
Financial Statements.................... 37
Code # 19011-0897
</TABLE>
Merrill Lynch Logo
MERRILL LYNCH
CONVERTIBLE FUND, INC.
[MLYNCH COMPASS GRAPH]
STATEMENT OF
ADDITIONAL
INFORMATION
August 4, 1997
Distributor:
Merrill Lynch
Funds Distributor, Inc.
<PAGE> 121
APPENDIX FOR GRAPHIC AND IMAGE MATERIAL
Pursuant to Rule 304 of Regulation S-T, the following table presents
fair and accurate narrative descriptions of graphic and image material omitted
from this EDGAR Submission File due to ASCII-incompatibility and
cross-references this material to the location of each occurrence in the text.
<TABLE>
<CAPTION>
DESCRIPTION OF OMITTED LOCATION OF GRAPHIC
GRAPHIC OR IMAGE OR IMAGE IN TEXT
- ---------------------- -------------------
<S> <C>
Compass plate, circular Back cover of Prospectus and
graph paper and Merrill Lynch back cover of Statement of
logo including stylized market Additional Information
bull.
</TABLE>
