MANAGEMENT DISCUSSION AND ANALYSIS
Federated ARMs Fund
Annual Report For Fiscal Year Ended August 31, 1999
INSTITUTIONAL SHARES
INSTITUTIONAL SERVICE SHARES
Federated ARMs Fund (the "fund") invests at least 65% of its total assets in
U.S. government adjustable and floating rate mortgage securities. The investment
objective of the fund is to provide current income consistent with minimum
volatility of principal. The fund is assigned an AAAf credit rating 1 by
Standard and Poor's. As of August 31, 1999, the average duration of the fund was
1.6 years.
The annual reporting period ended August 31, 1999 witnessed extremes in interest
rates and mortgage spreads. Initially, the financial market crisis of 1998
prompted central banks around the world to ease monetary policy as investors
shunned all but the safest, most liquid securities. This flight-to-quality bid
drove U.S. Treasury yields to record lows. As markets stabilized, focus returned
to economic fundamentals which reflected substantial momentum. Subsequent
Federal Reserve Board (the "Fed") action and inflationary angst drove market
yields materially higher from the first quarter lows.
Gross Domestic Product averaged nearly 4% for the one-year period ended June 30,
1999. Employment growth, consumer confidence and equity market gains contributed
to strong consumer spending. Conversely, manufacturing output was negatively
impacted over the first half of the reporting period due to overseas economic
woes. In the past six months, however, the manufacturing sector has rebounded.
September's National Association of Purchasing Manager's survey rose to the
highest level since 1994, due in part to strong export demand. At present, the
U.S. economy appears strong on all fronts.
The Fed eased monetary policy on three occasions in the first portion of the
reporting period to forestall a "seizing up" of financial markets. A consequent
return to stability and concern over potential inflation prompted the Fed to
reverse course in the latest quarter. Fed funds were raised by 25 basis point
increments in June and August 1999, partially offsetting last year's cumulative
75 basis point easing.
Considerable interest rate volatility resulted from the financial market crisis,
consequent recovery and concern over a potentially overheating economy. The
2-year Treasury yield, for example, began the reporting period at 4.87%. Strong
demand for safety and liquidity pushed yields down to 3.82% in October 1998
before reversing course and reaching a high of 5.78% in August 1999. Yield
movements of such magnitude made for a challenging adjustable rate mortgage
(ARM) investment environment.
1 An AAAf rating indicates that the fund's portfolio holdings and counterparties
provide extremely strong protection against losses from credit defaults. Ratings
are subject to change, and do not remove market risks.
Prepayment risk was of great concern at the outset of the reporting period.
Initially, the 1- to 10-year Treasury yield spread measured just 18 basis
points. Such a flat yield curve acts as refinance incentive for ARM borrowers.
Given such an environment, ARM holdings were reduced in favor of prepayment
protected collateralized mortgage obligations and 15-year mortgage backed
securities. The 1- to 10-year spread increased over time, closing the reporting
period at 71 basis points. As the refinance incentive declined over the course
of the year, the adjustable allocation was increased with the addition of the
Cost-of-Funds Index, Government National Mortgage Association (GNMA) and hybrid
ARMs.
Within the year, ARM spreads varied substantially. However, the year-over- year
change in par-priced GNMA ARM option-adjusted spread was one basis point. The
ending spread measured 86 basis points, up one basis point. While the 12-month
spread change is minimal, the environment is drastically different. The
refinance incentive declined and stabilized at a multi-year low at fiscal year
end. Spreads have contracted from highs reached in fall 1998 and summer 1999;
present spreads are, however, historically attractive. The risk reduction
combined with wide spreads results in a positive sector outlook.
The fund's net total return for the Institutional Shares and Institutional
Service Shares for the 12-month reporting period ended August 31, 1999 was 3.74%
2 and 3.49%,2 respectively, compared to 4.56%3 for the Merrill Lynch 1-Year
Treasury Index and 3.90%4 for the Lipper ARM fund average.
2 Performance quoted represents past performance and is not indicative of future
results. Investment return and principal value will fluctuate so that an
investor's shares, when redeemed, may be worth more or less than their original
cost.
3 The Merrill Lynch 1-Year Treasury Index is an unmanaged index tracking 1- year
U.S. government securities. The index is produced by Merrill Lynch, Pierce,
Fenner & Smith, Inc. Investments cannot be made in this index.
4 Lipper figures represent the average of the total returns reported by all of
the mutual funds designated by Lipper Analytical Services, Inc. as falling into
respective categories indicated. Lipper figures do not reflect sales charges.
INSTITUTIONAL SHARES
GROWTH OF $25,000 INVESTED IN FEDERATED ARMS FUND
The graphic presentation here displayed consists of a line graph. The
corresponding components of the line graph are listed underneath. The
Institutional Shares of Federated ARMs Fund are represented by a solid line. The
Lehman Brothers 1-3 Year Government Bond Index (LB1-3GBI) is represented by a
dotted line, the Lehman Brothers Adjustable Rate Mortgage Index (LBARMI) is
represented by a dashed line, the Merrill Lynch 1 Year Treasury Index (ML1TI) is
represented by a broken line and the Lipper Adjustable Rate Mortgage Funds
Average (LARMFA) is represented by a lightly shaded solid line. The line graph
is a visual representation of a comparison of change in value of a $25,000
hypothetical investment in the Institutional Shares of the Fund, the LB1-3GBI,
the LBARMI, the ML1TI and the LARMFA. The "x" axis reflects computation periods
from 8/31/89 to 8/31/99. The "y" axis reflects the cost of the investment. The
right margin reflects the ending value of the hypothetical investment in the
Fund's Institutional Shares as compared to the LB1-3GBI, the LBARMI, the ML1TI
and the LARMFA. The ending values were $45,982, $48,217, $53,187, $50,300 and
$46,390, respectively.
<TABLE>
AVERAGE ANNUAL TOTAL RETURN FOR THE PERIOD ENDED AUGUST 31, 1999
<S> <C>
1 Year 3.74%
5 Years 5.68%
10 Years 6.28%
Start of Performance (12/3/85) 6.43%
</TABLE>
The graph above illustrates the hypothetical investment of $25,000 1 in the
Federated ARMs Fund (Institutional Shares) (the "Fund") from August 31, 1989 to
August 31, 1999 compared to the Lehman Brothers 1-3 Year Government Bond Index
(LB1-3GBI),2 the Lehman Brothers Adjustable Rate Mortgage Index (LBARMI), the
Merrill Lynch 1-Year Treasury Index (ML1TI)3,4 and the Lipper Adjustable Rate
Mortgage Funds Average (LARMFA).3,5
PAST PERFORMANCE IS NOT PREDICTIVE OF FUTURE PERFORMANCE. YOUR INVESTMENT RETURN
AND PRINCIPAL VALUE WILL FLUCTUATE SO WHEN SHARES ARE REDEEMED, THEY MAY BE
WORTH MORE OR LESS THAN ORIGINAL COST. MUTUAL FUNDS ARE NOT OBLIGATIONS OF OR
GUARANTEED BY ANY BANK AND ARE NOT FEDERALLY INSURED.
This report must be preceded or accompanied by the Fund's prospectus dated
October 31, 1999, and, together with financial statements contained therein,
constitutes the Fund's annual report.
1 The Fund's performance assumes the reinvestment of all dividends and
distributions. The LB1-3GBI, LBARMI, ML1TI and the LARMFA have been adjusted to
reflect reinvestment of dividends on securities in the indices and the average.
2 The Fund's Adviser has elected to change the benchmark index from the LB1-3GBI
to the ML1TI because the ML1TI is more representative of the securities in which
the Fund invests.
3 For this illustration, the LBARMI, ML1TI and the LARMFA began their
performance on 1/31/92, in conjunction with the change in investment policy of
the Fund. The indices and the average have been assigned a beginning value of
$36,062, the value of the Fund on 1/31/92.
4 The LB1-3GBI, LBARMI and the ML1TI are not adjusted to reflect sales charges,
expenses, or other fees that the Securities and Exchange Commission requires to
be reflected in the Fund's performance. The indices are unmanaged.
5 The LARMFA represents the average of the total returns reported by all of the
mutual funds designated by Lipper Analytical Services, Inc. as falling into the
respective categories indicated. Lipper figures do not reflect sales charges.
However, these total returns are reported net of expenses or other fees that the
Securities and Exchange Commission requires to be reflected in a fund's
performance.
Note: The Fund changed its investment policy from investing primarily in
intermediate and long-term U.S. Treasury securities to investing primarily
in adjustable rate U.S. government mortgage securities, effective 1/20/92.
INSTITUTIONAL SERVICE SHARES
GROWTH OF $25,000 INVESTED IN FEDERATED ARMS FUND
The graphic presentation here displayed consists of a line graph. The
corresponding components of the line graph are listed underneath. The
Institutional Service Shares of Federated ARMs Fund is represented by a solid
line. The Lehman Brothers 1-3 Year Government Bond Index (LB1-3GBI) is
represented by a dotted line, the Lehman Brothers Adjustable Rate Mortgage Index
(LBARMI) is represented by a dashed line, the Merrill Lynch 1 Year Treasury
Index (ML1TI) is represented by a broken line and the Lipper Adjustable Rate
Mortgage Funds Average (LARMFA) is represented by a lightly shaded solid line.
The line graph is a visual representation of a comparison of change in value of
a $25,000 hypothetical investment in the Institutional Service Shares of the
Fund, the LB1-3GBI, the LBARMI, the ML1TI and the LARMFA. The "x" axis reflects
computation periods from 4/25/92 to 8/31/99. The "y" axis reflects the cost of
the investment. The right margin reflects the ending value of the hypothetical
investment in the Fund's Institutional Service Shares as compared to the
LB1-3GBI, the LBARMI, the ML1TI and the LARMFA. The ending values were $35,050,
$39,830, $38,077, $36,037 and $32,858, respectively.
<TABLE>
AVERAGE ANNUAL TOTAL RETURN FOR THE PERIOD ENDED AUGUST 31, 1999
<S> <C>
1 Year 3.49%
5 Years 5.41%
Start of Performance (4/25/92) 4.70%
</TABLE>
The graph above illustrates the hypothetical investment of $25,000 1 in the
Federated ARMs Fund (Institutional Service Shares) (the "Fund") from April 25,
1992 (start of performance) to August 31, 1999 compared to the Lehman Brothers
1-3 Year Government Bond Index (LB1-3GBI),2 the Lehman Brothers Adjustable Rate
Mortgage Index (LBARMI), the Merrill Lynch 1-Year Treasury Index (ML1TI)3 and
the Lipper Adjustable Rate Mortgage Funds Average (LARMFA).4
PAST PERFORMANCE IS NOT PREDICTIVE OF FUTURE PERFORMANCE. YOUR INVESTMENT RETURN
AND PRINCIPAL VALUE WILL FLUCTUATE SO WHEN SHARES ARE REDEEMED, THEY MAY BE
WORTH MORE OR LESS THAN ORIGINAL COST. MUTUAL FUNDS ARE NOT OBLIGATIONS OF OR
GUARANTEED BY ANY BANK AND ARE NOT FEDERALLY INSURED.
This report must be preceded or accompanied by the Fund's prospectus dated
October 31, 1999, and, together with financial statements contained therein,
constitutes the Fund's annual report.
1 The Fund's performance assumes the reinvestment of all dividends and
distributions. The LB1-3GBI, LBARMI, ML1TI and the LARMFA have been adjusted to
reflect reinvestment of dividends on securities in the indices and the average.
2 The Fund's Adviser has elected to change the benchmark index from the LB1-3GBI
to the ML1TI because the ML1TI is more representative of the securities in which
the Fund invests.
3 The LB1-3GBI, LBARMI and the ML1TI are not adjusted to reflect sales charges,
expenses, or other fees that the Securities and Exchange Commission requires to
be reflected in the Fund's performance. The indices are unmanaged.
4 The LARMFA represents the average of the total returns reported by all of the
mutual funds designated by Lipper Analytical Services, Inc. as falling into the
respective categories indicated. Lipper figures do not reflect sales charges.
However, these total returns are reported net of expenses or other fees that the
Securities and Exchange Commission requires to be reflected in a fund's
performance.
[Graphic]
Federated ARMs Fund
Federated Investors Funds
5800 Corporate Drive
Pittsburgh, PA 15237-7000
1-800-341-7400
WWW.FEDERATEDINVESTORS.COM
Federated Securities Corp., Distributor
Cusip 314082108
Cusip 314082207
G00567-01ARS (10/99)
[Graphic]
