FEDERATED ARMS FUND, 497, 1996-10-30

FEDERATED ARMS FUND
497, 1996-10-30

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FEDERATED ARMS FUND

INSTITUTIONAL SHARES

PROSPECTUS

The Institutional Shares offered by this prospectus represent interests in a
diversified portfolio of securities (the "Fund") of Federated ARMs Fund (the
"Trust"). The Trust is an open-end management investment company (a mutual
fund).

The investment objective of the Fund is to provide current income consistent
with minimal volatility of principal. The Fund concentrates at least 65% of
the value of its total assets in adjustable and floating rate mortgage
securities ("ARMs") which are issued or guaranteed as to payment of
principal and interest by the U.S. government, its agencies or
instrumentalities.

THE SHARES OFFERED BY THIS PROSPECTUS ARE NOT DEPOSITS OR OBLIGATIONS OF ANY
BANK, ARE NOT ENDORSED OR GUARANTEED BY ANY BANK, AND ARE NOT INSURED BY THE
FEDERAL DEPOSIT INSURANCE CORPORATION, THE FEDERAL RESERVE BOARD, OR ANY
OTHER GOVERNMENT AGENCY. INVESTMENT IN THESE SHARES INVOLVES INVESTMENT
RISKS, INCLUDING THE POSSIBLE LOSS OF PRINCIPAL.

This prospectus contains the information you should read and know before you
invest in Institutional Shares of the Fund. Keep this prospectus for future
reference.

The Fund has also filed a Statement of Additional Information for
Institutional Shares and Institutional Service Shares dated October 31,
1996, with the Securities and Exchange Commission ("SEC"). The information
contained in the Statement of Additional Information is incorporated by
reference into this prospectus. You may request a copy of the Statement of
Additional Information or a paper copy of this prospectus if you have
received your prospectus electronically, free of charge by calling
1-800-341-7400. To obtain other information or to make inquiries about the
Fund, contact the Fund at the address listed in the back of this prospectus.
The Statement of Additional Information, material incorporated by reference
into this document, and other information regarding the Fund is maintained
electronically with the SEC at Internet Web site (http://www.sec.gov).

THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED
UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE
CONTRARY IS A CRIMINAL OFFENSE.

Prospectus dated October 31, 1996

TABLE OF CONTENTS

SUMMARY OF FUND EXPENSES 1
FINANCIAL HIGHLIGHTS --
INSTITUTIONAL SHARES 2
GENERAL INFORMATION 3
INVESTMENT INFORMATION 3
Investment Objective 3
Investment Policies 3
Investment Limitations 8
TRUST INFORMATION 8
Management of the Trust 8
Distribution of Institutional Shares 10
Administration of the Fund 10
NET ASSET VALUE 11
INVESTING IN INSTITUTIONAL SHARES 11
Share Purchases 11
Minimum Investment Required 11
What Shares Cost 12
Exchanging Securities for
Institutional Shares 12
Certificates and Confirmations 12
Dividends 12
Capital Gains 12
REDEEMING INSTITUTIONAL SHARES 12
Telephone Redemption 13
Written Requests 13
Accounts with Low Balances 14
SHAREHOLDER INFORMATION 14
Voting Rights 14
TAX INFORMATION 14
Federal Income Tax 14
State and Local Taxes 15
PERFORMANCE INFORMATION 15
OTHER CLASSES OF SHARES 15
FINANCIAL HIGHLIGHTS --
INSTITUTIONAL SERVICE SHARES 16
FINANCIAL STATEMENTS 17
REPORT OF ERNST & YOUNG LLP,
INDEPENDENT AUDITORS 26
ADDRESSES 27
<TABLE>
<CAPTION>

SUMMARY OF FUND EXPENSES

INSTITUTIONAL SHARES
SHAREHOLDER TRANSACTION EXPENSES

<S> <C>

Maximum Sales Charge Imposed on Purchases
(as a percentage of offering price) None
Maximum Sales Charge Imposed on Reinvested Dividends
(as a percentage of offering price) None
Contingent Deferred Sales Charge (as a percentage of original purchase
price or redemption proceeds, as applicable) None
Redemption Fee (as a percentage of amount redeemed, if applicable) None
Exchange Fee None

ANNUAL OPERATING EXPENSES
(As a percentage of average net assets)

Management Fee (after waiver)(1) 0.41%
12b-1 Fee None
Total Other Expenses 0.14%
Shareholder Services Fee (after waiver)(2) 0.00%
Total Operating Expenses(3) 0.55%

</TABLE>

(1) The management fee has been reduced to reflect the voluntary waiver of a
portion of the management fee. The adviser can terminate this voluntary
waiver at any time at its sole discretion. The maximum management fee is
0.60%.

(2) The shareholder services fee has been reduced to reflect the voluntary
waiver of the shareholder services fee. The shareholder services provider
can terminate this voluntary waiver at any time at its sole discretion. The
maximum shareholder services fee is 0.25%.

(3) The total operating expenses would have been 0.99% absent the voluntary
waivers of a portion of the management fee and the shareholder services fee.

The purpose of this table is to assist an investor in understanding the
various costs and expenses that a shareholder of the Fund will bear, either
directly or indirectly. For more complete descriptions of the various costs
and expenses, see "Investing in Institutional Shares" and "Trust
Information." Wire-transferred redemptions of less than $5,000 may be
subject to additional fees.
<TABLE>
<CAPTION>

EXAMPLE 1 YEAR 3 YEARS 5 YEARS 10 YEARS
You would pay the following expenses on a
$1,000 investment assuming (1) 5% annual
return and (2) redemption at the end of
each time period $6 $18 $31 $69

</TABLE>

THE ABOVE EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF PAST OR
FUTURE EXPENSES. ACTUAL EXPENSES MAY BE GREATER OR LESS THAN THOSE SHOWN.

FEDERATED ARMS FUND
FINANCIAL HIGHLIGHTS -- INSTITUTIONAL SHARES

(FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD)

Reference is made to the Report of Ernst & Young LLP, Independent Auditors,
on page 26.
<TABLE>
<CAPTION>

<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
YEAR ENDED AUGUST 31,
1996 1995 1994 1993 1992 1991 1990 1989 1988 1987

NET ASSET VALUE,
BEGINNING OF
PERIOD $ 9.65 $ 9.63 $ 9.98 $10.01 $ 9.67 $ 8.99 $ 9.47 $ 8.88 $ 8.99 $9.98
INCOME FROM
INVESTMENT
OPERATIONS
Net investment
income 0.58 0.56 0.45 0.50 0.63 0.69 0.71 0.72 0.73 0.78
Net realized and
unrealized gain
(loss)
on investments (0.01) 0.02 (0.35) (0.03) 0.42 0.68 (0.48) 0.59 (0.11) (0.99)
Total from
investment
operations 0.57 0.58 0.10 0.47 1.05 1.37 0.23 1.31 0.62 (0.21)
LESS
DISTRIBUTIONS
Distributions
from net
investment income (0.58) (0.56) (0.45) (0.50) (0.63) (0.69) (0.71) (0.72) (0.73) (0.78)
Distributions
from net
realized gain on
investments -- -- -- -- (0.08) -- -- -- -- --
Total distributions (0.58) (0.56) (0.45) (0.50) (0.71) (0.69) (0.71) (0.72) (0.73) (0.78)
NET ASSET VALUE,
END OF PERIOD $ 9.64 $ 9.65 $ 9.63 $ 9.98 $10.01 $ 9.67 $ 8.99 $ 9.47 $ 8.88 $ 8.99
TOTAL RETURN(A) 6.02% 6.21% 0.99% 4.82% 11.21% 15.73% 2.45% 15.25% 7.09% (2.33)%
RATIOS TO
AVERAGE NET
ASSETS
Expenses 0.55% 0.55% 0.55% 0.51% 0.51% 0.78% 0.78% 0.79% 0.75% 0.81%
Net investment
income 5.94% 5.74% 4.51% 4.97% 5.95% 7.36% 7.62% 7.81% 8.10% 7.88%
Expense waiver/
reimbursement(b) 0.44% 0.43% 0.14% 0.21% 0.32% 1.02% 1.02% 0.95% 1.18% 0.75%
SUPPLEMENTAL DATA
Net assets, end
of period
(000 omitted) $653,313 $856,500 $1,238,813 $2,669,888 $1,090,944 $30,330 $26,261 $25,574 $16,753 $7,405
Portfolio
turnover 134% 124% 65% 36% 38% 127% 170% 85% 125% 228%

</TABLE>

(a) Based on net asset value, which does not reflect the sales charge or
contingent deferred sales charge, if applicable.

(b) This voluntary expense decrease is reflected in both the expense and net
investment income ratios shown above.

(See Notes which are an integral part of the Financial Statements)

GENERAL INFORMATION

The Trust was established as a Massachusetts business trust under a
Declaration of Trust dated May 24, 1985. The Declaration of Trust permits
the Trust to offer separate series of shares of beneficial interest
representing interests in separate portfolios of securities. The shares in
any one portfolio may be offered in separate classes. With respect to this
Fund, as of the date of this prospectus, the Board of Trustees (the
"Trustees") has established two classes of shares, Institutional Shares and
Institutional Service Shares. This prospectus relates only to Institutional
Shares (the "Shares") of the Fund.

Shares of the Fund are sold primarily to accounts for which financial
institutions act in a fiduciary or agency capacity, and other accounts where
a financial institution maintains master accounts with an aggregate
investment of at least $400 million in certain mutual funds which are
advised or distributed by affiliates of Federated Investors. Shares are also
made available to financial intermediaries, public, and private
organizations. In addition, Shares are designed to provide an appropriate
investment for particular financial institutions that are subject to
government agency regulations, including credit unions, savings
associations, and national banks. An investment in the Fund serves as a
convenient means of accumulating an interest in a professionally managed,
diversified portfolio which invests at least 65% of the value of its total
assets in U.S. government securities, all of which government securities
will be adjustable and floating rate mortgage securities which are issued or
guaranteed as to payment of principal and interest by the U.S. government,
its agencies or instrumentalities. A minimum initial investment of $25,000
over a 90-day period is required.

Shares are currently sold and redeemed at net asset value without a sales
charge imposed by the Fund.

INVESTMENT INFORMATION

INVESTMENT OBJECTIVE

The investment objective of the Fund is to provide current income consistent
with minimal volatility of principal. Current income includes, in general,
discount earned on U.S. Treasury bills and agency discount notes, interest
earned on mortgage related securities and other U.S. government securities,
and short-term capital gains. The investment objective cannot be changed
without approval of shareholders. The Fund anticipates that it will
experience minimal volatility of principal due to the frequent adjustments
to interest rates on adjustable and floating rate mortgage securities which
comprise the portfolio. Of course, there can be no assurance that the Fund
will be able to maintain minimal volatility of principal or that it will
achieve its investment objective. The Fund endeavors to achieve its
investment objective, however, by following the investment policies
described in this prospectus.

INVESTMENT POLICIES

Except as otherwise noted, the investment policies described below may not
be changed by the Trustees without shareholder approval.
The Fund will limit its investments to those that are permitted for purchase
by federal savings associations pursuant to applicable rules, regulations,
or interpretations of the Office of Thrift Supervision and by federal credit
unions under the Federal Credit Union Act and the rules, regulations, and
interpretations of the National Credit Union Administration (the "NCUA").
Should additional permitted investments be allowed as a result of future
changes in applicable regulations or federal laws, the Fund reserves the
right, without shareholder approval, to make such investments consistent
with the Fund's investment objective, policies, and limitations. Further,
should existing statutes or regulations change so as to cause any securities
held by the Fund to become ineligible for purchase by federal savings
associations or federal credit unions, the Fund will dispose of those
securities at times advantageous to the Fund.

As operated within the above limitations, and pursuant to the Fund's
investment policy, which may be changed without shareholder approval, to
limit its investment to securities that are appropriate direct investments
for national banks, the Fund will also serve as an appropriate vehicle for a
national bank as an investment for its own account.

ACCEPTABLE INVESTMENTS. The Fund pursues its investment objective by
investing at least 65% of the value of its total assets in a professionally
managed portfolio of U.S. government securities. As a matter of investment
policy, which may be changed without shareholder approval, all of these U.S.
government securities will be adjustable and floating rate mortgage
securities which are issued or guaranteed as to payment of principal and
interest by the U.S. government, its agencies or instrumentalities.

The types of mortgage securities in which the Fund may invest include the
following:

* adjustable rate mortgage securities;
* collateralized mortgage obligations;

* real estate mortgage investment conduits; and

* other securities collateralized by or representing interests in real
estate mortgages whose interest rates reset at periodic intervals and are
issued or guaranteed by the U.S. government, its agencies or
instrumentalities.

In addition to the securities described above, the Fund may also invest in
direct obligations of the U.S. Treasury, such as U.S. Treasury bills, notes,
and bonds, as well as obligations of U.S. government agencies or
instrumentalities which are not collateralized by or represent interests in
real estate mortgages, as described above.

The Fund may also invest in mortgage related securities, as defined in
section 3(a)(41) of the Securities Exchange Act of 1934, as amended, which
are issued by private entities such as investment banking firms and
companies related to the construction industry. The privately issued
mortgage related securities in which the Fund may invest include:

* privately issued securities which are collateralized by pools of mortgages
in which each mortgage is guaranteed as to payment of principal and interest
by an agency or instrumentality of the U.S. government;

* privately issued securities which are collateralized by pools of mortgages
in which payment of principal and interest are guaranteed by the issuer and
such guarantee is collateralized by U.S. government securities; and

* other privately issued securities in which the proceeds of the issuance
are invested in mortgage backed securities and payment of the principal and
interest are supported by the credit of any agency or instrumentality of the
U.S. government.

The privately issued mortgage related securities provide for a periodic
payment consisting of both interest and principal. The interest portion of
these payments will be distributed by the Fund as income, and the capital
portion will be reinvested.

The prices of fixed income securities fluctuate inversely to the direction
of interest rates.

ADJUSTABLE RATE MORTGAGE SECURITIES ("ARMS"). ARMs are pass-through mortgage
securities with adjustable rather than fixed interest rates. The ARMs in
which the Fund invests are issued by Government National Mortgage
Association ("GNMA"), Federal National Mortgage Association ("FNMA"), and
Federal Home Loan Mortgage Corporation ("FHLMC") and are actively traded.
The underlying mortgages which collateralize ARMs issued by GNMA are fully
guaranteed by the Federal Housing Administration ("FHA") or Veterans
Administration ("VA"), while those collateralizing ARMs issued by FHLMC or
FNMA are typically conventional residential mortgages conforming to strict
underwriting size and maturity constraints.

Unlike conventional bonds, ARMs pay back principal over the life of the ARMs
rather than at maturity. Thus, a holder of the ARMs, such as the Fund, would
receive monthly scheduled payments of principal and interest and may receive
unscheduled principal payments representing payments on the underlying
mortgages. At the time that a holder of the ARMs reinvests the payments and
any unscheduled prepayments of principal that it receives, the holder may
receive a rate of interest which is actually lower than the rate of interest
paid on the existing ARMs. As a consequence, ARMs may be a less effective
means of "locking in" long-term interest rates than other types of U.S.
government securities.

Not unlike other U.S. government securities, the market value of ARMs will
generally vary inversely with changes in market interest rates. Thus, the
market value of ARMs generally declines when interest rates rise and
generally rises when interest rates decline.

While ARMs generally entail less risk of a decline during periods of rapidly
rising rates, ARMs may also have less potential for capital appreciation
than other similar investments (e.g., investments with comparable
maturities) because, as interest rates decline, the likelihood increases
that mortgages will be prepaid. Furthermore, if ARMs are purchased at a
premium, mortgage foreclosures and unscheduled principal payments may result
in some loss of a holder's principal investment to the extent of the premium
paid. Conversely, if ARMs are purchased at a discount, both a scheduled
payment of principal and an unscheduled prepayment of principal would
increase current and total returns and would accelerate the recognition of
income, which would be taxed as ordinary income when distributed to
shareholders.

COLLATERALIZED MORTGAGE OBLIGATIONS ("CMOS"). CMOs are bonds issued by
single-purpose, stand-alone finance subsidiaries or trusts of financial
institutions, government agencies, investment bankers, or companies related
to the construction industry. CMOs purchased by the Fund may be:

* collateralized by pools of mortgages in which each mortgage is guaranteed
as to payment of principal and interest by an agency or instrumentality of
the U.S. government;

* collateralized by pools of mortgages in which payment of principal and
interest is guaranteed by the issuer and such guarantee is collateralized by
U.S. government securities; or

* securities in which the proceeds of the issuance are invested in mortgage
securities and payment of the principal and interest are supported by the
credit of an agency or instrumentality of the U.S. government.
The Fund will only purchase CMOs which are investment grade, as rated by a
nationally recognized statistical rating organization.

REAL ESTATE MORTGAGE INVESTMENT CONDUITS ("REMICS"). REMICs are offerings of
multiple class real estate mortgage-backed securities which qualify and
elect treatment as such under provisions of the Internal Revenue Code.
Issuers of REMICs may take several forms, such as trusts, partnerships,
corporations, associations or a segregated pool of mortgages. Once REMIC
status is elected and obtained, the entity is not subject to federal income
taxation. Instead, income is passed through the entity and is taxed to the
person or persons who hold interests in the REMIC. A REMIC interest must
consist of one or more classes of "regular interests," some of which may
offer adjustable rates (the type in which the Fund primarily invests), and a
single class of "residual interests." To qualify as a REMIC, substantially
all of the assets of the entity must be in assets directly or indirectly
secured principally by real property.

REGULATORY COMPLIANCE. In accordance with the Rules and Regulations of the
NCUA, unless the purchase is made solely to reduce interest-rate risk, the
Fund will not invest in any CMO or REMIC security that meets any of the
following three tests: (1) the CMO or REMIC has an expected average life
greater than 10 years; (2) the average life of the CMO or REMIC extends by
more than four years assuming an immediate and sustained parallel shift in
the yield curve of plus 300 basis points, or shortens by more than six years
assuming an immediate and sustained parallel shift in the yield curve of
minus 300 basis points; or (3) the estimated change in the price of the CMO
or REMIC is more than 17%, due to an immediate and sustained parallel shift
in the yield curve of plus or minus 300 basis points.

Neither test (1) nor (2) above apply to floating or adjustable rate CMOs or
REMICs with all of the following characteristics: (a) the interest rate of
the instrument is reset at least annually; (b) the interest rate is below
the contractual cap of the instrument; (c) the instrument is tied to a
widely-used market rate; and (d) the instrument varies directly (not
inversely) and is reset in proportion with the index's changes.

The Fund may not purchase a residual interest in a CMO or REMIC. In
addition, the Fund will not purchase zero coupon securities with maturities
greater than 10 years.

RESETS. The interest rates paid on the ARMs, CMOs, and REMICs in which the
Fund invests generally are readjusted or reset at intervals of one year or
less to an increment over some predetermined interest rate index. There are
two main categories of indices: those based on U.S. Treasury securities and
those derived from a calculated measure, such as a cost of funds index or a
moving average of mortgage rates. Commonly utilized indices include the
one-year and five-year constant maturity Treasury Note rates, the
three-month Treasury Bill rate, the 180-day Treasury Bill rate, rates on
longer-term Treasury securities, the National Median Cost of Funds, the
one-month or three-month London Interbank Offered Rate (LIBOR), the prime
rate of a specific bank, or commercial paper rates. Some indices, such as
the one-year constant maturity Treasury Note rate, closely mirror changes in
market interest rate levels. Others tend to lag changes in market rate
levels and tend to be somewhat less volatile.

CAPS AND FLOORS. The underlying mortgages which collateralize the ARMs,
CMOs, and REMICs in which the Fund invests will frequently have caps and
floors which limit the maximum amount by which the loan rate to the
residential borrower may change up or down: (1) per reset or adjustment
interval and (2) over the life of the loan. Some residential mortgage loans
restrict periodic adjustments by limiting changes in the borrower's monthly
principal and interest payments rather than limiting interest rate changes.
These payment caps may result in negative amortization.

The value of mortgage securities in which the Fund invests may be affected
if market interest rates rise or fall faster and farther than the allowable
caps or floors on the underlying residential mortgage loans. An example of
the effect of caps and floors on a residential mortgage loan may be found in
the Statement of Additional Information. Additionally, even though the
interest rates on the underlying residential mortgages are adjustable,
amortization and prepayments may occur, thereby causing the effective
maturities of the mortgage securities in which the Fund invests to be
shorter than the maturities stated in the underlying mortgages.

TEMPORARY INVESTMENTS. For defensive purposes only, the Fund may also invest
temporarily in cash and money market instruments during times of unusual
market conditions and to maintain liquidity. Money market instruments may
include obligations such as:

* obligations of the U.S. government or its agencies or instrumentalities;
and

* repurchase agreements.

REPURCHASE AGREEMENTS. Repurchase agreements are arrangements in which
banks, broker/dealers, and other recognized financial institutions sell U.S.
government securities or other securities to the Fund and agree at the time
of sale to repurchase them at a mutually agreed upon time and price within
one year from the date of acquisition. To the extent that the original
seller does not repurchase the securities from the Fund, the Fund could
receive less than the repurchase price on any sale of such securities.

LENDING OF PORTFOLIO SECURITIES. In order to generate additional income, the
Fund may lend portfolio securities on a short-term or a long-term basis up
to one-third of the value of its total assets to broker/dealers, banks, or
other institutional borrowers of securities. The Fund will only enter into
loan arrangements with broker/dealers, banks, or other institutions which
the investment adviser has determined are creditworthy under guidelines
established by the Fund's Board of Trustees and will receive collateral in
the form of cash or U.S. government securities equal to at least 100% of the
value of the securities loaned.

There is the risk that when lending portfolio securities, the securities may
not be available to the Fund on a timely basis and the Fund may, therefore,
lose the opportunity to sell the securities at a desirable price. In
addition, in the event that a borrower of securities would file for
bankruptcy or become insolvent, disposition of the securities may be delayed
pending court action.

WHEN-ISSUED AND DELAYED DELIVERY TRANSACTIONS. The Fund may purchase
securities on a when-issued or delayed delivery basis. These transactions
are arrangements in which the Fund purchases securities with payment and
delivery scheduled for a future time. The seller's failure to complete these
transactions may cause the Fund to miss a price or yield considered to be
advantageous. Settlement dates may be a month or more after entering into
these transactions, and the market values of the securities purchased may
vary from the purchase prices. Accordingly, the Fund may pay more/less than
the market value of the securities on the settlement date.

The Fund may dispose of a commitment prior to settlement if the adviser
deems it appropriate to do so. In addition, the Fund may enter into
transactions to sell its purchase commitments to third parties at current
market values and simultaneously acquire other commitments to purchase
similar securities at later dates. The Fund may realize short-term profits
or losses upon the sale of such commitments.

PORTFOLIO TURNOVER. The Fund does not intend to invest for the purpose of
seeking short-term profits, however securities in its portfolio will be sold
whenever the Fund's investment adviser believes it is appropriate to do so
in light of the Fund's investment objective, without regard to the length of
time a particular security may have been held.
INVESTMENT LIMITATIONS

The Fund will not:

* invest in stripped mortgage securities, including securities which
represent a share of only the interest payments or only the principal
payments from underlying mortgage related securities;

* borrow money directly or through reverse repurchase agreements
(arrangements in which the Fund sells a portfolio instrument for a
percentage of its cash value with an agreement to buy it back on a set date)
or pledge securities except, under certain circumstances, the Fund may
borrow up to one-third of the value of its net assets and pledge up to 10%
of the value of its total assets to secure such borrowings; or

* invest more than 5% of the value of its total assets in securities of
issuers which have records of less than three years of continuous
operations, including the operation of any predecessor. With respect to the
asset-backed securities, the Fund will treat the originator of the asset
pool as the company issuing the securities for purposes of determining
compliance with this limitation.

The above investment limitations cannot be changed without shareholder
approval. The following limitation, however, may be changed by the Trustees
without shareholder approval. Shareholders will be notified before any
material change in this limitation becomes effective.

The Fund will not:

* invest more than 15% of its net assets in securities which are illiquid,
including repurchase agreements providing for settlement in more than seven
days after notice.
TRUST INFORMATION

MANAGEMENT OF THE TRUST

BOARD OF TRUSTEES. The Trust is managed by a Board of Trustees. The Trustees
are responsible for managing the Trust's business affairs and for exercising
all the Trust's powers except those reserved for the shareholders. The
Executive Committee of the Board of Trustees handles the Board's
responsibilities between meetings of the Board.

INVESTMENT ADVISER. Investment decisions for the Fund are made by Federated
Management, the Fund's investment adviser (the "Adviser"), subject to
direction by the Trustees. The Adviser continually conducts investment
research and supervision for the Fund and is responsible for the purchase or
sale of portfolio instruments, for which it receives an annual fee from the
Fund.

ADVISORY FEES. The Adviser receives an annual investment advisory fee equal
to .60% of the Fund's average daily net assets. The Adviser may voluntarily
choose to waive a portion of its fee or reimburse the Fund for certain
operating expenses. This does not include reimbursement to the Fund of any
expenses incurred by shareholders who use the transfer agent's subaccounting
facilities. The Adviser can terminate this voluntary waiver of its advisory
fee at any time in its sole discretion. The Adviser has also undertaken to
reimburse the Fund for operating expenses in excess of limitations
established by certain states.

ADVISER'S BACKGROUND. Federated Management, a Delaware business trust
organized on April 11, 1989, is a registered investment adviser under the
Investment Advisers Act of 1940. It is a subsidiary of Federated Investors.
All of the Class A (voting) shares of Federated Investors are owned by a
trust, the trustees of which are John F. Donahue, Chairman and Trustee of
Federated Investors, Mr. Donahue's wife, and Mr. Donahue's son, J.
Christopher Donahue, President and Trustee of Federated Investors.

Federated Management and other subsidiaries of Federated Investors serve as
investment advisers to a number of investment companies and private
accounts. Certain other subsidiaries also provide administrative services to
a number of investment companies. With over $80 billion invested across more
than 250 funds under management and/or administration by its subsidiaries,
as of December 31, 1995, Federated Investors is one of the largest mutual
fund investment managers in the United States. With more than 1,800
employees, Federated continues to be led by the management who founded the
company in 1955. Federated funds are presently at work in and through 4,000
financial institutions nationwide. More than 100,000 investment
professionals have selected Federated funds for their clients.

Kathleen M. Foody-Malus, Susan M. Nason, and Todd A. Abraham are the Fund's
portfolio managers. Ms. Foody-Malus has been the Fund's portfolio manager
since January 1992. Ms. Foody-Malus joined Federated Investors in 1983 and
has been a Vice President of the Fund's investment adviser since 1993. Ms.
Foody-Malus served as an Assistant Vice President of the investment adviser
from 1990 until 1992. Ms. Foody-Malus received her M.B.A. in
Accounting/Finance from the University of Pittsburgh.

Susan M. Nason has been the Fund's portfolio manager since July 1993. Ms.
Nason joined Federated Investors in 1987 and has been a Vice President of
the Fund's investment adviser since 1993. Ms. Nason served as an Assistant
Vice President of the investment adviser from 1990 until 1992. Ms. Nason is
a Chartered Financial Analyst and received her M.B.A. in Finance from
Carnegie-Mellon University.

Todd A. Abraham has been the Fund's portfolio manager since August 1995. Mr.
Abraham joined Federated Investors in 1993 as an Investment Analyst and has
been an Assistant Vice President of the Fund's investment adviser since
1995. Mr. Abraham served as a Portfolio Analyst at Ryland Mortgage Company
from 1992 to 1993 and as a Bond Administrator at Ryland Asset Management
Company from 1990 to 1992. Mr. Abraham received his M.B.A. in Finance from
Loyola College.

Both the Trust and the Adviser have adopted strict codes of ethics governing
the conduct of all employees who manage the Fund and its portfolio
securities. These codes recognize that such persons owe a fiduciary duty to
the Fund's shareholders and must place the interests of shareholders ahead
of the employees' own interest. Among other things, the codes: require
preclearance and periodic reporting of personal securities transactions;
prohibit personal transactions in securities being purchased or sold, or
being considered for purchase or sale, by the Fund; prohibit purchasing
securities in initial public offerings; and prohibit taking profits on
securities held for less than sixty days. Violations of the codes are
subject to review by the Board of Trustees, and could result in severe
penalties.

DISTRIBUTION OF INSTITUTIONAL SHARES

Federated Securities Corp. is the principal distributor for Shares of the
Fund. It is a Pennsylvania corporation organized on November 14, 1969, and
is the principal distributor for a number of investment companies. Federated
Securities Corp. is a subsidiary of Federated Investors.

State securities laws may require certain financial institutions such as
depository institutions to register as dealers.

SHAREHOLDER SERVICES. The Trust has entered into a Shareholder Services
Agreement with Federated Shareholder Services, a subsidiary of Federated
Investors, under which the Trust may make payments up to .25% of the average
daily net asset value of its Shares, computed at an annual rate, to obtain
certain personal services for shareholders and to maintain shareholder
accounts. From time to time and for such periods as deemed appropriate, the
amount stated above may be reduced voluntarily.

Under the Shareholder Services Agreement, Federated Shareholder Services
will either perform shareholder services directly or will select financial
institutions to perform shareholder services. Financial institutions will
receive fees based upon shares owned by their clients or customers. The
schedules of such fees and the basis upon which such fees will be paid will
be determined from time to time by the Trust and Federated Shareholder
Services.

SUPPLEMENTAL PAYMENTS TO FINANCIAL INSTITUTIONS. In addition to payments
made pursuant to the Shareholder Services Agreement, Federated Securities
Corp. and Federated Shareholder Services, from their own assets, may pay
financial institutions supplemental fees for the performance of substantial
sales services, distribution-related support services, or shareholder
services. The support may include sponsoring sales, educational and training
seminars for their employees, providing sales literature, and engineering
computer software programs that emphasize the attributes of the Trust. Such
assistance will be predicated upon the amount of Shares the financial
institution sells or may sell, and/or upon the type and nature of sales or
marketing support furnished by the financial institution. Any payments made
by the distributor may be reimbursed by the Trust's investment adviser or
it's affiliates.

ADMINISTRATION OF THE FUND

MAXIMUM AVERAGE AGGREGATE
ADMINISTRATIVE FEE DAILY NET ASSETS

.15% on the first $250 million
.125% on the next $250 million
.10% on the next $250 million
.075% on assets in excess of $750 million

The administrative fee received during any fiscal year shall be at least
$125,000 per portfolio and $30,000 per each additional class of shares.
Federated Services Company may choose voluntarily to waive a portion of its
fee.

NET ASSET VALUE

The Fund's net asset value per Share fluctuates. The net asset value for
Shares is determined by adding the interest of the Shares in the market
value of all securities and other assets of the Fund, subtracting the
interest of the Shares in the liabilities of the Fund and those attributable
to Shares, and dividing the remainder by the total number of Shares
outstanding. The net asset value for Shares will exceed that of
Institutional Service Shares due to the variance in daily net income
realized by each class as a result of different distribution charges
incurred by the classes. Such variance will reflect only accrued net income
to which the shareholders of a particular class are entitled.

INVESTING IN INSTITUTIONAL SHARES

SHARE PURCHASES
Shares are sold on days on which the New York Stock Exchange is open. Shares
may be purchased either by wire or mail.

To purchase Shares of the Fund, open an account by calling Federated
Securities Corp. Information needed to establish the account will be taken
over the telephone. The Fund reserves the right to reject any purchase
request.

BY WIRE. To purchase Shares of the Fund by Federal Reserve wire, call the
Fund before 4:00 p.m. (Eastern time) to place an order. The order is
considered received immediately. Payment by federal funds must be received
before 3:00 p.m. (Eastern time) on the next business day following the
order. Federal funds should be wired as follows: Federated Shareholder
Services Company, c/o State Street Bank and Trust Company, Boston,
Massachusetts; Attention: EDGEWIRE; For Credit to: Federated ARMs Fund
- --Institutional Shares; Fund Number (this number can be found on the account
statement or by contacting the Fund); Group Number or Order Number; Nominee
or Institution Name; ABA Number 011000028. Shares cannot be purchased on
days on which the New York Stock Exchange is closed and on federal holidays
restricting wire transfers. Questions on wire purchases should be directed
to your shareholder services representative at the telephone number listed
on your account statement.

BY MAIL. To purchase Shares of the Fund by mail, send a check made payable
to Federated ARMs Fund -- Institutional Shares to: Federated Shareholder
Services Company, P.O. Box 8600, Boston, Massachusetts 02266-8600. Orders by
mail are considered received after payment by check is converted by the
transfer agent's bank, State Street Bank, into federal funds. This is
normally the next business day after State Street Bank receives the check.

MINIMUM INVESTMENT REQUIRED

The minimum initial investment in the Fund is $25,000 plus any financial
intermediary's fee, if applicable. However, an account may be opened with a
smaller amount as long as the $25,000 minimum is reached within 90 days. The
minimum investment for an institutional investor will be calculated by
combining all accounts it maintains with the Fund. Accounts established
through a financial intermediary may be subject to a smaller minimum
investment.

WHAT SHARES COST

Shares are sold at their net asset value next determined after an order is
received. There is no sales charge imposed by the Fund. Investors who
purchase Shares through a financial intermediary may be charged an
additional service fee by that financial intermediary.

The net asset value is determined as of the close of trading ( normally 4:00
p.m., Eastern time) on the New York Stock Exchange, Monday through Friday,
except on: (i) days on which there are not sufficient changes in the value
of the Fund's portfolio securities that its net asset value might be
materially affected; (ii) days on which no Shares are tendered for
redemption and no orders to purchase Shares are received; and (iii) the
following holidays: New Year's Day, Presidents' Day, Good Friday, Memorial
Day, Independence Day, Labor Day, Thanksgiving Day, and Christmas Day.

EXCHANGING SECURITIES FOR INSTITUTIONAL SHARES

Investors may exchange certain U.S. government securities or a combination
of securities and cash for Shares. The securities and any cash must have a
market value of at least $25,000. The Fund reserves the right to determine
the acceptability of securities to be exchanged. Securities accepted by the
Fund are valued in the same manner as the Fund values its assets.
Shareholders wishing to exchange securities should first contact Federated
Securities Corp.
CERTIFICATES AND CONFIRMATIONS

As transfer agent for the Fund, Federated Shareholder Services Company
maintains a Share account for each shareholder. Share certificates are not
issued unless requested by contacting the Fund.

Detailed confirmations of each purchase or redemption are sent to each
shareholder. Monthly confirmations are sent to report dividends paid during
the month.

DIVIDENDS

Dividends are declared daily and paid monthly. Dividends are declared just
prior to determining net asset value. If an order for Shares is placed on
the preceding business day, Shares purchased by wire begin earning dividends
on the business day wire payment is received by State Street Bank. If the
order for Shares and payment by wire are received on the same day, Shares
begin earning dividends on the next business day. Shares purchased by check
begin earning dividends on the business day after the check is converted,
upon instruction of the transfer agent, into federal funds. Dividends are
automatically reinvested on payment dates in additional Shares of the Fund
unless cash payments are requested by contacting the Fund.

CAPITAL GAINS

Capital gains realized by the Fund, if any, will be distributed at least
once every twelve months.

REDEEMING INSTITUTIONAL SHARES

The Fund redeems Shares at their net asset value next determined after the
Fund receives the redemption request. Investors who redeem Shares through a
financial intermediary may be charged a service fee by that financial
intermediary. Redemptions will be made on days on which the Fund computes
its net asset value. Redemption requests must be received in proper form and
can be made by telephone request or by written request.

TELEPHONE REDEMPTION

Shareholders may redeem their Shares by telephoning the Fund before 4:00
p.m. (Eastern time). The proceeds will normally be wired the following
business day, but in no event longer than seven days later, to the
shareholder's account at a domestic commercial bank that is a member of the
Federal Reserve System. If at any time the Fund shall determine it necessary
to terminate or modify this method of redemption, shareholders would be
promptly notified.

An authorization form permitting the Fund to accept telephone requests must
first be completed. Authorization forms and information on this service are
available from Federated Securities Corp. Telephone redemption instructions
may be recorded. If reasonable procedures are not followed by the Fund, it
may be liable for losses due to unauthorized or fraudulent telephone
instructions.

In the event of drastic economic or market changes, the shareholders may
experience difficulty in redeeming by telephone. If such a case should
occur, another method of redemption, such as that discussed in "Written
Requests," should be considered.

WRITTEN REQUESTS

Shares may also be redeemed by sending a written request to Federated
Shareholder Services Company, P.O. Box 8600, Boston Massachusetts
02266-8600. Call the Fund for specific instructions before redeeming by
letter. The shareholder will be asked to provide in the request his name,
the Fund name, the class of Shares, his account number, and the share or
dollar amount requested. If Share certificates have been issued, they should
be sent unendorsed with the written request by registered or certified mail
to the address above noted.

SIGNATURES. Shareholders requesting a redemption of any amount to be sent to
an address other than that on record with the Fund, or a redemption payable
other than to the shareholder of record must have their signatures
guaranteed by:

* a trust company or commercial bank whose deposits are insured by the Bank
Insurance Fund ("BIF"), which is administered by the Federal Deposit
Insurance Corporation ("FDIC");

* a member of the New York, American, Boston, Midwest, or Pacific Stock
Exchanges;

* a savings bank or savings association whose deposits are insured by the
Savings Association Insurance Fund ("SAIF"), which is administered by the
FDIC; or

* any other "eligible guarantor institution," as defined in the Securities
Exchange Act of 1934.

The Fund does not accept signatures guaranteed by a notary public.

The Fund and its transfer agent have adopted standards for accepting
signature guarantees from the above institutions. The Fund and its transfer
agent reserve the right to amend these standards at any time without notice.

RECEIVING PAYMENT. Normally, a check for the proceeds is mailed within one
business day, but in no event more than seven days, after receipt of a
proper written redemption request.
ACCOUNTS WITH LOW BALANCES

Due to the high cost of maintaining accounts with low balances, the Fund may
redeem Shares in any account and pay the proceeds to the shareholder if the
account balance falls below a required minimum value of $25,000 due to
shareholder redemptions. This requirement does not apply, however, if the
balance falls below $25,000 because of changes in the Fund's net asset
value. Before Shares are redeemed to close an account, the shareholder is
notified in writing and allowed 30 days to purchase additional Shares to
meet the minimum requirement.

SHAREHOLDER INFORMATION

VOTING RIGHTS

Each Share of the Fund gives the shareholder one vote in Trustee elections
and other matters submitted to shareholders for vote. All shares of each
portfolio in the Trust have equal voting rights except that, in matters
affecting only a particular Fund or class, only shares of that particular
Fund or class are entitled to vote.

As a Massachusetts business trust, the Trust is not required to hold annual
shareholder meetings. Shareholder approval will be sought only for certain
changes in the Trust's or the Fund's operation and for the election of
Trustees under certain circumstances.

Trustees may be removed by the Trustees or by shareholders at a special
meeting. A special meeting of the Fund shall be called by the Trustees upon
the written request of shareholders owning at least 10% of the Trust's
outstanding shares of all portfolios entitled to vote.

TAX INFORMATION
FEDERAL INCOME TAX

The Fund will pay no federal income tax because the Fund expects to meet
requirements of the Internal Revenue Code, as amended, applicable to
regulated investment companies and to receive the special tax treatment
afforded to such companies.

The Fund will be treated as a single, separate entity for federal income tax
purposes so that income (including capital gains) and losses related by the
Trust's other portfolios, if any, will not be combined for tax purposes with
those realized by the Fund.

Unless otherwise exempt, shareholders are required to pay federal income tax
on any dividends and other distributions, including capital gains
distributions, received. This applies whether dividends and distributions
are received in cash or as additional Shares. Distributions representing
long-term capital gains, if any, will be taxable to shareholders as
long-term capital gains no matter how long the shareholders have held the
Shares.

STATE AND LOCAL TAXES

In the opinion of Houston, Houston & Donnelly, counsel to the Fund, Fund
shares may be subject to personal property taxes imposed by counties,
municipalities, and school districts in Pennsylvania to the extent that the
Fund's portfolio securities would be subject to such taxes if owned directly
by residents of those jurisdictions. Shareholders are urged to consult their
own tax advisers regarding the status of their accounts under state and
local tax laws.

PERFORMANCE INFORMATION

From time to time the Fund advertises its total return and yield for
Institutional Shares.

Total return represents the change, over a specified period of time, in the
value of an investment in Institutional Shares after reinvesting all income
and capital gain distributions. It is calculated by dividing that change by
the initial investment and is expressed as a percentage.

The yield of Institutional Shares is calculated by dividing the net
investment income per share (as defined by the Securities and Exchange
Commission) earned by Institutional Shares over a thirty-day period by the
offering price per share of Institutional Shares on the last day of the
period. This number is then annualized using semi-annual compounding. The
yield does not necessarily reflect income actually earned by Institutional
Shares and, therefore, may not correlate to the dividends or other
distributions paid to shareholders.

The Institutional Shares are sold without any sales charge or other similar
non-recurring charges.

Total return and yield will be calculated separately for Institutional
Shares and Institutional Service Shares.

From time to time, advertisements for the Fund may refer to ratings,
rankings, and other information in certain financial publications and/or
compare the Fund's performance to certain indices.

OTHER CLASSES OF SHARES

The Fund also offers another class of shares called Institutional Service
Shares. Institutional Service Shares are sold to banks and other
institutions that hold assets in an agency capacity and rely upon the
distribution services provided by the distributor for the marketing of these
shares, as well as to retail customers of such institutions, and are subject
to a minimum initial investment of $25,000. Institutional Service Shares are
sold at net asset value and are distributed pursuant to a Rule 12b-1 Plan
adopted by the Trust whereby the distributor is paid a fee of .25% of the
Institutional Service Shares' average net assets.

Shares and Institutional Service Shares are subject to certain of the same
expenses. Expense differences between Shares and Institutional Service
Shares may affect the performance of each class.

To obtain more information and a prospectus for Institutional Service
Shares, investors may call
1-800-341-7400.

FEDERATED ARMS FUND
FINANCIAL HIGHLIGHTS -- INSTITUTIONAL SERVICE SHARES

(FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD)

Reference is made to the Report of Ernst & Young LLP, Independent Auditors,
on page 26.
<TABLE>
<CAPTION>

YEAR ENDED AUGUST 31,
1996 1995 1994 1993 1992(A)

<S> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING $ 9.65 $ 9.63 $ 9.98 $10.01 $ 9.98
OF PERIOD
INCOME FROM INVESTMENT OPERATIONS
Net investment income 0.55 0.54 0.42 0.48 0.18
Net realized and
unrealized gain (loss)
on investments (0.01) 0.02 (0.35) (0.03) 0.03
Total from investment 0.54 0.56 0.07 0.45 0.21
operations
LESS DISTRIBUTIONS
Distributions from net (0.55) (0.54) (0.42) (0.48) (0.18)
investment income
NET ASSET VALUE, END OF $ 9.64 $ 9.65 $ 9.63 $ 9.98 $10.01
PERIOD
TOTAL RETURN(B) 5.75% 5.94% 0.74% 4.56% 2.11%
RATIOS TO AVERAGE NET ASSETS
Expenses 0.80% 0.80% 0.80% 0.76% 0.76%*
Net investment income 5.69% 5.44% 4.26% 4.72% 5.46%*
Expense 0.44% 0.43% 0.23% 0.21% 0.32%*
waiver/reimbursement(c)
SUPPLEMENTAL DATA
Net assets, end of period $109,536 $135,689 $255,891 $499,418 $113,095
(000 omitted)
Portfolio turnover 134% 124% 65% 36% 38%
* Computed on an annualized basis.

(a) Reflects operations for the period from May 4, 1992 (date of initial
public investment) to August 31, 1992.

(b) Based on net asset value, which does not reflect the sales charge or
contingent deferred sales charge, if applicable.

(See Notes which are an integral part of the Financial Statements)

FEDERATED ARMS FUND
PORTFOLIO OF INVESTMENTS

AUGUST 31, 1996

PRINCIPAL
AMOUNT VALUE

U.S. GOVERNMENT OBLIGATIONS--84.2%
FEDERAL HOME LOAN MORTGAGE CORP. PC ARM--42.8%
$ 316,341,787 7.073%-7.797%, 11/1/2017-7/1/2030 $ 326,229,830
FEDERAL NATIONAL MORTGAGE ASSOCIATION ARM--21.8%
163,137,385 4.998%-8.051%, 8/1/2018-3/1/2029 166,613,922
FEDERAL NATIONAL MORTGAGE ASSOCIATION--2.4%
18,858 12.00%, 3/1/2013 21,321
3,214,321 11.50%, 8/1/2014-11/1/2015 3,607,015
5,474,413 11.00%, 12/1/2015 6,095,320
7,704,313 9.50%, 12/1/1999 8,240,526
Total 17,964,182
GOVERNMENT NATIONAL MORTGAGE ASSOCIATION ARM--8.3%
48,813,822 6.00%, 10/20/2025-5/20/2026 48,913,751
14,470,413 5.50%, 10/20/2025 14,368,831
Total 63,282,582
GOVERNMENT NATIONAL MORTGAGE ASSOCIATION--8.9%
4,671,499 12.00%, 9/15/2013-1/15/2014 5,342,980
34,526,557 11.50%, 10/15/2010-4/15/2020 39,047,117
21,117,358 11.00%, 12/15/2009-4/15/2026 23,604,982
Total 67,995,079
TOTAL U.S. GOVERNMENT OBLIGATIONS (IDENTIFIED COST $638,931,639) 642,085,595
U.S. TREASURY OBLIGATIONS--11.4%
U.S. TREASURY NOTES--11.4%
25,000,000 5.875%, 4/30/1998 24,849,500
27,000,000 6.00%, 5/31/1998 26,870,400
35,000,000 6.125%, 3/31/1998 34,945,400
TOTAL U.S. TREASURY OBLIGATIONS (IDENTIFIED COST $86,809,370) 86,665,300

FEDERATED ARMS FUND

PRINCIPAL
AMOUNT VALUE

(A)REPURCHASE AGREEMENT -- 3.0%
$ 23,520,000 BT Securities Corp., 5.27%, dated 8/30/1996, due 9/3/1996
(AT AMORTIZED COST) $ 23,520,000
TOTAL INVESTMENTS (IDENTIFIED COST $749,261,009)(B) $ 752,270,895

(a) The repurchase agreement is fully collateralized by U.S. government
and/or agency obligations based on market prices at the date of the
portfolio. The investment in the repurchase agreement is through
participation in a joint account with other Federated funds.

(b) The cost of investments for federal tax purposes amounts to
$749,311,238. The net unrealized appreciation of investments on a federal
tax basis amounts to $2,959,657 which is comprised of $4,729,963
appreciation and $1,770,296 depreciation at August 31, 1996.

Note: The categories of investments are shown as a percentage of net assets
($762,849,631) at August 31, 1996.

The following acronyms are used throughout this portfolio:

ARM -- Adjustable Rate Mortgage
PC -- Participation Certificate

(See Notes which are an integral part of the Financial Statements)

FEDERATED ARMS FUND
STATEMENT OF ASSETS AND LIABILITIES

AUGUST 31, 1996

ASSETS:
Total investments in securities, at value
(identified cost $749,261,009 and
tax cost $749,311,238) $ 752,270,895
Income receivable 13,657,482
Receivable for shares sold 314,583
Total assets 766,242,960
LIABILITIES:
Payable for shares redeemed $ 378,267
Income distribution payable 2,924,076
Accrued expenses 90,986
Total liabilities 3,393,329
NET ASSETS for 79,100,268 shares outstanding $ 762,849,631
NET ASSETS CONSIST OF:
Paid in capital $ 844,256,200
Net unrealized appreciation of investments 3,009,886
Accumulated net realized loss on investments (84,456,165)
Undistributed net investment income 39,710
Total Net Assets $ 762,849,631
NET ASSET VALUE, OFFERING PRICE AND REDEMPTION PROCEEDS PER
SHARE:
INSTITUTIONAL SHARES:
$653,313,362 o 67,742,265 shares outstanding $9.64
INSTITUTIONAL SERVICE SHARES:
$109,536,269 o 11,358,003 shares outstanding $9.64

(See Notes which are an integral part of the Financial Statements)

FEDERATED ARMS FUND
STATEMENT OF OPERATIONS

YEAR ENDED AUGUST 31, 1996

INVESTMENT INCOME:
Interest (net of dollar roll
expense of $752,387) $ 56,629,979
EXPENSES:
Investment advisory fee $ 5,228,816
Administrative personnel
and services fee 659,077
Custodian fees 180,637
Transfer and dividend disbursing
agent fees and expenses 94,791
Directors'/Trustees' fees 19,760
Auditing fees 17,706
Legal fees 5,522
Portfolio accounting fees 138,799
Distribution services fee --
Institutional Service
Shares 308,922
Shareholder services fee
-- Institutional Shares 1,869,751
Shareholder services fee --
Institutional Service Shares 308,922
Share registration costs 26,200
Printing and postage 18,009
Insurance premiums 16,166
Taxes 27,623
Miscellaneous 16,576
Total expenses 8,937,277
Waivers --
Waiver of investment advisory fee $ (1,618,615)
Waiver of distribution services fee
-- Institutional Service Shares (305,215)
Waiver of shareholder
services fee --
Institutional Shares (1,869,751)
Waiver of shareholder
services fee -- Institutional
Service Shares (3,707)
Total waivers (3,797,288)
Net expenses 5,139,989
Net 51,489,990
investment
income
REALIZED AND UNREALIZED GAIN
(LOSS) ON INVESTMENTS:
Net realized gain on investments 1,044,840
Net change in unrealized
appreciation of
investments (1,656,353)
Net realized and unrealized loss on
investments (611,513)
Change in net assets resulting
from operations $ 50,878,477

(See Notes which are an integral part of the Financial Statements)

FEDERATED ARMS FUND
STATEMENT OF CHANGES IN NET ASSETS

YEAR ENDED AUGUST 31,
1996 1995

INCREASE (DECREASE) IN NET ASSETS:
OPERATIONS--
Net investment income $ 51,489,990 $ 66,805,803
Net realized gain (loss) on
investments ($8,689,597 and
$57,180,753 net losses, respectively,
as computed for federal
tax purposes) 1,044,840 (14,896,854)
Net change in unrealized appreciation
(depreciation) (1,656,353) 12,930,685
Change in net assets resulting
from operations 50,878,477 64,839,634
DISTRIBUTIONS TO SHAREHOLDERS--
Distributions from net investment income
Institutional Shares (44,631,616) (56,778,571)
Institutional Service Shares (7,063,166) (9,782,730)
Change in net assets resulting from
distributions to shareholders (51,694,782) (66,561,301)
SHARE TRANSACTIONS--
Proceeds from sale of shares 61,181,863 53,202,918
Net asset value of shares issued to
shareholders in payment of
distributions declared 11,612,765 16,413,082
Cost of shares redeemed (301,318,243) (570,408,807)
Change in net assets resulting from
share transactions (228,523,615) (500,792,807)
Change in net assets (229,339,920) (502,514,474)
NET ASSETS:
Beginning of period 992,189,551 1,494,704,025
End of period (including
undistributed net investment income
of $39,710 and $244,502,
respectively) $ 762,849,631 $ 992,189,551

</TABLE>

(See Notes which are an integral part of the Financial Statements)

FEDERATED ARMS FUND
NOTES TO FINANCIAL STATEMENTS

AUGUST 31, 1996

1. ORGANIZATION

Federated ARMs Fund (the "Fund") is registered under the Investment Company
Act of 1940, as amended (the "Act"), as a diversified, open-end management
investment company. The Fund offers two classes of shares: Institutional
Shares and Institutional Service Shares.

2. SIGNIFICANT ACCOUNTING POLICIES

The following is a summary of significant accounting policies consistently
followed by the Fund in the preparation of its financial statements. These
policies are in conformity with generally accepted accounting principles.

INVESTMENT VALUATIONS -- U.S. government securities are generally valued at
the mean between the over-the-counter bid and asked prices as furnished by
an independent pricing service. Short-term securities with remaining
maturities of sixty days or less at the time of purchase may be valued at
amortized cost, which approximates fair market value.

REPURCHASE AGREEMENTS -- It is the policy of the Fund to require the
custodian bank to take possession, to have legally segregated in the Federal
Reserve Book Entry System, or to have segregated within the custodian bank's
vault, all securities held as collateral under repurchase agreement
transactions. Additionally, procedures have been established by the Fund to
monitor, on a daily basis, the market value of each repurchase agreement's
collateral to ensure that the value of collateral at least equals the
repurchase price to be paid under the repurchase agreement transaction.

The Fund will only enter into repurchase agreements with banks and other
recognized financial institutions, such as broker/dealers, which are deemed
by the Fund's adviser to be creditworthy pursuant to the guidelines and/or
standards reviewed or established by the Board of Trustees (the "Trustees").
Risks may arise from the potential inability of counterparties to honor the
terms of the repurchase agreement. Accordingly, the Fund could receive less
than the repurchase price on the sale of collateral securities.

INVESTMENT INCOME, EXPENSES AND DISTRIBUTIONS -- Interest income and
expenses are accrued daily. Bond premium and discount, if applicable, are
amortized as required by the Internal Revenue Code, as amended (the "Code").
Distributions to shareholders are recorded on the ex-dividend date.

FEDERAL TAXES -- It is the Fund's policy to comply with the provisions of
the Code applicable to regulated investment companies and to distribute to
shareholders each year substantially all of its income. Accordingly, no
provisions for federal tax are necessary.

At August 31, 1996, the Fund, for federal tax purposes, had a capital loss
carryforward of $84,405,481, which will reduce the Fund's taxable income
arising from future net realized gain on investments, if any, to the extent
permitted by the Code, and thus will reduce the amount of the distributions
to shareholders which would otherwise be necessary to relieve the Fund of
any liability for federal tax. Pursuant to the Code, such capital loss
carryforward will expire as follows:

EXPIRATION YEAR EXPIRATION AMOUNT

2001 $ 1,799,433
2002 $16,735,698
2003 $57,180,753
2004 $ 8,689,597

WHEN-ISSUED AND DELAYED DELIVERY TRANSACTIONS -- The Fund may engage in
when-issued or delayed delivery transactions. The Fund records when-issued
securities on the trade date and maintains security positions such that
sufficient liquid assets will be available to make payment for the
securities purchased. Securities purchased on a when-issued or delayed
delivery basis are marked to market daily and begin earning interest on the
settlement date.

DOLLAR ROLL TRANSACTIONS -- The Fund enters into dollar roll transactions,
with respect to mortgage securities issued by GNMA, FNMA and FHLMC, in which
the Fund sells mortgage securities to financial institutions and
simultaneously agrees to accept substantially similar (same type, coupon and
maturity) securities at a later date at an agreed upon price. Dollar roll
transactions are short-term financing arrangements which will not exceed
twelve months. The Fund will use the proceeds generated from the
transactions to invest in short-term investments, which may enhance the
Fund's current yield and total return.

USE OF ESTIMATES -- The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the amounts of assets, liabilities,
expenses and revenues reported in the financial statements. Actual results
could differ from those estimated.
OTHER -- Investment transactions are accounted for on the trade date.

3. SHARES OF BENEFICIAL INTEREST

The Declaration of Trust permits the Trustees to issue an unlimited number
of full and fractional shares of beneficial interest (without par value) for
each class of shares.

Transactions in shares were as follows:
<TABLE>
<CAPTION>

YEAR ENDED AUGUST 31,
1996 1995
<S> <C> <C> <C> <C>
INSTITUTIONAL SHARES SHARES AMOUNT SHARES AMOUNT

Shares sold 5,202,156 $ 50,287,411 4,182,411 $ 40,047,848
Shares issued to shareholders
in payment of distributions
declared 1,021,472 9,866,718 1,395,941 13,381,363
Shares redeemed (27,194,052) (262,675,429) (45,474,917) (434,478,884)
Net change resulting from
Institutional Share transactions (20,970,424) $ (202,521,300) (39,896,565) $ (381,049,673)

YEAR ENDED AUGUST 31,
1996 1995
INSTITUTIONAL SERVICE SHARES SHARES AMOUNT SHARES AMOUNT

Shares sold 1,125,713 $ 10,894,452 1,373,723 $ 13,155,070
Shares issued to shareholders
in payment of distributions
declared 180,764 1,746,047 316,407 3,031,719
Shares redeemed (4,002,502) (38,642,814) (14,200,812) (135,929,923)
Net change
resulting from
Institutional
Service Share transactions (2,696,025) $ (26,002,315) (12,510,682) $ (119,743,134)
Net change resulting from
share transactions (23,666,449) $ (228,523,615) (52,407,247) $ (500,792,807)
</TABLE>

4. INVESTMENT ADVISORY FEE AND OTHER TRANSACTIONS WITH AFFILIATES

INVESTMENT ADVISORY FEE -- Federated Management, the Fund's investment
adviser, (the "Adviser"), receives for its services an annual investment
advisory fee equal to 0.60% of the Fund's average daily net assets. The
Adviser may voluntarily choose to waive any portion of its fee. The Adviser
can modify or terminate this voluntary waiver at any time at its sole
discretion.

ADMINISTRATIVE FEE -- Federated Services Company ("FServ"), under the
Administrative Services Agreement, provides the Fund with administrative
personnel and services. The fee paid to FServ is based on the level of
average aggregate daily net assets of all funds advised by subsidiaries of
Federated Investors for the period. The administrative fee received during
the period of the Administrative Services Agreement shall be at least
$125,000 per portfolio and $30,000 per each additional class of shares.

DISTRIBUTION SERVICES FEE -- The Fund has adopted a Distribution Plan (the
"Plan") pursuant to Rule 12b-1 under the Act. Under the terms of the Plan,
the Fund will compensate Federated Securities Corp. ("FSC"), the principal
distributor, from the net assets of the Fund to finance activities intended
to result in the sale of the Fund's Institutional Service Shares. The Plan
provides that the Fund may incur distribution expenses up to .25% of the
average daily net assets of the Institutional Service Shares, annually, to
compensate FSC. FSC may voluntarily choose to waive a portion of its fee.
FSC can modify or terminate this voluntary waiver at any time at its sole
discretion.

SHAREHOLDER SERVICES FEE -- Under the terms of a Shareholder Services
Agreement with Federated Shareholder Services ("FSS"), the Fund will pay FSS
up to .25% of the average daily net assets of each class of shares for the
period. This fee is to obtain certain services for shareholders and to
maintain shareholder accounts. FSS may voluntarily choose to waive any
portion of its fee. FSS can modify or terminate this voluntary waiver at any
time at its sole discretion.

TRANSFER AGENT AND DIVIDEND DISBURSING AGENT FEES AND EXPENSES -- FServ,
through its subsidiary, Federated Shareholder Services Company ("FSSC"),
serves as transfer and dividend disbursing agent for the Fund. The fee paid
to FSSC is based on the size, type, and number of accounts and transactions
made by shareholders.

PORTFOLIO ACCOUNTING FEES -- FServ also maintains the Fund's accounting
records for which it receives a fee. The fee is based on the level of the
Fund's average daily net assets for the period, plus out-of-pocket expenses.

INTERFUND TRANSACTIONS -- During the period ended August 31, 1996, the Fund
engaged in purchase and sale transactions with funds that have a common
investment adviser, common Directors/Trustees, and/or common Officers. These
transactions were made at current market value pursuant to Rule 17a-7 under
the Act amounting to $352,014,611 and $26,907,420, respectively.

GENERAL -- Certain of the Officers and Trustees of the Fund are Officers and
Directors or Trustees of the above companies.

5. INVESTMENT TRANSACTIONS

Purchases and sales of investments, excluding short-term securities, for the
period ended August 31, 1996, were as follows:

PURCHASES $1,093,824,046
SALES $1,284,568,771

REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

To the Trustees and Shareholders of
FEDERATED ARMs FUND:

We have audited the accompanying statement of assets and liabilities of
Federated ARMs Fund, including the portfolio of investments, as of August
31, 1996, and the related statement of operations for the year then ended,
the statement of changes in net assets for each of the two years in the
period then ended, and the financial highlights for the periods presented
therein. These financial statements and financial highlights are the
responsibility of the Fund's management. Our responsibility is to express an
opinion on these financial statements and 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
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 as of August 31, 1996, by correspondence with the
custodian. An audit also includes assessing the accounting principles used
and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audits provide
a reasonable basis for our opinion.

In our opinion, the financial statements and financial highlights referred
to above present fairly, in all material respects, the financial position of
Federated ARMs Fund at August 31, 1996, the results of its operations for
the year then ended, the changes in its net assets for each of the two years
in the period then ended, and the financial highlights for the periods
presented therein, in conformity with generally accepted accounting
principles.
ERNST & YOUNG LLP
Pittsburgh, Pennsylvania
October 10, 1996

ADDRESSES

Federated ARMs Fund
Institutional Shares Federated Investors Tower
Pittsburgh, Pennsylvania 15222-3779
Distributor
Federated Securities Corp. Federated Investors Tower
Pittsburgh, Pennsylvania 15222-3779
Investment Adviser
Federated Management Federated Investors Tower
Pittsburgh, Pennsylvania 15222-3779
Custodian
State Street Bank and P.O. Box 8600
Trust Company Boston, Massachusetts 02266-8600

Transfer Agent and Dividend Disbursing Agent
Federated Shareholder P.O. Box 8600
Services Company Boston, Massachusetts 02266-8600

Independent Auditors
Ernst & Young LLP One Oxford Centre
Pittsburgh, Pennsylvania 15219

FEDERATED ARMS FUND
INSTITUTIONAL SHARES
PROSPECTUS

A Diversified Portfolio of
Federated ARMs Fund,
an Open-End Management
Investment Company

Prospectus dated October 31, 1996

[GRAPHICS]

Federated Investors

Federated Investors Tower
Pittsburgh, PA 15222-3779

Federated Securities Corp. is the distributor of the fund
and is a subsidiary of Federated Investors.

Cusip 314082108
8100309A-IS (10/96)
FEDERATED ARMS FUND

INSTITUTIONAL SERVICE SHARES

PROSPECTUS

The Institutional Service Shares offered by this prospectus represent
interests in a diversified portfolio of securities (the "Fund") of Federated
ARMs Fund (the "Trust"). The Trust is an open-end management investment
company (a mutual fund).

This prospectus contains the information you should read and know before you
invest in Institutional Service Shares of the Fund. Keep this prospectus for
future reference.

Prospectus dated October 31, 1996
TABLE OF CONTENTS

SUMMARY OF FUND EXPENSES 1
FINANCIAL HIGHLIGHTS --
INSTITUTIONAL SERVICE SHARES 2
GENERAL INFORMATION 3
INVESTMENT INFORMATION 3
Investment Objective 3
Investment Policies 3
Investment Limitations 8
TRUST INFORMATION 8
Management of the Trust 8
Distribution of Institutional Service
Shares 10
Administration of the Fund 11
NET ASSET VALUE 11
INVESTING IN INSTITUTIONAL SERVICE SHARES
11
Share Purchases 11
Exchange Privilege 12
Minimum Investment Required 12
What Shares Cost 12
Exchanging Securities for
Institutional Service Shares 12
Certificates and Confirmations 12
Dividends 13
Capital Gains 13
REDEEMING INSTITUTIONAL SERVICE SHARES
13
Telephone Redemption 13
Written Requests 13
Accounts with Low Balances 14
SHAREHOLDER INFORMATION 14
Voting Rights 14
TAX INFORMATION 15
Federal Income Tax 15
State and Local Taxes 15
PERFORMANCE INFORMATION 15
OTHER CLASSES OF SHARES 16
FINANCIAL HIGHLIGHTS --
INSTITUTIONAL SHARES 17
FINANCIAL STATEMENTS 18
REPORT OF ERNST & YOUNG LLP,
INDEPENDENT AUDITORS 27
ADDRESSES 28

SUMMARY OF FUND EXPENSES

INSTITUTIONAL SERVICE SHARES
SHAREHOLDER TRANSACTION EXPENSES
<TABLE>
<S> <C>
Maximum Sales Charge Imposed on Purchases
(as a percentage of offering price) None
Maximum Sales Charge Imposed on Reinvested Dividends
(as a percentage of offering price) None
Contingent Deferred Sales Charge (as a percentage of original purchase
price or redemption proceeds, as applicable) None
Redemption Fee (as a percentage of amount redeemed, if applicable) None
Exchange Fee None
<CAPTION>
ANNUAL OPERATING EXPENSES
(As a percentage of average net assets)
<S> <C> <C>
Management Fee (after waiver)(1) 0.41%
12b-1 Fee (after waiver)(2) 0.00%
Total Other Expenses 0.39%
Shareholder Services Fee 0.25%
Total Operating Expenses(3) 0.80%
</TABLE>

(2) The 12b-1 fee has been reduced to reflect the voluntary waiver of the
12b-1 fee. The distributor can terminate this voluntary waiver at any time
at its sole discretion. The maximum 12b-1 fee is 0.25%.

(3) The total operating expenses would have been 1.24% absent the voluntary
waivers of a portion of the management fee and the 12b-1 fee.

The purpose of this table is to assist an investor in understanding the
various costs and expenses that a shareholder of Institutional Service
Shares of the Fund will bear, either directly or indirectly. For more
complete descriptions of the various costs and expenses, see "Investing in
Institutional Shares" and "Trust Information." Wire-transferred redemptions
of less than $5,000 may be subject to additional fees.
<TABLE>
<S> <C> <C> <C> <C>
EXAMPLE 1 YEAR 3 YEARS 5 YEARS 10 YEARS
You would pay the following expenses on a $1,000
investment assuming (1) 5% annual return and
(2) redemption at the end of each time period $8 $26 $44 $99
</TABLE>

THE ABOVE EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF PAST OR
FUTURE EXPENSES. ACTUAL EXPENSES MAY BE GREATER OR LESS THAN THOSE SHOWN.

FEDERATED ARMS FUND
FINANCIAL HIGHLIGHTS -- INSTITUTIONAL SERVICE SHARES

(FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD)

Reference is made to the Report of Ernst & Young LLP, Independent Auditors,
on page 27.
<TABLE>
<CAPTION>
YEAR ENDED AUGUST 31,
1996 1995 1994 1993 1992(A)
<S> <C> <C> <C> <C> <C>
NET ASSET VALUE,
BEGINNING OF PERIOD $ 9.65 $ 9.63 $ 9.98 $10.01 $ 9.98

INCOME FROM INVESTMENT
OPERATIONS
Net investment income 0.55 0.54 0.42 0.48 0.18
Net realized and
unrealized gain (loss)
on investments (0.01) 0.02 (0.35) (0.03) 0.03
Total from investment
operations 0.54 0.56 0.07 0.45 0.21
LESS DISTRIBUTIONS
Distributions from net
investment income (0.55) (0.54) (0.42) (0.48) (0.18)
NET ASSET VALUE,
END OF PERIOD $ 9.64 $ 9.65 $ 9.63 $ 9.98 $10.01
TOTAL RETURN(B) 5.75% 5.94% 0.74% 4.56% 2.11%
RATIOS TO AVERAGE
NET ASSETS
Expenses 0.80% 0.80% 0.80% 0.76% 0.76%*
Net investment income 5.69% 5.44% 4.26% 4.72% 5.46%*
Expense waiver/
reimbursement(c) 0.44% 0.43% 0.23% 0.21% 0.32%*
SUPPLEMENTAL DATA
Net assets,
end of period
(000 omitted) $109,536 $135,689 $255,891 $499,418 $113,095
Portfolio turnover 134% 124% 65% 36% 38%
</TABLE>

* Computed on an annualized basis.

(a) Reflects operations for the period from May 4, 1992 (date of initial
public investment) to August 31, 1992.

(b) Based on net asset value, which does not reflect the sales charge or
contingent deferred sales charge, if applicable.

(See Notes which are an integral part of the Financial Statements)

GENERAL INFORMATION

The Trust was established as a Massachusetts business trust under a
Declaration of Trust dated May 24, 1985. The Declaration of Trust permits
the Trust to offer separate series of shares of beneficial interest
representing interests in separate portfolios of securities. The shares in
any one portfolio may be offered in separate classes. With respect to this
Fund, as of the date of this prospectus, the Board of Trustees (the
"Trustees") has established two classes of shares, Institutional Service
Shares and Institutional Shares. This prospectus relates only to
Institutional Service Shares (the "Shares") of the Fund.

Shares of the Fund are designed to give banks and other institutions that
hold assets in an agency capacity and rely upon the distribution services
provided by the distributor for the marketing of these Shares, as well as to
retail customers of such institutions, a convenient means of accumulating an
interest in a professionally managed, diversified portfolio which invests at
least 65% of the value of its total assets in U.S. government securities,
all of which government securities will be adjustable and floating rate
mortgage securities which are issued or guaranteed as to payment of
principal and interest by the U.S. government, its agencies or
instrumentalities. In addition, the Fund is designed to provide an
appropriate investment for particular financial institutions which are
subject to government agency regulations, including credit unions, savings
associations, and national banks. A minimum initial investment of $25,000
over a 90-day period is required.

Shares are currently sold and redeemed at net asset value without a sales
charge imposed by the Fund.

INVESTMENT INFORMATION

INVESTMENT OBJECTIVE

INVESTMENT POLICIES

Except as otherwise noted, the investment policies described below may not
be changed by the Trustees without shareholder approval.

The Fund will limit its investments to those that are permitted for purchase
by federal savings associations pursuant to applicable rules, regulations,
or interpretations of the Office of Thrift Supervision and by federal credit
unions under the Federal Credit Union Act and the rules, regulations, and
interpretations of the National Credit Union Administration (the "NCUA").
Should additional permitted investments be allowed as a result of future
changes in applicable regulations or federal laws, the Fund reserves the
right, without shareholder approval, to make such investments consistent
with the Fund's investment objective, policies, and limitations. Further,
should existing statutes or regulations change so as to cause any securities
held by the Fund to become ineligible for purchase by federal savings
associations or federal credit unions, the Fund will dispose of those
securities at times advantageous to the Fund.

As operated within the above limitations, and pursuant to the Fund's
investment policy, which may be changed without shareholder approval, to
limit its investments to securities that are appropriate direct investments
for national banks, the Fund will also serve as an appropriate vehicle for a
national bank as an investment for its own account.

The types of mortgage securities in which the Fund may invest include the
following:

* adjustable rate mortgage securities;

* collateralized mortgage obligations;

* real estate mortgage investment conduits; and

* other privately issued securities in which the proceeds of the issuance
are invested in mortgage-backed securities and payment of the principal and
interest are supported by the credit of any agency or instrumentality of the
U.S. government.

The prices of fixed income securities fluctuate inversely to the direction
of interest rates.

* collateralized by pools of mortgages in which each mortgage is guaranteed
as to payment of principal and interest by an agency or instrumentality of
the U.S. government;

* collateralized by pools of mortgages in which payment of principal and
interest is guaranteed by the issuer and such guarantee is collateralized by
U.S. government securities; or

The Fund will only purchase CMOs which are investment grade, as rated by a
nationally recognized statistical rating organization.

The Fund may not purchase a residual interest in a CMO or REMIC. In
addition, the Fund will not purchase zero coupon securities with maturities
greater than 10 years.

* obligations of the U.S. government or its agencies or instrumentalities;
and

* repurchase agreements.

INVESTMENT LIMITATIONS

The Fund will not:

* invest in stripped mortgage securities, including securities which
represent a share of only the interest payments or only the principal
payments from underlying mortgage related securities;

The Fund will not:

* invest more than 15% of its net assets in securities which are illiquid,
including repurchase agreements providing for settlement in more than seven
days after notice.

TRUST INFORMATION

MANAGEMENT OF THE TRUST

DISTRIBUTION OF INSTITUTIONAL SERVICE SHARES

State securities laws may require certain financial institutions such as
depository institutions to register as dealers.

DISTRIBUTION PLAN AND SHAREHOLDER SERVICES. Under a distribution plan
adopted in accordance with Rule 12b-1 under the Investment Company Act of
1940 (the "Plan"), the distributor may be paid a fee by the Trust in an
amount computed at an annual rate of up to .25% of the average daily net
asset value of the Shares. The distributor may select financial institutions
such as banks, fiduciaries, custodians for public funds, investment
advisers, and broker/dealers to provide sales services or
distribution-related support services as agents for their clients or
customers.

The Plan is a compensation-type plan. As such, the Trust makes no payments
to the distributor except as described above. Therefore, the Trust does not
pay for unreimbursed expenses of the distributor, including amounts expended
by the distributor in excess of amounts received by it from the Trust,
interest, carrying, or other financing charges in connection with excess
amounts expended, or the distributor's overhead expenses. However, the
distributor may be able to recover such amounts or may earn a profit from
future payments made by the Trust under the Plan.

In addition, the Trust has entered into a Shareholder Services Agreement
with Federated Shareholder Services, a subsidiary of Federated Investors,
under which the Trust may make payments up to .25% of the average daily net
asset value of its shares to obtain certain personal services for
shareholders and to maintain shareholder accounts. From time to time and for
such periods as deemed appropriate, the amount stated above may be reduced
voluntarily.

Under the Shareholder Services Agreement, Federated Shareholder Services
will either perform shareholder services directly or will select financial
institutions to perform shareholder services. Financial institutions will
receive fees based upon shares owned by their clients or customers. The
schedules of such fees and the basis upon which fees will be paid will be
determined from time to time by the Trust and Federated Shareholder
Services.

SUPPLEMENTAL PAYMENTS TO FINANCIAL INSTITUTIONS. In addition to payments
made pursuant to the Distribution Plan and Shareholder Services Agreement,
Federated Securities Corp. and Federated Shareholder Services, from their
own assets, may pay financial institutions supplemental fees for the
performance of substantial sales services, distribution-related support
services, or shareholder services. The support may include sponsoring sales,
educational and training seminars for their employees, providing sales
literature, and engineering computer software programs that emphasize the
attributes of the Trust. Such assistance will be predicated upon the amount
of shares the financial institution sells or may sell, and/or upon the type
and nature of sales or marketing support furnished by the financial
institution. Any payments made by the distributor may be reimbursed by the
Trust's investment adviser or its affiliates.

ADMINISTRATION OF THE FUND

ADMINISTRATIVE SERVICES. Federated Services Company, a subsidiary of
Federated Investors, provides administrative personnel and services
(including certain legal and financial reporting services) necessary to
operate the Fund. Federated Services Company provides these at an annual
rate which relates to the average aggregate daily net assets of all funds
advised by subsidiaries of Federated Investors ("Federated Funds") as
specified below:
<TABLE>
<CAPTION>
MAXIMUM AVERAGE AGGREGATE
ADMINISTRATIVE FEE DAILY NET ASSETS
<C> <S>
.15% on the first $250 million
.125% on the next $250 million
.10% on the next $250 million
.075% on assets in excess of $750 million
</TABLE>

NET ASSET VALUE

The Fund's net asset value per share fluctuates. The net asset value for
Shares is determined by adding the interest of the Shares in the market
value of all securities and other assets of the Fund, subtracting the
interest of the Shares in the liabilities of the Fund and those attributable
to Shares, and dividing the remainder by the total number of Shares
outstanding. The net asset value for Institutional Shares will exceed that
of Shares due to the variance in daily net income realized by each class as
a result of different distribution charges incurred by the classes. Such
variance will reflect only accrued net income to which the shareholders of a
particular class are entitled.

INVESTING IN INSTITUTIONAL SERVICE SHARES

SHARE PURCHASES

Shares are sold on days on which the New York Stock Exchange is open. Shares
may be purchased either by wire or mail.

BY WIRE. To purchase Shares of the Fund by Federal Reserve wire, call the
Fund before 4:00 p.m. (Eastern time) to place an order. The order is
considered received immediately. Payment by federal funds must be received
before 3:00 p.m. (Eastern time) on the next business day following the
order. Federal funds should be wired as follows: Federated Shareholder
Services Company, c/o State Street Bank and Trust Company, Boston,
Massachusetts; Attention: EDGEWIRE; For Credit to: Federated ARMs Fund--
Institutional Service Shares; Fund Number (this number can be found on the
account statement or by contacting the Fund); Group Number or Order Number;
Nominee or Institution Name; ABA Number 011000028. Shares cannot be
purchased on days on which the New York Stock Exchange is closed and on
federal holidays restricting wire transfers. Questions on wire purchases
should be directed to your shareholder services representative at the
telephone number listed on your account statement.

BY MAIL. To purchase Shares of the Fund by mail, send a check made payable
to Federated ARMs Fund -- Institutional Service Shares to: Federated
Shareholder Services Company, P.O. Box 8600, Boston, Massachusetts
02266-8600. Orders by mail are considered received after payment by check is
converted by the transfer agent's bank, State Street Bank, into federal
funds. This is normally the next business day after State Street Bank
receives the check.

EXCHANGE PRIVILEGE

Financial institutions that maintain master accounts with an aggregate
investment of at least $400 million in certain funds which are advised or
distributed by affiliates of Federated Investors may exchange their Shares
for Institutional Shares of the Trust.

MINIMUM INVESTMENT REQUIRED

The minimum initial investment in the Fund is $25,000 plus any
non-affiliated bank or broker's fee, if applicable. However, an account may
be opened with a smaller amount as long as the $25,000 minimum is reached
within 90 days. An institutional investor's minimum investment will be
calculated by combining all accounts it maintains with the Fund. Accounts
established through a non-affiliated bank or broker may be subject to a
smaller minimum investment.

WHAT SHARES COST

Shares are sold at their net asset value next determined after an order is
received. There is no sales charge imposed by the Fund. Investors who
purchase Shares through a non-affiliated bank or broker may be charged an
additional service fee by that bank or broker.

The net asset value is determined as of the close of trading (normally 4:00
p.m., Eastern time) on the New York Stock Exchange, Monday through Friday,
except on: (i) days on which there are not sufficient changes in the value
of the Fund's portfolio securities that its net asset value might be
materially affected; (ii) days on which no Shares are tendered for
redemption and no orders to purchase Shares are received; and (iii) the
following holidays: New Year's Day, Presidents' Day, Good Friday, Memorial
Day, Independence Day, Labor Day, Thanksgiving Day, and Christmas Day.

EXCHANGING SECURITIES FOR INSTITUTIONAL SERVICE SHARES

CERTIFICATES AND CONFIRMATIONS

As transfer agent for the Fund, Federated Shareholder Services Company
maintains a Share account for each shareholder. Share certificates are not
issued unless requested by contacting the Fund.

Detailed confirmations of each purchase or redemption are sent to each
shareholder. Monthly confirmations are sent to report dividends paid during
the month.

DIVIDENDS

CAPITAL GAINS

Capital gains realized by the Fund, if any, will be distributed at least
once every twelve months.

REDEEMING INSTITUTIONAL SERVICE SHARES

The Fund redeems Shares at their net asset value next determined after the
Fund receives the redemption request. Redemptions will be made on days on
which the Fund computes its net asset value. Redemption requests must be
received in proper form and can be made by telephone request or by written
request.

TELEPHONE REDEMPTION

WRITTEN REQUESTS

Shares may also be redeemed by sending a written request to Federated
Shareholder Services Company, P.O. Box 8600, Boston, Massachusetts
02266-8600. Call the Fund for specific instructions before redeeming by
letter. The shareholder will be asked to provide in the request his name,
the Fund name, the class of Shares, his account number, and the share or
dollar amount requested. If Share certificates have been issued, they should
be sent unendorsed with the written request by registered or certified mail
to the address above noted.

* a trust company or commercial bank whose deposits are insured by the Bank
Insurance Fund ("BIF"), which is administered by the Federal Deposit
Insurance Corporation ("FDIC");

* a member of the New York, American, Boston, Midwest, or Pacific Stock
Exchanges;

* a savings bank or savings association whose deposits are insured by the
Savings Association Insurance Fund ("SAIF"), which is administered by the
FDIC; or

* any other "eligible guarantor institution," as defined in the Securities
Exchange Act of 1934.

The Fund does not accept signatures guaranteed by a notary public.

RECEIVING PAYMENT. Normally, a check for the proceeds is mailed within one
business day, but in no event more than seven days, after receipt of a
proper written redemption request.

ACCOUNTS WITH LOW BALANCES
Due to the high cost of maintaining accounts with low balances, the Fund may
redeem Shares in any account and pay the proceeds to the shareholder if the
account balance falls below a required minimum value of $25,000 due to
shareholder redemptions. This requirement does not apply, however, if the
balance falls below $25,000 because of changes in the Fund's net asset
value. Before Shares are redeemed to close an account, the shareholder is
notified in writing and allowed 30 days to purchase additional Shares to
meet the minimum requirement.

SHAREHOLDER INFORMATION

VOTING RIGHTS

TAX INFORMATION

FEDERAL INCOME TAX
The Fund will pay no federal income tax because the Fund expects to meet
requirements of the Internal Revenue Code, as amended, applicable to
regulated investment companies and to receive the special tax treatment
afforded to such companies.

STATE AND LOCAL TAXES

PERFORMANCE INFORMATION

From time to time, the Fund advertises its total return and yield for
Institutional Service Shares.
Total return represents the change, over a specified period of time, in the
value of an investment in Institutional Service Shares after reinvesting all
income and capital gain distributions. It is calculated by dividing that
change by the initial investment and is expressed as a percentage.

The yield of Institutional Service Shares is calculated by dividing the net
investment income per share (as defined by the Securities and Exchange
Commission) earned by Institutional Service Shares over a thirty-day period
by the offering price per share of Institutional Service Shares on the last
day of the period. This number is then annualized using semi-annual
compounding. The yield does not necessarily reflect income actually earned
by Institutional Service Shares and, therefore, may not correlate to the
dividends or other distributions paid to shareholders.

The Institutional Service Shares are sold without any sales charge or other
similar non-recurring charges.

Total return and yield will be calculated separately for Institutional
Service Shares and Institutional Shares.

From time to time, advertisements for the Fund may refer to ratings,
rankings, and other information in certain financial publications and/or
compare the Fund's performance to certain indices.

OTHER CLASSES OF SHARES

The Fund also offers another class of shares called Institutional Shares.
Institutional Shares are sold primarily to accounts for which financial
institutions act in a fiduciary or agency capacity, and other accounts where
a financial institution maintains master accounts with an aggregate
investment of at least $400 million in certain mutual funds which are
advised or distributed by affiliates of Federated Investors. Shares are also
made available to financial intermediaries, public, and private
organizations. A minimum initial investment of $25,000 over a 90-day period
is required. Institutional Shares are sold at net asset value and are
distributed without a Rule 12b-1 Plan.

Shares and Institutional Shares are subject to certain of the same expenses.
Expense differences between Shares and Institutional Shares may affect the
performance of each class.

To obtain more information and a prospectus for Institutional Shares,
investors may call 1-800-341-7400.

FEDERATED ARMS FUND
FINANCIAL HIGHLIGHTS -- INSTITUTIONAL SHARES

(FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD)

Reference is made to the Report of Ernst & Young LLP, Independent Auditors,
on page 27.
<TABLE>
<CAPTION>
YEAR ENDED AUGUST 31,
1996 1995 1994 1993 1992 1991 1990 1989 1988 1987
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
NET ASSET VALUE,
BEGINNING OF
PERIOD $ 9.65 $ 9.63 $ 9.98 $10.01 $ 9.67 $ 8.99 $ 9.47 $ 8.88 $ 8.99 $9.98
INCOME FROM
INVESTMENT
OPERATIONS
Net investment
income 0.58 0.56 0.45 0.50 0.63 0.69 0.71 0.72 0.73 0.78
Net realized and
unrealized gain
(loss)
on investments (0.01) 0.02 (0.35) (0.03) 0.42 0.68 (0.48) 0.59 (0.11) (0.99)
Total from
investment
operations 0.57 0.58 0.10 0.47 1.05 1.37 0.23 1.31 0.62 (0.21)
LESS
DISTRIBUTIONS
Distributions
from net
investment income (0.58) (0.56) (0.45) (0.50) (0.63) (0.69) (0.71) (0.72) (0.73) (0.78)
Distributions
from net
realized gain on
investments -- -- -- -- (0.08) -- -- -- -- --
Total distributions (0.58) (0.56) (0.45) (0.50) (0.71) (0.69) (0.71) (0.72) (0.73) (0.78)
NET ASSET VALUE,
END OF PERIOD $ 9.64 $ 9.65 $ 9.63 $ 9.98 $10.01 $ 9.67 $ 8.99 $ 9.47 $ 8.88 $ 8.99
TOTAL RETURN(A) 6.02% 6.21% 0.99% 4.82% 11.21% 15.73% 2.45% 15.25% 7.09% (2.33)%
RATIOS TO
AVERAGE NET
ASSETS
Expenses 0.55% 0.55% 0.55% 0.51% 0.51% 0.78% 0.78% 0.79% 0.75% 0.81%
Net investment
income 5.94% 5.74% 4.51% 4.97% 5.95% 7.36% 7.62% 7.81% 8.10% 7.88%
Expense waiver/
reimbursement(b) 0.44% 0.43% 0.14% 0.21% 0.32% 1.02% 1.02% 0.95% 1.18% 0.75%
SUPPLEMENTAL DATA
Net assets, end
of period
(000 omitted) $653,313 $856,500 $1,238,813 $2,669,888 $1,090,944 $30,330 $26,261 $25,574 $16,753 $7,405
Portfolio
turnover 134% 124% 65% 36% 38% 127% 170% 85% 125% 228%
</TABLE>

(a) Based on net asset value, which does not reflect the sales charge or
contingent deferred sales charge, if applicable.

(b) This voluntary expense decrease is reflected in both the expense and net
investment income ratios shown above.

(See Notes which are an integral part of the Financial Statements)

FEDERATED ARMS FUND
PORTFOLIO OF INVESTMENTS

AUGUST 31, 1996
<TABLE>
<CAPTION>
PRINCIPAL
AMOUNT VALUE
<C> <S> <C>
U.S. GOVERNMENT OBLIGATIONS--84.2%
FEDERAL HOME LOAN MORTGAGE CORP. PC ARM--42.8%
$ 316,341,787 7.073%-7.797%, 11/1/2017-7/1/2030 $ 326,229,830
FEDERAL NATIONAL MORTGAGE ASSOCIATION ARM--21.8%
163,137,385 4.998%-8.051%, 8/1/2018-3/1/2029 166,613,922
FEDERAL NATIONAL MORTGAGE ASSOCIATION--2.4%
18,858 12.00%, 3/1/2013 21,321
3,214,321 11.50%, 8/1/2014-11/1/2015 3,607,015
5,474,413 11.00%, 12/1/2015 6,095,320
7,704,313 9.50%, 12/1/1999 8,240,526
Total 17,964,182
GOVERNMENT NATIONAL MORTGAGE ASSOCIATION ARM--8.3%
48,813,822 6.00%, 10/20/2025-5/20/2026 48,913,751
14,470,413 5.50%, 10/20/2025 14,368,831
Total 63,282,582
GOVERNMENT NATIONAL MORTGAGE ASSOCIATION--8.9%
4,671,499 12.00%, 9/15/2013-1/15/2014 5,342,980
34,526,557 11.50%, 10/15/2010-4/15/2020 39,047,117
21,117,358 11.00%, 12/15/2009-4/15/2026 23,604,982
Total 67,995,079
TOTAL U.S. GOVERNMENT OBLIGATIONS (IDENTIFIED COST $638,931,639) 642,085,595
U.S. TREASURY OBLIGATIONS--11.4%
U.S. TREASURY NOTES--11.4%
25,000,000 5.875%, 4/30/1998 24,849,500
27,000,000 6.00%, 5/31/1998 26,870,400
35,000,000 6.125%, 3/31/1998 34,945,400
TOTAL U.S. TREASURY OBLIGATIONS (IDENTIFIED COST $86,809,370) 86,665,300
</TABLE>

FEDERATED ARMS FUND
<TABLE>
<CAPTION>
PRINCIPAL
AMOUNT VALUE
<C> <S> <C>
(A)REPURCHASE AGREEMENT -- 3.0%
$ 23,520,000 BT Securities Corp., 5.27%, dated 8/30/1996, due 9/3/1996
(AT AMORTIZED COST) $ 23,520,000
TOTAL INVESTMENTS (IDENTIFIED COST $749,261,009)(B) $ 752,270,895
</TABLE>

Note: The categories of investments are shown as a percentage of net assets
($762,849,631) at August 31, 1996.

The following acronyms are used throughout this portfolio:

ARM -- Adjustable Rate Mortgage
PC -- Participation Certificate

(See Notes which are an integral part of the Financial Statements)

FEDERATED ARMS FUND
STATEMENT OF ASSETS AND LIABILITIES

AUGUST 31, 1996
<TABLE>
<S> <C> <C>
ASSETS:
Total investments in securities, at value
(identified cost $749,261,009 and
tax cost $749,311,238) $ 752,270,895
Income receivable 13,657,482
Receivable for shares sold 314,583
Total assets 766,242,960
LIABILITIES:
Payable for shares redeemed $ 378,267
Income distribution payable 2,924,076
Accrued expenses 90,986
Total liabilities 3,393,329
NET ASSETS for 79,100,268 shares outstanding $ 762,849,631
NET ASSETS CONSIST OF:
Paid in capital $ 844,256,200
Net unrealized appreciation of investments 3,009,886
Accumulated net realized loss on investments (84,456,165)
Undistributed net investment income 39,710
Total Net Assets $ 762,849,631
NET ASSET VALUE, OFFERING PRICE AND REDEMPTION PROCEEDS PER
SHARE:
INSTITUTIONAL SHARES:
$653,313,362 / 67,742,265 shares outstanding $9.64
INSTITUTIONAL SERVICE SHARES:
$109,536,269 / 11,358,003 shares outstanding $9.64
</TABLE>

(See Notes which are an integral part of the Financial Statements)

FEDERATED ARMS FUND
STATEMENT OF OPERATIONS

YEAR ENDED AUGUST 31, 1996
<TABLE>
<S> <C> <C> <C>
INVESTMENT INCOME:
Interest (net of dollar roll
expense of $752,387) $ 56,629,979
EXPENSES:
Investment advisory fee $ 5,228,816
Administrative personnel
and services fee 659,077
Custodian fees 180,637
Transfer and dividend disbursing
agent fees and expenses 94,791
Directors'/Trustees' fees 19,760
Auditing fees 17,706
Legal fees 5,522
Portfolio accounting fees 138,799
Distribution services fee --
Institutional Service
Shares 308,922
Shareholder services fee
-- Institutional Shares 1,869,751
Shareholder services fee --
Institutional Service Shares 308,922
Share registration costs 26,200
Printing and postage 18,009
Insurance premiums 16,166
Taxes 27,623
Miscellaneous 16,576
Total expenses 8,937,277
Waivers --
Waiver of investment advisory fee $ (1,618,615)
Waiver of distribution services fee
-- Institutional Service Shares (305,215)
Waiver of shareholder
services fee --
Institutional Shares (1,869,751)
Waiver of shareholder
services fee -- Institutional
Service Shares (3,707)
Total waivers (3,797,288)
Net expenses 5,139,989
Net 51,489,990
investment
income
REALIZED AND UNREALIZED GAIN
(LOSS) ON INVESTMENTS:
Net realized gain on investments 1,044,840
Net change in unrealized
appreciation of
investments (1,656,353)
Net realized and unrealized loss on
investments (611,513)
Change in net assets resulting
from operations $ 50,878,477
</TABLE>

(See Notes which are an integral part of the Financial Statements)

FEDERATED ARMS FUND
STATEMENT OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
YEAR ENDED AUGUST 31,
1996 1995
<S> <C> <C>
INCREASE (DECREASE) IN NET ASSETS:
OPERATIONS--
Net investment income $ 51,489,990 $ 66,805,803
Net realized gain (loss) on
investments ($8,689,597 and
$57,180,753 net losses, respectively,
as computed for federal
tax purposes) 1,044,840 (14,896,854)
Net change in unrealized appreciation
(depreciation) (1,656,353) 12,930,685
Change in net assets resulting
from operations 50,878,477 64,839,634
DISTRIBUTIONS TO SHAREHOLDERS--
Distributions from net investment income
Institutional Shares (44,631,616) (56,778,571)
Institutional Service Shares (7,063,166) (9,782,730)
Change in net assets resulting from
distributions to shareholders (51,694,782) (66,561,301)
SHARE TRANSACTIONS--
Proceeds from sale of shares 61,181,863 53,202,918
Net asset value of shares issued to
shareholders in payment of
distributions declared 11,612,765 16,413,082
Cost of shares redeemed (301,318,243) (570,408,807)
Change in net assets resulting from
share transactions (228,523,615) (500,792,807)
Change in net assets (229,339,920) (502,514,474)
NET ASSETS:
Beginning of period 992,189,551 1,494,704,025
End of period (including
undistributed net investment income
of $39,710 and $244,502,
respectively) $ 762,849,631 $ 992,189,551
</TABLE>

(See Notes which are an integral part of the Financial Statements)

FEDERATED ARMS FUND
NOTES TO FINANCIAL STATEMENTS

AUGUST 31, 1996

1. ORGANIZATION

2. SIGNIFICANT ACCOUNTING POLICIES

OTHER -- Investment transactions are accounted for on the trade date.

3. SHARES OF BENEFICIAL INTEREST

The Declaration of Trust permits the Trustees to issue an unlimited number
of full and fractional shares of beneficial interest (without par value) for
each class of shares.
Transactions in shares were as follows:
<TABLE>
<CAPTION>
YEAR ENDED AUGUST 31,
1996 1995
INSTITUTIONAL SHARES SHARES AMOUNT SHARES AMOUNT
<S> <C> <C> <C> <C>
Shares sold 5,202,156 $ 50,287,411 4,182,411 $ 40,047,848
Shares issued to shareholders
in payment of distributions
declared 1,021,472 9,866,718 1,395,941 13,381,363
Shares redeemed (27,194,052) (262,675,429) (45,474,917) (434,478,884)
Net change resulting from
Institutional Share transactions (20,970,424) $ (202,521,300) (39,896,565) $ (381,049,673)
<CAPTION>
YEAR ENDED AUGUST 31,
1996 1995
INSTITUTIONAL SERVICE SHARES SHARES AMOUNT SHARES AMOUNT
<S> <C> <C> <C> <C>
Shares sold 1,125,713 $ 10,894,452 1,373,723 $ 13,155,070
Shares issued to shareholders
in payment of distributions
declared 180,764 1,746,047 316,407 3,031,719
Shares redeemed (4,002,502) (38,642,814) (14,200,812) (135,929,923)
Net change
resulting from
Institutional
Service Share transactions (2,696,025) $ (26,002,315) (12,510,682) $ (119,743,134)
Net change resulting from
share transactions (23,666,449) $ (228,523,615) (52,407,247) $ (500,792,807)
</TABLE>

4. INVESTMENT ADVISORY FEE AND OTHER TRANSACTIONS WITH AFFILIATES

GENERAL -- Certain of the Officers and Trustees of the Fund are Officers and
Directors or Trustees of the above companies.

5. INVESTMENT TRANSACTIONS

Purchases and sales of investments, excluding short-term securities, for the
period ended August 31, 1996, were as follows:

PURCHASES $1,093,824,046
SALES $1,284,568,771

REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

To the Trustees and Shareholders of
FEDERATED ARMs FUND:

ERNST & YOUNG LLP

Pittsburgh, Pennsylvania

October 10, 1996

ADDRESSES

Federated ARMs Fund
Institutional Service Shares Federated Investors Tower
Pittsburgh, Pennsylvania 15222-3779

Distributor
Federated Securities Corp. Federated Investors Tower
Pittsburgh, Pennsylvania 15222-3779

Investment Adviser
Federated Management Federated Investors Tower
Pittsburgh, Pennsylvania 15222-3779

Custodian
State Street Bank and P.O. Box 8600
Trust Company Boston, Massachusetts 02266-8600

Transfer Agent and Dividend Disbursing Agent
Federated Shareholder P.O. Box 8600
Services Company Boston, Massachusetts 02266-8600

Independent Public Accountants
Ernst & Young LLP One Oxford Centre
Pittsburgh, Pennsylvania 15219
FEDERATED ARMS FUND
INSTITUTIONAL SERVICE SHARES
PROSPECTUS

A Diversified Portfolio of
Federated ARMs Fund,
an Open-End Management
Investment Company

October 31, 1996

[GRAPHIC]

Federated Investors

Federated Investors Tower
Pittsburgh, PA 15222-3779

Federated Securities Corp. is the distributor of the fund
and is a subsidiary of Federated Investors.

Cusip 314082207
8100309A-SS (10/96)

FEDERATED ARMS FUND
INSTITUTIONAL SHARES
INSTITUTIONAL SERVICE SHARES
STATEMENT OF ADDITIONAL INFORMATION
This Statement of Additional Information should be read with the
respective prospectus for Institutional Shares or Institutional Service
Shares of Federated ARMs Fund (the "Fund") dated October 31, 1996. This
Statement is not a prospectus itself. You may request a copy of a
prospectus or a paper copy of this Statement, if you have received it
electronically, free of charge by calling 1-800-341-7400.
FEDERATED INVESTORS TOWER
PITTSBURGH, PENNSYLVANIA 15222-3779

Statement dated October 31, 1996

Federated Investors
Federated Investors Tower
Pittsburgh, PA 15222-3779

Federated Securities Corp. is the distributor of the Fund(s)
and is a subsidiary of Federated Investors.
Cusip 314082108
Cusip 314082207
8100309 B (10/96)

GENERAL INFORMATION ABOUT THE FUND 1

INVESTMENT OBJECTIVE AND POLICIES 1

Types of Investments 1
When-Issued and Delayed Delivery
Transactions 2
Repurchase Agreements 2
Lending of Portfolio Securities 2
Reverse Repurchase Agreements 2
Portfolio Turnover 2
INVESTMENT LIMITATIONS 3

FEDERATED ARMS FUND MANAGEMENT 4

Fund Ownership 8
Trustees Compensation 9
Trustee Liability 10
INVESTMENT ADVISORY SERVICES 10

Adviser to the Fund 10
Advisory Fees 10
Other Related Services 10
BROKERAGE TRANSACTIONS 10

OTHER SERVICES 11

Fund Administration 11
Custodian and Portfolio Accountant 11
Transfer Agent 11

Independent Auditors 11
PURCHASING SHARES 11

Distribution Plan (Institutional Service
Shares only) and Shareholder Services 11
Conversion to Federal Funds 12
DETERMINING NET ASSET VALUE 12

Determining Value of Securities 12
REDEEMING SHARES 12

EXCHANGING SECURITIES FOR FUND SHARES 12

Tax Consequences 13
MASSACHUSETTS PARTNERSHIP LAW 13

TAX STATUS 13

The Fund's Tax Status 13
Shareholders' Tax Status 13
TOTAL RETURN 13

YIELD 14

PERFORMANCE COMPARISONS 14

Economic and Market Information 15
ABOUT FEDERATED INVESTORS 15

Mutual Fund Market 15
Institutional Clients 15
Trust Organizations 15
Broker/Dealers and Bank Broker/Dealer

Subsidiaries 16
APPENDIX 17

GENERAL INFORMATION ABOUT THE FUND

Federated ARMs Fund (the "Fund") was established as a Massachusetts
business trust under a Declaration of Trust dated May 24, 1985. The
Declaration of Trust permits the Fund to offer separate series and classes
of shares.
Shares of the Fund are offered in two classes, Institutional Shares and
Institutional Service Shares (individually and collectively referred to as
the "Shares"). This Statement of Additional Information relates to both of
the above-mentioned Shares of the Fund.
INVESTMENT OBJECTIVE AND POLICIES

The Fund's investment objective is to provide current income consistent
with minimal volatility of principal. Current income includes, in general,
discount earned on U.S. Treasury bills and agency discount notes, interest
earned on mortgage-related securities and other U.S. government securities,
and short-term capital gains. The investment objective cannot be changed
without approval of shareholders. The Fund anticipates that it will
experience minimal volatility of principal due to the frequent adjustments
to interest rates on adjustable and floating rate mortgage securities which
comprise the portfolio. Of course, there can be no assurance that the Fund
will be able to maintain minimal volatility of principal or that it will
achieve its investment objective. The Fund endeavors to achieve its
investment objective, however, by following the investment policies
described in each prospectus and this Statement of Additional Information.
TYPES OF INVESTMENTS
The Fund will invest at least 65% of the value of its total assets in
adjustable and floating rate mortgage securities which are issued or
guaranteed as to payment of principal and interest by the U.S. government,

its agencies or instrumentalities. These securities and other U.S.
government or agency obligations are backed by:
othe full faith and credit of the U.S. Treasury;
othe issuer's right to borrow from the U.S. Treasury;
othe discretionary authority of the U.S. government to purchase
certain obligations of agencies or instrumentalities; or
othe credit of the agency or instrumentality issuing the obligations.
Examples of agencies and instrumentalities which may not always receive
financial support from the U.S. government are:
oFederal Farm Credit System, including the National Bank for
Cooperatives, Farm Credit Banks, and Banks for Cooperatives;
oFederal Home Loan Banks;
oFederal National Mortgage Association;
oStudent Loan Marketing Association; and
oFederal Home Loan Mortgage Corporation.
PRIVATELY ISSUED MORTGAGE-RELATED SECURITIES
Privately issued mortgage-related securities generally represent an
ownership interest in federal agency mortgage pass-through securities,
such as those issued by Government National Mortgage Association. The
terms and characteristics of the mortgage instruments may vary among
pass-through mortgage loan pools.
The market for such mortgage-related securities has expanded
considerably since its inception. The size of the primary issuance
market and the active participation in the secondary market by
securities dealers and other investors make government-related pools
highly liquid.

CAPS AND FLOORS
The value of mortgage-related securities in which the Fund invests may
be affected if interest rates rise or fall faster and farther than the
allowable caps on the underlying residential mortgage loans. For
example, consider a residential mortgage loan with a rate which
adjusts annually, an initial interest rate of 10%, a 2% per annum
interest rate cap, and a 5% life of loan interest rate cap. If the
index against which the underlying interest rate on the residential
mortgage loan is compared--such as the one-year Treasury-- moves up by
3%, the residential mortgage loan rate may not increase by more than
2% to 12% the first year. As one of the underlying residential
mortgages for the securities in which the Fund invests, the
residential mortgage would depress the value of the securities and,
therefore, the net asset value of the Fund. If the index against which
the interest rate on the underlying residential mortgage loan is
compared moves up no faster or farther than the cap on the underlying
mortgage loan allows, or if the index moves down as fast or faster
than the floor on the underlying mortgage loan allows, the mortgage
would maintain or improve the value of the securities in which the
Fund invests and, therefore, the net asset value of the Fund.
WHEN-ISSUED AND DELAYED DELIVERY TRANSACTIONS
These transactions are made to secure what is considered to be an
advantageous price or yield for the Fund. No fees or other expenses, other
than normal transaction costs, are incurred. However, liquid assets of the
Fund sufficient to make payment for the securities to be purchased are
segregated on the Fund's records at the trade date. These assets are marked
to market daily and are maintained until the transaction has been settled.
The Fund does not intend to engage in when-issued and delayed delivery

transactions to an extent that would cause the segregation of more than 20%
of the total value of its assets.
REPURCHASE AGREEMENTS
The Fund requires its custodian to take possession of the securities
subject to repurchase agreements, and these securities are marked to market
daily. To the extent that the original seller does not repurchase the
securities from the Fund, the Fund could receive less than the repurchase
price on any sale of such securities. In the event that a defaulting seller
files for bankruptcy or becomes insolvent, disposition of such securities
by the Fund might be delayed pending court action. The Fund believes that
under the regular procedures normally in effect for custody of the Fund's
portfolio securities subject to repurchase agreements, a court of competent
jurisdiction would rule in favor of the Fund and allow retention or
disposition of such securities. The Fund will only enter into repurchase
agreements with banks and other recognized financial institutions, such as
broker/dealers, which are deemed by the Fund's adviser to be creditworthy
pursuant to guidelines established by the Board of Trustees (the
"Trustees").
LENDING OF PORTFOLIO SECURITIES
The collateral received when the Fund lends portfolio securities must be
valued daily and, should the market value of the loaned securities
increase, the borrower must furnish additional collateral to the Fund.
During the time portfolio securities are on loan, the borrower pays the
Fund any dividends or interest paid on such securities. Loans are subject
to termination at the option of the Fund or the borrower. The Fund may pay
reasonable administrative and custodial fees in connection with a loan and
may pay a negotiated portion of the interest earned on the cash or
equivalent collateral to the borrower or placing broker.

REVERSE REPURCHASE AGREEMENTS
The Fund may also enter into reverse repurchase agreements. These
transactions are similar to borrowing cash. In a reverse repurchase
agreement, the Fund transfers possession of a portfolio instrument to
another person, such as a financial institution, broker, or dealer, in
return for a percentage of the instrument's market value in cash, and
agrees that on a stipulated date in the future the Fund will repurchase the
portfolio instrument by remitting the original consideration plus interest
at an agreed upon rate. The use of reverse repurchase agreements may enable
the Fund to avoid selling portfolio instruments at a time when a sale may
be deemed to be disadvantageous, but the ability to enter into reverse
repurchase agreements does not ensure that the Fund will be able to avoid
selling portfolio instruments at a disadvantageous time.
When effecting reverse repurchase agreements, liquid assets of the Fund, in
a dollar amount sufficient to make payment for the obligations to be
purchased, are segregated at the trade date. These assets are marked to
market daily and are maintained until the transaction is settled.
During the period any reverse repurchase agreements are outstanding, but
only to the extent necessary to assure completion of the reverse repurchase
agreements, the Fund will restrict the purchase of portfolio instruments to
money market instruments maturing on or before the expiration date of the
reverse repurchase agreements.
PORTFOLIO TURNOVER
The Fund will not attempt to set or meet a portfolio turnover rate since
any turnover would be incidental to transactions undertaken in an attempt
to achieve the Fund's investment objective. For the fiscal years ended
August 31, 1996, and 1995, the portfolio turnover rates were 134% and
124%, respectively.

INVESTMENT LIMITATIONS

STRIPPED MORTGAGE SECURITIES
The Fund will not invest in stripped mortgage securities, including
securities which represent a share of only the interest payments or
only the principal payments from underlying mortgage related
securities.
BUYING ON MARGIN
The Fund will not purchase any securities on margin but may obtain
such short-term credits as may be necessary for the clearance of
transactions.
ISSUING SENIOR SECURITIES AND BORROWING MONEY
The Fund will not issue senior securities except that the Fund may
borrow money and engage in reverse repurchase agreements in amounts up
to one-third of the value of its net assets, including the amounts
borrowed.
The Fund will not borrow money or engage in reverse repurchase
agreements for investment leverage, but rather as a temporary,
extraordinary, or emergency measure or to facilitate management of the
portfolio by enabling the Fund to meet redemption requests when the
liquidation of portfolio securities is deemed to be inconvenient or
disadvantageous. The Fund will not purchase any securities while any
such borrowings are outstanding.
During the period any reverse repurchase agreements are outstanding,
but only to the extent necessary to assure completion of the reverse
repurchase agreements, the Fund will restrict the purchase of
portfolio instruments to money market instruments maturing on or
before the expiration date of the reverse repurchase agreements.

PLEDGING ASSETS
The Fund will not mortgage, pledge, or hypothecate any assets except
to secure permitted borrowings. In those cases, it may pledge assets
having a market value not exceeding the lesser of the dollar amounts
borrowed or 10% of the value of total assets at the time of the
borrowing.
DIVERSIFICATION OF INVESTMENTS
With respect to securities comprising 75% of the value of its total
assets, the Fund will not purchase securities of any one issuer (other
than cash, cash items, or securities issued or guaranteed by the
government of the United States or its agencies or instrumentalities
and repurchase agreements collateralized by U.S. government
securities) if, as a result, more than 5% of the value of its total
assets would be invested in securities of that issuer.
INVESTING IN REAL ESTATE
The Fund will not buy or sell real estate, although it may invest in
the securities of companies whose business involves the purchase or
sale of real estate or in securities which are secured by real estate
or interests in real estate.
INVESTING IN COMMODITIES
The Fund will not purchase or sell commodities.
UNDERWRITING
The Fund will not underwrite any issue of securities, except as it may
be deemed to be an underwriter under the Securities Act of 1933 in
connection with the sale of securities in accordance with its
investment objective, policies, and limitations.

LENDING CASH OR SECURITIES
The Fund will not lend any of its assets, except portfolio securities
up to one-third of the value of its total assets.
SELLING SHORT
The Fund will not sell securities short.
INVESTING IN ILLIQUID SECURITIES
The Fund will not invest more than 15% of its net assets in securities
which are illiquid, including repurchase agreements providing for
settlement in more than seven days after notice.
INVESTING IN SECURITIES OF OTHER INVESTMENT COMPANIES
The Fund will not purchase securities of other investment companies,
except by purchases in the open market involving only customary
brokerage commissions and as a result of which not more than 5% of the
value of its total assets would be invested in such securities, or
except as part of a merger, consolidation, or other acquisition.
INVESTING IN NEW ISSUERS
The Fund will not invest more than 5% of the value of its total assets
in securities of issuers which have records of less than three years
of continuous operations, including the operation of any predecessor.
With respect to the asset-backed securities, the Fund will treat the
originator of the asset pool as the company issuing the securities for
purposes of determining compliance with this limitation.
The above investment limitations cannot be changed without shareholder
approval.
Except with respect to borrowing money, if a percentage limitation is
adhered to at the time of investment, a later increase or decrease in
percentage resulting from any change in value or net assets will not result
in a violation of such restriction.

The Fund did not engage in reverse repurchase agreements, purchase
securities of other investment companies, borrow money, or invest in
illiquid securities in excess of 5% of the value of its total assets during
the last fiscal year and has no present intent to do so in the coming
fiscal year.
For purposes of its policies and limitations, the Fund considers
certificates of deposit and demand and time deposits issued by a U.S.
branch of a domestic bank having capital, surplus, and undivided profits in
excess of $100,000,000 at the time of investment to be "cash items."
FEDERATED ARMS FUND MANAGEMENT

Officers and Trustees are listed with their addresses, birthdates, present
positions with Federated ARMS Fund, and principal occupations.

John F. Donahue@*
Federated Investors Tower
Pittsburgh, PA
Birthdate: July 28, 1924
Chairman and Trustee
Chairman and Trustee, Federated Investors, Federated Advisers, Federated
Management, and Federated Research; Chairman and Director, Federated
Research Corp. and Federated Global Research Corp.; Chairman, Passport
Research, Ltd.; Chief Executive Officer and Director or Trustee of the
Funds.

Thomas G. Bigley
28th Floor, One Oxford Centre

Pittsburgh, PA
Birthdate: February 3, 1934
Trustee
Chairman of the Board, Children's Hospital of Pittsburgh; formerly, Senior
Partner, Ernst & Young LLP; Director, MED 3000 Group, Inc.; Trustee,
University of Pittsburgh; Director or Trustee of the Funds.

John T. Conroy, Jr.
Wood/IPC Commercial Department
John R. Wood and Associates, Inc., Realtors
3255 Tamiami Trail North
Naples, FL
Birthdate: June 23, 1937
Trustee
President, Investment Properties Corporation; Senior Vice-President, John
R. Wood and Associates, Inc., Realtors; Partner or Trustee in private real
estate ventures in Southwest Florida; formerly, President, Naples Property
Management, Inc. and Northgate Village Development Corporation; Director or
Trustee of the Funds.

William J. Copeland
One PNC Plaza - 23rd Floor
Pittsburgh, PA
Birthdate: July 4, 1918

Trustee
Director and Member of the Executive Committee, Michael Baker, Inc.;
formerly, Vice Chairman and Director, PNC Bank, N.A., and PNC Bank Corp.;
Director, Ryan Homes, Inc.; Director or Trustee of the Funds.

James E. Dowd
571 Hayward Mill Road
Concord, MA
Birthdate: May 18, 1922
Trustee
Attorney-at-law; Director, The Emerging Germany Fund, Inc.; Trustee of the
Funds.

Lawrence D. Ellis, M.D.*
3471 Fifth Avenue, Suite 1111
Pittsburgh, PA
Birthdate: October 11, 1932
Trustee
Professor of Medicine, University of Pittsburgh; Medical Director,
University of Pittsburgh Medical Center - Downtown; Member, Board of
Directors, University of Pittsburgh Medical Center; formerly, Hematologist,
Oncologist, and Internist, Presbyterian and Montefiore Hospitals; Director
or Trustee of the Funds.

Edward L. Flaherty, Jr.@
Miller, Ament, Henny & Kochuba
205 Ross Street

Pittsburgh, PA
Birthdate: June 18, 1924
Trustee
Attorney of Counsel, Miller, Ament, Henny & Kochuba; Director, Eat'N Park
Restaurants, Inc.; formerly, Counsel, Horizon Financial, F.A., Western
Region; Director or Trustee of the Funds.

Peter E. Madden
One Royal Palm Way
100 Royal Palm Way
Palm Beach, FL
Birthdate: March 16, 1942
Trustee
Consultant; Former State Representative, Commonwealth of Massachusetts;
formerly, President, State Street Bank and Trust Company and State Street
Boston Corporation; Director or Trustee of the Funds.

Gregor F. Meyer
Miller, Ament, Henny & Kochuba
205 Ross Street
Pittsburgh, PA
Birthdate: October 6, 1926
Trustee

Attorney, Member of Miller, Ament, Henny & Kochuba; Chairman, Meritcare,
Inc.; Director, Eat'N Park Restaurants, Inc.; Director or Trustee of the
Funds.

John E. Murray, Jr., J.D., S.J.D.
President, Duquesne University
Pittsburgh, PA
Birthdate: December 20, 1932
Trustee
President, Law Professor, Duquesne University; Consulting Partner, Mollica,
Murray and Hogue; Director or Trustee of the Funds.

Wesley W. Posvar
1202 Cathedral of Learning
University of Pittsburgh
Pittsburgh, PA
Birthdate: September 14, 1925
Trustee
Professor, International Politics; Management Consultant; Trustee, Carnegie
Endowment for International Peace, RAND Corporation, Online Computer
Library Center, Inc., National Defense University, U.S. Space Foundation
and Czech Management Center; President Emeritus, University of Pittsburgh;
Founding Chairman, National Advisory Council for Environmental Policy and
Technology, Federal Emergency Management Advisory Board and Czech
Management Center; Director or Trustee of the Funds.

Marjorie P. Smuts
4905 Bayard Street
Pittsburgh, PA
Birthdate: June 21, 1935
Trustee
Public relations/Marketing/Conference Planning, Manchester Craftsmen's
Guild; Restaurant Consultant, Frick Art & History Center; Conference
Coordinator, University of Pittsburgh Art History Department; Director or
Trustee of the Funds.

Glen R. Johnson
Federated Investors Tower
Pittsburgh, PA
Birthdate: May 2, 1929
President
Trustee, Federated Investors; President and/or Trustee of some of the
Funds; staff member, Federated Securities Corp.

J. Christopher Donahue
Federated Investors Tower
Pittsburgh, PA
Birthdate: April 11, 1949
Executive Vice President

President and Trustee, Federated Investors, Federated Advisers, Federated
Management, and Federated Research; President and Director, Federated
Research Corp. and Federated Global Research Corp.; President, Passport
Research, Ltd.; Trustee, Federated Shareholder Services Company, and
Federated Shareholder Services; Director, Federated Services Company;
President or Executive Vice President of the Funds; Director or Trustee of
some of the Funds. Mr. Donahue is the son of John F. Donahue, Chairman and
Trustee of the Company.

John W. McGonigle
Federated Investors Tower
Pittsburgh, PA
Birthdate: October 26, 1938
Executive Vice President , Secretary and Treasurer
Executive Vice President, Secretary, and Trustee, Federated Investors;
Trustee, Federated Advisers, Federated Management, and Federated Research;
Director, Federated Research Corp. and Federated Global Research Corp.;
Trustee, Federated Shareholder Services Company; Director, Federated
Services Company; President and Trustee, Federated Shareholder Services;
Director, Federated Securities Corp.; Executive Vice President and
Secretary of the Funds; Treasurer of some of the Funds.

Richard B. Fisher
Federated Investors Tower
Pittsburgh, PA
Birthdate: May 17, 1923
Vice President

Executive Vice President and Trustee, Federated Investors; Chairman and
Director, Federated Securities Corp.; President or Vice President of some
of the Funds; Director or Trustee of some of the Funds.

*This Trustee is deemed to be an ``interested person'' as defined in
the Investment Company Act of 1940.
@Member of the Executive Committee. The Executive Committee of the
Board of Trustees handles the responsibilities of the Board between
meetings of the Board.
As used in the table above, "The Funds" and "Funds" mean the following
investment companies: 111 Corcoran Funds; Annuity Management Series; Arrow
Funds; Automated Government Money Trust; Blanchard Funds; Blanchard
Precious Metals Fund, Inc.; Cash Trust Series II; Cash Trust Series, Inc. ;
DG Investor Series; Edward D. Jones & Co. Daily Passport Cash Trust;
Federated Adjustable Rate U.S. Government Fund, Inc.; Federated American
Leaders Fund, Inc.; Federated ARMs Fund; Federated Equity Funds; Federated
Equity Income Fund, Inc.; Federated Fund for U.S. Government Securities,
Inc.; Federated GNMA Trust; Federated Government Income Securities, Inc.;
Federated Government Trust; Federated High Income Bond Fund, Inc.;
Federated High Yield Trust; Federated Income Securities Trust; Federated
Income Trust; Federated Index Trust; Federated Institutional Trust;
Federated Insurance Series; Federated Investment Portfolios; Federated
Investment Trust; Federated Master Trust; Federated Municipal Opportunities
Fund, Inc.; Federated Municipal Securities Fund, Inc.; Federated Municipal
Trust; Federated Short-Term Municipal Trust; Federated Short-Term U.S.
Government Trust; Federated Stock and Bond Fund, Inc.; Federated Stock
Trust; Federated Tax-Free Trust; Federated Total Return Series, Inc.;
Federated U.S. Government Bond Fund; Federated U.S. Government Securities

Fund: 1-3 Years; Federated U.S. Government Securities Fund: 2-5 Years;
Federated U.S. Government Securities Fund: 5-10 Years; Federated Utility
Fund, Inc.; First Priority Funds; Fixed Income Securities, Inc.; High Yield
Cash Trust; Intermediate Municipal Trust; International Series, Inc.;
Investment Series Funds, Inc.; Investment Series Trust; Liberty Term
Trust, Inc. - 1999; Liberty U.S. Government Money Market Trust; Liquid Cash
Trust; Managed Series Trust; Money Market Management, Inc.; Money Market
Obligations Trust; Money Market Trust; Municipal Securities Income Trust;
Newpoint Funds; Peachtree Funds; RIMCO Monument Funds; Targeted Duration
Trust; Tax-Free Instruments Trust; The Planters Funds; The Starburst Funds;
The Starburst Funds II; The Virtus Funds; Trust for Financial Institutions;
Trust for Government Cash Reserves; Trust for Short-Term U.S. Government
Securities; Trust for U.S. Treasury Obligations; and World Investment
Series, Inc.
FUND OWNERSHIP
Officers and Trustees own less than 1% of the Fund's outstanding shares.
As of October 7, 1996, the following shareholders of record owned 5% or
more of the Institutional Service Shares of the Fund: Hawaii Federal &
State Employee Federal Credit Union, Hilo, Hawaii, owned approximately
962,095 shares (8.75%); Bellco First FCU, Greenwood Village, Colorado,
owned approximately 1,467,075 shares (13.34%); First Federal Savings & Loan
of Charleston, North Charleston, South Carolina, owned approximately
1,004,017 shares (9.13%); The Cato Corporation, Charlotte, North Carolina
owned approximately 591,534 shares (5.38%); and RAF Financial Corporation
for the benefit of Manteno State Bank, Denver, Colorado, owned
approximately 764,776 shares (6.95%).

As of October 7, 1996, the following shareholder of record owned 5% or more
of the Institutional Shares of the Fund: APCO Employees Credit Union,
Birmingham, Alabama, owned approximately 6,008,538 shares (9.04%).

TRUSTEES COMPENSATION

AGGREGATE
NAME , COMPENSATION
POSITION WITH FROM TOTAL COMPENSATION PAID
TRUST TRUST*# FROM FUND COMPLEX +

John F. Donahue $0 $0 for the Trust and
Chairman and Trustee 54 other investment companies in the Fund
Complex
Thomas G. Bigley++ $1,887.63 $86,331 for the Trust and
Trustee 54 other investment companies in the Fund Complex
John T. Conroy, Jr. $2,059.60 $115,760 for the Trust and
Trustee 54 other investment companies in the Fund Complex
William J. Copeland $2,059.60 $115,760 for the Trust and
Trustee 54 other investment companies in the Fund Complex
James E. Dowd $2,059.60 $115,760 for the Trust and
Trustee 54 other investment companies in the Fund Complex
Lawrence D. Ellis, M.D. $1,887.63 $104,898 for the Trust and
Trustee 54 other investment companies in the Fund Complex
Edward L. Flaherty, Jr. $2,059.60 $115,760 for the Trust and

Trustee 54 other investment companies in the Fund Complex
Peter E. Madden $1,887.63 $104,898 for the Trust and
Trustee 54 other investment companies in the Fund Complex
Gregor F. Meyer $1,887.63 $104,898 for the Trust and
Trustee 54 other investment companies in the Fund Complex
John E. Murray, Jr. $1,887.63 $104,898 for the Trust and
Trustee 54 other investment companies in the Fund Complex
Wesley W. Posvar $1,887.63 $104,898 for the Trust and
Trustee 54 other investment companies in the Fund Complex
Marjorie P. Smuts$1,887.63 $104,898 for the Trust and
Trustee 54 other investment companies in the Fund Complex

*Information is furnished for the fiscal year ended August 31, 1996.
#The agregate compensation is provided for the Trust which is comprised of
one portfolio.
+The information is provided for the last calendar year.
++Mr. Bigley served on 39 investment companies in the Federated Funds
Complex from January 1 through September 30, 1995. On October 1, 1995, he
was appointed a Trustee on 15 additional Federated Funds.
TRUSTEE LIABILITY
The Trust's Declaration of Trust provides that the Trustees will not be
liable for errors of judgment or mistakes of fact or law. However, they are
not protected against any liability to which they would otherwise be
subject by reason of willful misfeasance, bad faith, gross negligence, or
reckless disregard of the duties involved in the conduct of their office.

INVESTMENT ADVISORY SERVICES

ADVISER TO THE FUND
The Fund's investment adviser is Federated Management (the "Adviser"). It
is a subsidiary of Federated Investors. All of the voting securities of
Federated Investors are owned by a trust, the trustees of which are John F.
Donahue, his wife, and his son, J. Christopher Donahue.
The Adviser shall not be liable to the Trust, the Fund, or any shareholder
of the Fund for any losses that may be sustained in the purchase, holding,
or sale of any security, or for anything done or omitted by it, except acts
or omissions involving willful misfeasance, bad faith, gross negligence, or
reckless disregard of the duties imposed upon it by its contract with the
Trust.
ADVISORY FEES
For its advisory services, the Adviser receives an annual investment
advisory fee as described in the prospectus. During the fiscal years ended
August 31, 1996, 1995, and 1994, the Fund's Adviser earned $5,228,816,
$7,041,965, and $14,679,639, respectively, of which $1,618,615, $2,149,890,
and $3,459,009, respectively, were voluntarily waived because of
undertakings to limit the Fund's expenses.
STATE EXPENSE LIMITATIONS
The Adviser has undertaken to comply with the expense limitations
established by certain states for investment companies whose shares
are registered for sale in those states. If the Fund's normal
operating expenses (including the investment advisory fee, but not
including brokerage commissions, interest, taxes, and extraordinary
expenses) exceed 2 1/2% per year of the first $30 million of average
net assets, 2% per year of the next $70 million of average net assets,

and 1 1/2% per year of the remaining average net assets, the Adviser
will reimburse the Fund for its expenses over the limitation.
If the Fund's monthly projected operating expenses exceed this
limitation, the investment advisory fee paid will be reduced by the
amount of the excess, subject to an annual adjustment. If the expense
limitation is exceeded, the amount to be reimbursed by the Adviser
will be limited, in any single fiscal year, by the amount of the
investment advisory fee.
This arrangement is not part of the advisory contract and may be
amended or rescinded in the future.
OTHER RELATED SERVICES
Affiliates of the Adviser may, from time to time, provide certain
electronic equipment and software to institutional customers in order to
facilitate the purchase of shares of funds offered by Federated Securities
Corp.
BROKERAGE TRANSACTIONS

When selecting brokers and dealers to handle the purchase and sale of
portfolio instruments, the adviser looks for prompt execution of the order
at a favorable price. In working with dealers, the adviser will generally
use those who are recognized dealers in specific portfolio instruments,
except when a better price and execution of the order can be obtained
elsewhere. The adviser makes decisions on portfolio transactions and
selects brokers and dealers subject to guidelines established by the
Trustees. The adviser may select brokers and dealers who offer brokerage
and research services. These services may be furnished directly to the Fund
or to the adviser and may include: advice as to the advisability of
investing in securities; security analysis and reports; economic studies;
industry studies; receipt of quotations for portfolio evaluations; and

similar services. Research services provided by brokers and dealers may be
used by the adviser or its affiliates in advising the Fund and other
accounts. To the extent that receipt of these services may supplant
services for which the adviser or its affiliates might otherwise have paid,
it would tend to reduce their expenses. The adviser and its affiliates
exercise reasonable business judgment in selecting brokers who offer
brokerage and research services to execute securities transactions. They
determine in good faith that commissions charged by such persons are
reasonable in relationship to the value of the brokerage and research
services provided. During the fiscal year(s) ended August 31, 1996, 1995
and 1994, the Trust paid no brokerage commissions.
Although investment decisions for the Fund are made independently from
those of the other accounts managed by the adviser, investments of the type
the Fund may make may also be made by those other accounts. When the Fund
and one or more other accounts managed by the adviser are prepared to
invest in, or desire to dispose of, the same security, available
investments or opportunities for sales will be allocated in a manner
believed by the adviser to be equitable to each. In some cases, this
procedure may adversely affect the price paid or received by the Fund or
the size of the position obtained or disposed of by the Fund. In other
cases, however, it is believed that coordination and the ability to
participate in volume transactions will be to the benefit of the Fund.
OTHER SERVICES

FUND ADMINISTRATION
Federated Services Company, a subsidiary of Federated Investors, provides
administrative personnel and services to the Fund for a fee as described in
the prospectus. From March 1, 1994 to March 1, 1996, Federated
Administrative Services served as the Fund's Administrator. Prior to March

1, 1994, Federated Administrative Services, Inc. served as the Fund's
Administrator. Both former Administrators are subsidiaries of Federated
Investors. For purposes of this Statement of Additional Information,
Federated Services Company, Federated Administrative Services and Federated
Administrative Services, Inc. may hereinafter collectively be referred to
as the "Administrators." For the fiscal years ended August 31, 1996, 1995,
and 1994, the Administrators earned $659,077, $888,461, and $1,429,050,
respectively.
CUSTODIAN AND PORTFOLIO ACCOUNTANT
State Street Bank and Trust Company, Boston, MA, is custodian for the
securities and cash of the Fund. Federated Services Company, Pittsburgh,
PA, provides certain accounting and recordkeeping services with respect to
the Fund's portfolio investments. The fee paid for this service is based
upon the level of the Fund's average net assets for the period plus out-of-
pocket expenses.
TRANSFER AGENT
Federated Services Company, through its registered transfer agent,
Federated Shareholder Services Company, maintains all necessary shareholder
records. For its services, the transfer agent receives a fee based on size,
type, number of accounts and transactions made by shareholders.
INDEPENDENT AUDITORS
The independent auditors for the Fund are Ernst & Young LLP, Pittsburgh,
PA.
PURCHASING SHARES

Shares are sold at their net asset value without a sales charge on days the
New York Stock Exchange is open for business. The procedure for purchasing
Shares is explained in the respective prospectuses under "Investing in
Institutional Shares" or "Investing in Institutional Service Shares."

DISTRIBUTION PLAN (INSTITUTIONAL SERVICE SHARES ONLY) AND SHAREHOLDER
SERVICES
These arrangements permit the payment of fees to financial institutions,
the distributor, and Federated Shareholder Services to stimulate
distribution activities and to cause services to be provided to
shareholders by a representative who has knowledge of the shareholder's
particular circumstances and goals. These activities and services may
include, but are not limited to: marketing efforts; providing office space,
equipment, telephone facilities, and various clerical, supervisory,
computer, and other personnel as necessary or beneficial to establish and
maintain shareholder accounts and records; processing purchase and
redemption transactions and automatic investments of client account cash
balances; answering routine client inquiries; and assisting clients in
changing dividend options, account designations, and addresses.
With respect to the Institutional Service Shares, by adopting the
Distribution Plan, the Board of Trustees expects that the Fund will be able
to achieve a more predictable flow of cash for investment purposes and to
meet redemptions. This will facilitate more efficient portfolio management
and assist the Fund in pursuing its investment objectives. By identifying
potential investors whose needs are served by the Fund's objectives, and
properly servicing these accounts, the Fund may be able to curb sharp
fluctuations in rates of redemptions and sales.
Other benefits, which may be realized under either arrangement, may
include: (1) providing personal services to shareholders; (2) investing
shareholder assets with a minimum of delay and administrative detail; (3)
enhancing shareholder recordkeeping systems; and (4) responding promptly to
shareholders' requests and inquiries concerning their accounts.

For the fiscal period ending August 31, 1996, payments in the amount of
$308,922 were made pursuant to the Distribution Plan (Institutional Service
Shares only), of which $305,215 was voluntarily waived. In addition, for
this period, the Fund paid shareholder services fees in the amount of
$308,922 (Institutional Service Shares) and $1,869,751 (Institutional
Shares), of which $3,707 (Institutional Service Shares) and $1,869,751
(Institutional Shares) was voluntarily waived.
CONVERSION TO FEDERAL FUNDS
It is the Fund's policy to be as fully invested as possible so that maximum
interest may be earned. To this end, all payments from shareholders must be
in federal funds or be converted into federal funds before shareholders
begin to earn dividends. Federated Services Company acts as the
shareholder's agent in depositing checks and converting them to federal
funds.
DETERMINING NET ASSET VALUE

Net asset value generally changes each day. The days on which net asset
value is calculated by the Fund are described in each prospectus.
DETERMINING VALUE OF SECURITIES
Market values of the Fund's portfolio securities are determined as follows:
oas provided by an independent pricing service;
ofor short-term obligations, according to the mean between bid and
asked prices, as furnished by an independent pricing service, or for
short-term obligations with remaining maturities of 60 days or less
at the time of purchase, at amortized cost unless the Trustees
determines this is not fair value; or
oat fair value as determined in good faith by the Trustees.
Prices provided by independent pricing services may be determined without
relying exclusively on quoted prices. Pricing services may consider:

oyield;
oquality;
ocoupon rate;
omaturity;
otype of issue;
otrading characteristics; and
oother market data.
REDEEMING SHARES

The Fund redeems Shares at the next computed net asset value after the Fund
receives the redemption request. Redemption procedures are explained in the
respective prospectus under "Redeeming Institutional Shares," or "Redeeming
Institutional Service Shares." Although State Street Bank does not charge
for telephone redemptions, it reserves the right to charge a fee for the
cost of wire-transferred redemptions of less than $5,000.
EXCHANGING SECURITIES FOR FUND SHARES

Investors may exchange U.S. government securities they already own for
Shares, or they may exchange a combination of U.S. government securities
and cash for Shares. An investor should forward the securities in
negotiable form with an authorized letter of transmittal to Federated
Securities Corp. The Fund will notify the investor of its acceptance and
valuation of the securities within five business days of their receipt by
State Street Bank.
The Fund values securities in the same manner as the Fund values its
assets. The basis of the exchange will depend upon the net asset value of
Shares on the day the securities are valued. One Share will be issued for
each equivalent amount of securities accepted.

Any interest earned on the securities prior to the exchange will be
considered in valuing the securities. All interest, dividends,
subscription, or other rights attached to the securities become the
property of the Fund, along with the securities.
TAX CONSEQUENCES
Exercise of this exchange privilege is treated as a sale for federal income
tax purposes. Depending upon the cost basis of the securities exchanged for
Shares, a gain or loss may be realized by the investor.
MASSACHUSETTS PARTNERSHIP LAW

Under certain circumstances, shareholders may be held personally liable as
partners under Massachusetts law for acts or obligations of the Trust. To
protect its shareholders, the Trust has filed legal documents with
Massachusetts that expressly disclaim the liability of its shareholders for
acts or obligations of the Trust. These documents require notice of this
disclaimer to be given in each agreement, obligation, or instrument the
Trust or its Trustees enter into or sign.
In the unlikely event a shareholder is held personally liable for the
Trust's obligations, the Trust is required to use its property to protect
or compensate the shareholder. On request, the Trust will defend any claim
made and pay any judgment against a shareholder for any act or obligation
of the Trust. Therefore, financial

regulated investment companies and to receive the special tax treatment
afforded to such companies. To qualify for this treatment, the Fund must,
among other requirements:
oderive at least 90% of its gross income from dividends, interest,
and gains from the sale of securities;
oderive less than 30% of its gross income from the sale of securities
held less than three months;
oinvest in securities within certain statutory limits; and
odistribute to its shareholders at least 90% of its net income earned
during the year.
SHAREHOLDERS' TAX STATUS
Shareholders are subject to federal income tax on dividends and capital
gains received as cash or additional shares. No portion of any income
dividend paid by the Fund is eligible for the dividends received deduction
or exclusion available to corporations. These dividends, and any short-term
capital gains, are taxable as ordinary income.
CAPITAL GAINS
Shareholders will pay federal tax at capital gains rates on long-term
capital gains distributed to them regardless of how long they have held the
Shares.
TOTAL RETURN

The Fund's average annual total return for Institutional Shares for the
one-year, five-year and ten-year periods ended August 31, 1996, were 6.02%,
5.80%, and 6.60%, respectively. The Fund's average annual total return for
Institutional Service Shares for the one year period ended August 31, 1996
and for the period from May 4, 1992 (date of initial public investment) to
August 31, 1996, were 5.75% and 4.42%, respectively.

The average annual total return for both classes of shares of the Fund is
the average compounded rate of return for a given period that would equate
a $1,000 initial investment to the ending redeemable value of that
investment. The ending redeemable value is computed by multiplying the
number of shares owned at the end of the period by the net asset value per
share at the end of the period. The number of shares owned at the end of
the period is based on the number of shares purchased at the beginning of
the period with $1,000, adjusted over the period by any additional shares,
assuming the monthly reinvestment of all dividends and distributions.
YIELD

The Fund's yield for Institutional Shares for the thirty-day period ended
August 31, 1996, was 6.19%. The Fund's yield for Institutional Service
Shares was 5.93% for the same period.
The yield for both classes of shares of the Fund is determined by dividing
the net investment income per share (as defined by the Securities and
Exchange Commission) earned by either class of shares over a thirty-day
period by the maximum offering price per share by either class of shares on
the last day of the period. This value is then annualized using semi-annual
compounding. This means that the amount of income generated during the
thirty-day period is assumed to be generated each month over a twelve-month
period and is reinvested every six months. The yield does not necessarily
reflect income actually earned by either class because of certain
adjustments required by the Securities and Exchange Commission and,
therefore, may not correlate to the dividends or other distributions paid
to shareholders.
To the extent that financial institutions and broker/dealers charge fees in
connection with services provided in conjunction with an investment in

either class of shares, performance will be reduced for those shareholders
paying those fees.
PERFORMANCE COMPARISONS

The performance of both classes of shares depends upon such variables as:
oportfolio quality;
oaverage portfolio maturity;
otypes of instruments in which the portfolio is invested;
ochanges in interest rates and market value of portfolio securities;
ochanges in the Fund's or either class of Share's expenses; and
ovarious other factors.
Either class of Share's performance fluctuates on a daily basis largely
because net earnings and offering price per share fluctuate daily. Both net
earnings and maximum offering price per share are factors in the
computation of yield and total return.
Investors may use financial publications and/or indices to obtain a more
complete view of the Fund's performance. When comparing performance,
investors should consider all relevant factors such as the composition of
any index used, prevailing market conditions, portfolio compositions of
other funds, and methods used to value portfolio securities and compute
maximum offering price. The financial publications and/or indices which the
Fund uses in advertising may include:
oLEHMAN BROTHERS ADJUSTABLE RATE MORTGAGE FUNDS AVERAGE is comprised
of all agency guaranteed securities with coupons that periodically
adjust over a spread of a published index.
oLEHMAN BROTHERS 1-3 YEAR GOVERNMENT INDEX is comprised of all
publicly issued, non-convertible domestic debt of the U.S.
government, or any agency thereof, or any quasi-federal corporation.
The index also includes corporate debt guaranteed by the U.S.

government. Only notes and bonds with a minimum maturity of one year
and maximum maturity of 2.9 years are included.
oLIPPER ANALYTICAL SERVICES, INC., ranks funds in various fund
categories by making comparative calculations using total return.
Total return assumes the reinvestment of all capital gains
distributions and income dividends and takes into account any change
in net asset value over a specific period of time. From time to
time, the Fund will quote its Lipper ranking in the "U.S. Mortgage
Funds" category in advertising and sales literature.
oMORNINGSTAR, INC., an independent rating service, is the publisher
of the bi-weekly Mutual Fund Values. Mutual Fund Values rates more
than 1,000 NASDAQ-listed mutual funds of all types, according to
their risk-adjusted returns. The maximum rating is five stars, and
ratings are effective for two weeks.
Advertising and other promotional literature may include charts, graphs and
other illustrations using the Fund's returns, or returns in general, that
demonstrate basic investment concepts such as tax-deffered compounding,
dollar-cost averaging and systematic investment. In addition, the Fund can
compare its performance, or performance for the types of securities in
which it invests, to a variety of other invstments, such as bank savings
accounts, certificates of deposit, and Treasury bills.
ECONOMIC AND MARKET INFORMATION
Advertising and sales literature for the Fund may include discussions of
economic, financial and political developments and their effect on the
securities market. Such discussions may take the form of commentary on
these developments by the Fund portfolio managers and their views and
anaylsis on how such developments could affect the Fund. In addition,
advertising and sales literature may quote statistics and give general

information about the mutual fund industry, including the growth of the
industry, from sources such as the Investment Company Institute.
ABOUT FEDERATED INVESTORS

Federated Investors is dedicated to meeting investor needs which is
reflected in its investment decision making--structured, straightforward,
and consistent. This has resulted in a history of competitive performance
with a range of competitive investment products that have gained the
confidence of thousands of clients and their customers.
The company's disciplined security selection process is firmly rooted in
sound methodologies backed by fundamental and technical research.
Investment decisions are made and executed by teams of portfolio managers,
analysts, and traders dedicated to specific market sectors.
In the government sector, as of December 31, 1995, Federated Investors
managed 9 mortgage-backed, 5 government/agency and 17 government money
market mutual funds, with assets approximating $7.7 billion, $1.7 billion
and $20.9 billion, respectively. Federated trades approximately $300
million in U.S. government and mortgage-backed securities daily and places
approximately $13 billion in repurchase agreements each day. Federated
introduced the first U.S. government fund to invest in U.S. government bond
securities in 1969. Federated has been a major force in the short- and
intermediate-term government markets since 1982 and currently manages
nearly $10 billion in government funds within these maturity ranges.
J. Thomas Madden, Executive Vice President, oversees Federated's equity and
high yield corporate bond management while William D. Dawson, Executive
Vice President, oversees Federated's domestic fixed income management.
Henry A. Frantzen, Executive Vice President, oversees the management of
Federated's international portfolios.

MUTUAL FUND MARKET
Twenty-seven percent of American households are pursuing their financial
goals through mutual funds. These investors, as well as businesses and
institutions, have entrusted over $3 trillion to the more than 5,500 funds
available.*
Federated Investors, through its subsidiaries, distributes mutual funds for
a variety of investment applications. Specific markets include:
INSTITUTIONAL CLIENTS
Federated meets the needs of more than 4,000 institutional clients
nationwide by managing and servicing separate accounts and mutual funds for
a variety of applications, including defined benefit and defined
contribution programs, cash management, and asset/liability management.
Institutional clients include corporations, pension funds, tax-exempt
entities, foundations/endowments, insurance companies, and investment and
financial advisors. The marketing effort to these institutional clients is
headed by John B. Fisher, President, Institutional Sales Division.
TRUST ORGANIZATIONS
Other institutional clients include close relationships with more than
1,500 banks and trust organizations. Virtually all of the trust divisions
of the top 100 bank holding companies use Federated funds in their clients'
portfolios. The marketing effort to trust clients is headed by Mark R.
Gensheimer, Executive Vice President, Bank Marketing & Sales.

BROKER/DEALERS AND BANK BROKER/DEALER SUBSIDIARIES
Federated mutual funds are available to consumers through major brokerage
firms nationwide--including 200 New York Stock Exchange firms--supported by
more wholesalers than any other mutual fund distributor. Federated's

service to financial professionals and institutions has earned it high
rankings in several DALBAR Surveys. The marketing effort to these firms is
headed by James F. Getz, President, Broker/Dealer Division.
*source: Investment Company Institute

APPENDIX

STANDARD & POOR'S RATINGS GROUP LONG TERM DEBT RATING DEFINITIONS
AAA Debt rated `AAA'' has the highest rating assigned by Standard & Poor's
Ratings Group. 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 in higher
rated categories.
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.
B Debt rated `B'' has a greater vulnerability to default but currently
has the capacity to meet interest payments and principal repayments.
Adverse business, financial, or economic conditions will 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'' rating.
MOODY'S INVESTORS SERVICE, INC., CORPORATE BOND RATING DEFINITIONS
AAA Bonds which are rated `Aaa'' are judged to be of the best quality.
They carry the smallest degree of investment risk and are generally
referred to as `gilt edged.'' Interest payments are protected by a
large or by an exceptionally stable margin and principal is secure.
While the various protective elements are likely to change, such
changes as can be visualized are most unlikely to impair the
fundamentally strong position of such issues.
AA Bonds which are rated `Aa'' are judged to be of high quality by all
standards. Together with the `Aaa'' group, they comprise what are
generally known as high-grade bonds. They are rated lower than the
best bonds because margins of protection may not be as large as in
`Aaa'' securities or fluctuation of protective elements may be of
greater amplitude or there may be other elements present which make
the long-term 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 some time 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 `Ba'' are judged to have speculative elements; their
future cannot be considered as well-assured. Often the protection of
interest and principal payments may be very moderate and thereby not
well safeguarded during both good and bad times over the future.
Uncertainty of position characterizes bonds in this class.
B Bonds which are rated `B'' generally lack characteristics of the
desirable investment. Assurance of interest and principal payments or
of maintenance of other terms of the contract over any long period of
time may be small.
FITCH INVESTORS SERVICE, INC., INVESTMENT GRADE BOND RATING DEFINITIONS
AAA Bonds considered to be investment grade and of the highest credit
quality. The obligor has an exceptionally strong ability to pay
interest and repay principal, which is unlikely to be affected by
reasonably foreseeable events.
AA Bonds considered to be investment grade and of very high credit
quality. The obligor's ability to pay interest and repay principal is
very strong, although not quite as strong as bonds rated `AAA''.
Because bonds rated in the `AAA'' and ``AA'' categories are not

significantly vulnerable to foreseeable future developments, short-
term debt of these issuers is generally rated `F-1+''.
A Bonds considered to be investment grade and of high credit quality.
The obligor's ability to pay interest and repay principal is
considered to be strong, but may be more vulnerable to adverse changes
in economic conditions and circumstances than bonds with higher
ratings.
BBB Bonds considered to be investment grade and of satisfactory credit
quality. The obligor's ability to pay interest and repay principal is
considered to be adequate. Adverse changes in economic conditions and
circumstances, however, are more likely to have adverse impact on
these bonds, and therefore impair timely payment. The likelihood that
the ratings of these bonds will fall below investment grade is higher
than for bonds with higher ratings.
BB Bonds are considered speculative. The obligor's ability to pay
interest and repay principal may be affected over time by adverse
economic changes. However, business and financial alternatives can be
identified which could assist the obligor in satisfying its debt
service requirements.
B Bonds are considered highly speculative. While bonds in this class are
currently meeting debt service requirements, the probability of
continued timely payment of principal and interest reflects the
obligor's limited margin of safety and the need for reasonable
business and economic activity throughout the life of the issue.