STATEMENT OF ADDITIONAL INFORMATION
STRONG SHORT-TERM BOND FUND
STRONG GOVERNMENT SECURITIES FUND
STRONG CORPORATE BOND FUND
STRONG HIGH-YIELD BOND FUND
P.O. Box 2936
Milwaukee, Wisconsin 53201
Telephone: (414) 359-1400
Toll-Free: (800) 368-3863
This Statement of Additional Information is not a Prospectus
and should be read in conjunction with the Prospectus of Strong
Short-Term Bond Fund, Inc. (the "Short-Term Bond Fund"); Strong
Government Securities Fund, Inc. (the "Government Fund"); Strong
Corporate Bond Fund, Inc. (the "Corporate Bond Fund"); and Strong
High-Yield Bond Fund (the "High-Yield Fund"), which is a series
of Strong Income Funds, Inc. (individually, a "Fund" and
collectively, the "Funds"), dated March 1, 1997. Requests for
copies of the Prospectus should be made by calling one of the
numbers listed above. The financial statements appearing in the
Funds' Annual Report, which accompanies this Statement of
Additional Information, are incorporated herein by reference.
This Statement of Additional Information is dated March 1, 1997,
as supplemented July 8, 1997.
STRONG INCOME FUNDS
TABLE OF CONTENTS PAGE
INVESTMENT RESTRICTIONS 3
INVESTMENT POLICIES AND TECHNIQUES 4
Borrowing 5
Convertible Securities 5
Depositary Receipts 5
Derivative Instruments 6
Foreign Investment Companies 15
Foreign Securities 16
High-Yield (High-Risk) Securities 16
Illiquid Securities 18
Lending of Portfolio Securities 19
Loan Interests 19
Maturity 20
Mortgage- and Asset-Backed Securities 20
Mortgage Dollar Rolls and Reverse Repurchase Agreements 21
Municipal Obligations 22
Repurchase Agreements 22
Short Sales Against the Box 23
Temporary Defensive Position 23
Variable- or Floating-Rate Securities 23
Warrants 24
When-Issued Securities 24
Zero-Coupon, Step-Coupon and Pay-in-Kind Securities 25
DIRECTORS AND OFFICERS OF THE FUNDS 25
PRINCIPAL SHAREHOLDERS 28
INVESTMENT ADVISOR AND DISTRIBUTOR 28
PORTFOLIO TRANSACTIONS AND BROKERAGE 31
CUSTODIAN 35
TRANSFER AGENT AND DIVIDEND-DISBURSING AGENT 35
TAXES 36
DETERMINATION OF NET ASSET VALUE 38
ADDITIONAL SHAREHOLDER INFORMATION 38
FUND ORGANIZATION 39
SHAREHOLDER MEETINGS 40
PERFORMANCE INFORMATION 40
GENERAL INFORMATION 47
PORTFOLIO MANAGEMENT 50
LEGAL COUNSEL 51
INDEPENDENT ACCOUNTANTS 51
FINANCIAL STATEMENTS 51
APPENDIX A-1
No person has been authorized to give any information or to
make any representations other than those contained in this
Statement of Additional Information dated March 1, 1997, as
supplemented July 8, 1997 and the Prospectus dated March 1, 1997
and, if given or made, such information or representations may
not be relied upon as having been authorized by the Funds.
This Statement of Additional Information does not constitute an
offer to sell securities.
INVESTMENT RESTRICTIONS
The investment objective of the Short-Term Bond Fund is to
seek total return by investing for a high level of current income
with a low degree of share-price fluctuation. The investment
objective of the Government Fund is to seek total return by
investing for a high level of current income with a moderate
degree of share-price fluctuation. The investment objective of
the Corporate Bond Fund is to seek total return by investing for
a high level of current income with a moderate degree of share-
price fluctuation. The investment objective of the High-Yield
Fund is to seek total return by investing for a high level of
current income and capital growth. The Funds' investment
objectives and policies are described in detail in the Prospectus
under the caption "Investment Objectives and Policies." The
following are the Funds' fundamental investment limitations which
cannot be changed without shareholder approval.
Each Fund:
1. May not with respect to 75% of its total assets, purchase
the securities of any issuer (except securities issued or
guaranteed by the U.S. government or its agencies or
instrumentalities) if, as a result, (i) more than 5% of the
Fund's total assets would be invested in the securities of
that issuer, or (ii) the Fund would hold more than 10% of
the outstanding voting securities of that issuer.
2. May (i) borrow money from banks and (ii) make other
investments or engage in other transactions permissible
under the Investment Company Act of 1940 (the "1940 Act")
which may involve a borrowing, provided that the combination
of (i) and (ii) shall not exceed 33 1/3% of the value of the
Fund's total assets (including the amount borrowed), less
the Fund's liabilities (other than borrowings), except that
the Fund may borrow up to an additional 5% of its total
assets (not including the amount borrowed) from a bank for
temporary or emergency purposes (but not for leverage or the
purchase of investments). The Fund may also borrow money
from the other Strong Funds or other persons to the extent
permitted by applicable law.
3. May not issue senior securities, except as permitted under
the 1940 Act.
4. May not act as an underwriter of another issuer's
securities, except to the extent that the Fund may be deemed
to be an underwriter within the meaning of the Securities
Act of 1933 in connection with the purchase and sale of
portfolio securities.
5. May not purchase or sell physical commodities unless
acquired as a result of ownership of securities or other
instruments (but this shall not prevent the Fund from
purchasing or selling options, futures contracts, or other
derivative instruments, or from investing in securities or
other instruments backed by physical commodities).
6. May not make loans if, as a result, more than 33 1/3% of the
Fund's total assets would be lent to other persons, except
through (i) purchases of debt securities or other debt
instruments, or (ii) engaging in repurchase agreements.
7. May not purchase the securities of any issuer if, as a
result, more than 25% of the Fund's total assets would be
invested in the securities of issuers, the principal
business activities of which are in the same industry. With
respect to the Money Market Funds only, this limitation
shall not limit the Funds' purchases of obligations issued
by domestic banks.
8. May not purchase or sell real estate unless acquired as a
result of ownership of securities or other instruments (but
this shall not prohibit the Fund from purchasing or selling
securities or other instruments backed by real estate or of
issuers engaged in real estate activities).
9. May, notwithstanding any other fundamental investment policy
or restriction, invest all of its assets in the securities
of a single open-end management investment company with
substantially the same fundamental investment objective,
policies, and restrictions as the Fund.
The following are the Funds' non-fundamental operating
policies which may be changed by the Board of Directors of each
Fund without shareholder approval.
Each Fund may not:
1. Sell securities short, unless the Fund owns or has the right
to obtain securities equivalent in kind and amount to the
securities sold short, or unless it covers such short sale
as required by the current rules and positions of the
Securities and Exchange Commission or its staff, and
provided that transactions in options, futures contracts,
options on futures contracts, or other derivative
instruments are not deemed to constitute selling securities
short.
2. Purchase securities on margin, except that the Fund may
obtain such short-term credits as are necessary for the
clearance of transactions; and provided that margin deposits
in connection with futures contracts, options on futures
contracts, or other derivative instruments shall not
constitute purchasing securities on margin.
3. Invest in illiquid securities if, as a result of such
investment, more than 15% of its net assets would be
invested in illiquid securities, or such other amounts as
may be permitted under the 1940 Act.
4. Purchase securities of other investment companies except in
compliance with the 1940 Act and applicable state law.
5. Invest all of its assets in the securities of a single open-
end investment management company with substantially the
same fundamental investment objective, restrictions and
policies as the Fund.
6. Engage in futures or options on futures transactions which
are impermissible pursuant to Rule 4.5 under the Commodity
Exchange Act and, in accordance with Rule 4.5, will use
futures or options on futures transactions solely for bona
fide hedging transactions (within the meaning of the
Commodity Exchange Act), provided, however, that the Fund
may, in addition to bona fide hedging transactions, use
futures and options on futures transactions if the aggregate
initial margin and premiums required to establish such
positions, less the amount by which any such options
positions are in the money (within the meaning of the
Commodity Exchange Act), do not exceed 5% of the Fund's net
assets.
7. Borrow money except (i) from banks or (ii) through reverse
repurchase agreements or mortgage dollar rolls, and will not
purchase securities when bank borrowings exceed 5% of its
total assets.
8. Make any loans other than loans of portfolio securities,
except through (i) purchases of debt securities or other
debt instruments, or (ii) engaging in repurchase agreements.
Corporate Bond Fund. Under normal market conditions, the
Corporate Bond Fund will invest at least 65% of its total assets
in bonds. The Fund may invest up to 5% of its total assets in
warrants. In addition, the Advisor has adopted an internal
policy that the Fund will not invest more than 10% of its total
assets in debt obligations rated lower than BB or its equivalent.
For the purposes of this internal policy, convertible securities
will not be considered debt obligations.
Except for the fundamental investment limitations listed
above and each Fund's investment objective, the other investment
policies described in the Prospectus and this Statement of
Additional Information are not fundamental and may be changed
with approval of a Fund's Board of Directors. Unless noted
otherwise, if a percentage restriction is adhered to at the time
of investment, a later increase or decrease in percentage
resulting from a change in a Fund's assets (i.e., due to cash
inflows or redemptions) or in market value of the investment or a
Fund's assets will not constitute a violation of that
restriction.
INVESTMENT POLICIES AND TECHNIQUES
The following information supplements the discussion of the
Funds' investment objectives, policies and techniques that are
described in detail in the Prospectus under the captions
"Investment Objectives and Policies" and "Implementation of
Policies and Risks."
Borrowing
(All Funds)
A Fund may borrow money from banks and make other
investments or engage in other transactions permissible under the
1940 Act which may be considered a borrowing (such as mortgage
dollar rolls and reverse repurchase agreements) as discussed
under "Investment Restrictions." However, a Fund may not
purchase securities when bank borrowings exceed 5% of a Fund's
total assets. Presently, the Funds only intend to borrow from
banks for temporary or emergency purposes.
The Funds have established a line-of-credit (LOC) with
certain banks by which they may borrow funds for temporary or
emergency purposes. A borrowing is presumed to be for temporary
or emergency purposes if it is repaid by a Fund within sixty days
and is not extended or renewed. The Funds intend to use the LOC
to meet large or unexpected redemptions that would otherwise
force a Fund to liquidate securities under circumstances which
are unfavorable to a Fund's remaining shareholders. The Funds
pay a commitment fee to the banks for the LOC.
Convertible Securities
(All Funds)
A Fund may invest in convertible securities, which are
bonds, debentures, notes, preferred stocks, or other securities
that may be converted into or exchanged for a specified amount of
common stock of the same or a different issuer within a
particular period of time at a specified price or formula. A
convertible security entitles the holder to receive interest
normally paid or accrued on debt or the dividend paid on
preferred stock until the convertible security matures or is
redeemed, converted, or exchanged. Convertible securities have
unique investment characteristics in that they generally (i) have
higher yields than common stocks, but lower yields than
comparable non-convertible securities, (ii) are less subject to
fluctuation in value than the underlying stock since they have
fixed income characteristics, and (iii) provide the potential for
capital appreciation if the market price of the underlying common
stock increases. Most convertible securities currently are
issued by U.S. companies, although a substantial Eurodollar
convertible securities market has developed, and the markets for
convertible securities denominated in local currencies are
increasing.
The value of a convertible security is a function of its
"investment value" (determined by its yield in comparison with
the yields of other securities of comparable maturity and quality
that do not have a conversion privilege) and its "conversion
value" (the security's worth, at market value, if converted into
the underlying common stock). The investment value of a
convertible security is influenced by changes in interest rates,
with investment value declining as interest rates increase and
increasing as interest rates decline. The credit standing of the
issuer and other factors also may have an effect on the
convertible security's investment value. The conversion value of
a convertible security is determined by the market price of the
underlying common stock. If the conversion value is low relative
to the investment value, the price of the convertible security is
governed principally by its investment value. Generally, the
conversion value decreases as the convertible security approaches
maturity. To the extent the market price of the underlying
common stock approaches or exceeds the conversion price, the
price of the convertible security will be increasingly influenced
by its conversion value. A convertible security generally will
sell at a premium over its conversion value by the extent to
which investors place value on the right to acquire the
underlying common stock while holding a fixed income security.
A convertible security may be subject to redemption at the
option of the issuer at a price established in the convertible
security's governing instrument. If a convertible security held
by a Fund is called for redemption, a Fund will be required to
permit the issuer to redeem the security, convert it into the
underlying common stock, or sell it to a third party.
Depositary Receipts
(All Funds)
The Funds may invest in foreign securities by purchasing
depositary receipts, including American Depositary Receipts
("ADRs") and European Depositary Receipts ("EDRs"), or other
securities convertible into securities of foreign issuers. These
securities may not necessarily be denominated in the same
currency as the securities into which they may be converted.
Generally, ADRs, in registered form, are denominated in U.S.
dollars and are designed for use in the U.S. securities markets,
while EDRs, in bearer form, may be denominated in other
currencies and are designed for use in the European securities
markets. ADRs are receipts typically issued by a U.S. bank or
trust company evidencing ownership of the underlying securities.
EDRs are European receipts evidencing a similar arrangement. For
purposes of a Fund's investment policies, ADRs and EDRs are
deemed to have the same classification as the underlying
securities they represent, except that ADRs and EDRs shall be
treated as indirect foreign investments. Thus, an ADR or EDR
representing ownership of common stock will be treated as common
stock. ADR and EDR depositary receipts do not eliminate all of
the risks associated with directly investing in the securities of
foreign issuers.
ADR facilities may be established as either "unsponsored" or
"sponsored." While ADRs issued under these two types of
facilities are in some respects similar, there are distinctions
between them relating to the rights and obligations of ADR
holders and the practices of market participants.
A depositary may establish an unsponsored facility without
participation by (or even necessarily the acquiescence of) the
issuer of the deposited securities, although typically the
depositary requests a letter of non-objection from such issuer
prior to the establishment of the facility. Holders of
unsponsored ADRs generally bear all the costs of such facilities.
The depositary usually charges fees upon the deposit and
withdrawal of the deposited securities, the conversion of
dividends into U.S. dollars, the disposition of non-cash
distributions, and the performance of other services. The
depositary of an unsponsored facility frequently is under no
obligation to pass through voting rights to ADR holders in
respect of the deposited securities. In addition, an unsponsored
facility is generally not obligated to distribute communications
received from the issuer of the deposited securities or to
disclose material information about such issuer in the U.S. and
thus there may not be a correlation between such information and
the market value of the depositary receipts.
Sponsored ADR facilities are created in generally the same
manner as unsponsored facilities, except that the issuer of the
deposited securities enters into a deposit agreement with the
depositary. The deposit agreement sets out the rights and
responsibilities of the issuer, the depositary, and the ADR
holders. With sponsored facilities, the issuer of the deposited
securities generally will bear some of the costs relating to the
facility (such as dividend payment fees of the depositary),
although ADR holders continue to bear certain other costs (such
as deposit and withdrawal fees). Under the terms of most
sponsored arrangements, depositories agree to distribute notices
of shareholder meetings and voting instructions, and to provide
shareholder communications and other information to the ADR
holders at the request of the issuer of the deposited securities.
Derivative Instruments
(All Funds)
In General. A Fund may use derivative instruments for any
lawful purpose consistent with the Fund's investment objective
such as hedging or managing risk. Derivative instruments are
commonly defined to include securities or contracts whose values
depend on (or "derive" from) the value of one or more other
assets, such as securities, currencies, or commodities. These
"other assets" are commonly referred to as "underlying assets."
A derivative instrument generally consists of, is based
upon, or exhibits characteristics similar to options or forward
contracts. Options and forward contracts are considered to be the
basic "building blocks" of derivatives. For example, forward-
based derivatives include forward contracts, swap contracts, as
well as exchange-traded futures. Option-based derivatives include
privately negotiated, over-the-counter (OTC) options (including
caps, floors, collars, and options on forward and swap contracts)
and exchange-traded options on futures. Diverse types of
derivatives may be created by combining options or forward
contracts in different ways, and by applying these structures to
a wide range of underlying assets.
An option is a contract in which the "holder" (the buyer)
pays a certain amount (the "premium") to the "writer" (the
seller) to obtain the right, but not the obligation, to buy from
the writer (in a "call") or sell to the writer (in a "put") a
specific asset at an agreed upon price at or before a certain
time. The holder pays the premium at inception and has no
further financial obligation. The holder of an option-based
derivative generally will benefit from favorable movements in the
price of the underlying asset but is not exposed to corresponding
losses due to adverse movements in the value of the underlying
asset. The writer of an option-based derivative generally will
receive fees or premiums but generally is exposed to losses due
to changes in the value of the underlying asset.
A forward is a sales contract between a buyer (holding the
"long" position) and a seller (holding the "short" position) for
an asset with delivery deferred until a future date. The buyer
agrees to pay a fixed price at the agreed future date and the
seller agrees to deliver the asset. The seller hopes that the
market price on the delivery date is less than the agreed upon
price, while the buyer hopes for the contrary. The change in
value of a forward-based derivative generally is roughly
proportional to the change in value of the underlying asset.
Hedging. A Fund may use derivative instruments to protect
against possible adverse changes in the market value of
securities held in, or are anticipated to be held in, the Fund's
portfolio. Derivatives may also be used by a Fund to "lock-in"
the Fund's realized but unrecognized gains in the value of its
portfolio securities. Hedging strategies, if successful, can
reduce the risk of loss by wholly or partially offsetting the
negative effect of unfavorable price movements in the investments
being hedged. However, hedging strategies can also reduce the
opportunity for gain by offsetting the positive effect of
favorable price movements in the hedged investments.
Managing Risk. A Fund may also use derivative instruments
to manage the risks of the Fund's portfolio. Risk management
strategies include, but are not limited to, facilitating the sale
of portfolio securities, managing the effective maturity or
duration of debt obligations in a Fund's portfolio, establishing
a position in the derivatives markets as a substitute for buying
or selling certain securities, or creating or altering exposure
to certain asset classes, such as equity, debt, and foreign
securities. The use of derivative instruments may provide a less
expensive, more expedient or more specifically focused way for a
Fund to invest than "traditional" securities (i.e., stocks or
bonds) would.
Exchange or OTC Derivatives. Derivative instruments may be
exchange-traded or traded in OTC transactions between private
parties. Exchange-traded derivatives are standardized options
and futures contracts traded in an auction on the floor of a
regulated exchange. Exchange contracts are generally very
liquid. The exchange clearinghouse is the counterparty of every
contract. Thus, each holder of an exchange contract bears the
credit risk of the clearinghouse (and has the benefit of its
financial strength) rather than that of a particular
counterparty. Over-the-counter transactions are subject to
additional risks, such as the credit risk of the counterparty to
the instrument and are less liquid than exchange-traded
derivatives since they often can only be closed out with the
other party to the transaction.
Risks and Special Considerations. The use of derivative
instruments involves risks and special considerations as
described below. Risks pertaining to particular derivative
instruments are described in the sections that follow.
(1) Market Risk. The primary risk of derivatives is the
same as the risk of the underlying assets, namely that the value
of the underlying asset may go up or down. Adverse movements in
the value of an underlying asset can expose a Fund to losses.
Derivative instruments may include elements of leverage and,
accordingly, the fluctuation of the value of the derivative
instrument in relation to the underlying asset may be magnified.
The successful use of derivative instruments depends upon a
variety of factors, particularly Strong Capital Management,
Inc.'s (the "Advisor") ability to predict movements of the
securities, currencies, and commodity markets, which requires
different skills than predicting changes in the prices of
individual securities. There can be no assurance that any
particular strategy adopted will succeed. The Advisor's decision
to engage in a derivative instrument will reflect the Advisor's
judgment that the derivative transaction will provide value to
the Fund and its shareholders and is consistent with the Fund's
objectives, investment limitations, and operating policies. In
making such a judgment, the Advisor will analyze the benefits and
risks of the derivative transaction and weigh them in the context
of the Fund's entire portfolio and investment objective.
(2) Credit Risk. A Fund will be subject to the risk that a
loss may be sustained by the Fund as a result of the failure of a
counterparty to comply with the terms of a derivative instrument.
The counterparty risk for exchange-traded derivative instruments
is generally less than for privately-negotiated or OTC derivative
instruments, since generally a clearing agency, which is the
issuer or counterparty to each exchange-traded instrument,
provides a guarantee of performance. For privately-negotiated
instruments, there is no similar clearing agency guarantee. In
all transactions, a Fund will bear the risk that the counterparty
will default, and this could result in a loss of the expected
benefit of the derivative transaction and possibly other losses
to the Fund. A Fund will enter into transactions in derivative
instruments only with counterparties that the Advisor reasonably
believes are capable of performing under the contract.
(3) Correlation Risk. When a derivative transaction is
used to completely hedge another position, changes in the market
value of the combined position (the derivative instrument plus
the position being hedged) result from an imperfect correlation
between the price movements of the two instruments. With a
perfect hedge, the value of the combined position remains
unchanged for any change in the price of the underlying asset.
With an imperfect hedge, the values of the derivative instrument
and its hedge are not perfectly correlated. Correlation risk is
the risk that there might be imperfect correlation, or even no
correlation, between price movements of an instrument and price
movements of investments being hedged. For example, if the value
of a derivative instruments used in a short hedge (such as
writing a call option, buying a put option, or selling a futures
contract) increased by less than the decline in value of the
hedged investments, the hedge would not be perfectly correlated.
Such a lack of correlation might occur due to factors unrelated
to the value of the investments being hedged, such as speculative
or other pressures on the markets in which these instruments are
traded. The effectiveness of hedges using instruments on indices
will depend, in part, on the degree of correlation between price
movements in the index and price movements in the investments
being hedged.
(4) Liquidity Risk. Derivatives are also subject to
liquidity risk. Liquidity risk is the risk that a derivative
instrument cannot be sold, closed out, or replaced quickly at or
very close to its fundamental value. Generally, exchange
contracts are very liquid because the exchange clearinghouse is
the counterparty of every contract. OTC transactions are less
liquid than exchange-traded derivatives since they often can only
be closed out with the other party to the transaction. A Fund
might be required by applicable regulatory requirement to
maintain assets as "cover," maintain segregated accounts, and/or
make margin payments when it takes positions in derivative
instruments involving obligations to third parties (i.e.,
instruments other than purchased options). If a Fund was unable
to close out its positions in such instruments, it might be
required to continue to maintain such assets or accounts or make
such payments until the position expired, matured, or was closed
out. The requirements might impair a Fund's ability to sell a
portfolio security or make an investment at a time when it would
otherwise be favorable to do so, or require that the Fund sell a
portfolio security at a disadvantageous time. A Fund's ability
to sell or close out a position in an instrument prior to
expiration or maturity depends on the existence of a liquid
secondary market or, in the absence of such a market, the ability
and willingness of the counterparty to enter into a transaction
closing out the position. Therefore, there is no assurance that
any derivatives position can be sold or closed out at a time and
price that is favorable to a Fund.
(5) Legal Risk. Legal risk is the risk of loss caused by
the legal unenforcibility of a party's obligations under the
derivative. While a party seeking price certainty agrees to
surrender the potential upside in exchange for downside
protection, the party taking the risk is looking for a positive
payoff. Despite this voluntary assumption of risk, a
counterparty that has lost money in a derivative transaction may
try to avoid payment by exploiting various legal uncertainties
about certain derivative products.
(6) Systemic or "Interconnection" Risk. Interconnection
risk is the risk that a disruption in the financial markets will
cause difficulties for all market participants. In other words,
a disruption in one market will spill over into other markets,
perhaps creating a chain reaction. Much of the OTC derivatives
market takes place among the OTC dealers themselves, thus
creating a large interconnected web of financial obligations.
This interconnectedness raises the possibility that a default by
one large dealer could create losses at other dealers and
destabilize the entire market for OTC derivative instruments.
General Limitations. The use of derivative instruments is
subject to applicable regulations of the Securities and Exchange
Commission (the "SEC"), the several options and futures exchanges
upon which they may be traded, the Commodity Futures Trading
Commission ("CFTC"), and various state regulatory authorities.
In addition, a Fund's ability to use derivative instruments may
be limited by certain tax considerations. For a discussion of
the federal income tax treatment of a Fund's derivative
instruments, see "Taxes - Derivative Instruments."
Each Fund has filed a notice of eligibility for exclusion
from the definition of the term "commodity pool operator" with
the CFTC and the National Futures Association, which regulate
trading in the futures markets. In accordance with Rule 4.5 of
the regulations under the Commodity Exchange Act (the "CEA"), the
notice of eligibility for a Fund includes representations that
the Fund will use futures contracts and related options solely
for bona fide hedging purposes within the meaning of CFTC
regulations, provided that the Fund may hold other positions in
futures contracts and related options that do not qualify as a
bona fide hedging position if the aggregate initial margin
deposits and premiums required to establish these positions, less
the amount by which any such futures contracts and related
options positions are "in the money," do not exceed 5% of the
Fund's net assets. Adherence to these guidelines does not limit
a Fund's risk to 5% of the Fund's assets.
The SEC has identified certain trading practices involving
derivative instruments that involve the potential for leveraging
a Fund's assets in a manner that raises issues under the 1940
Act. In order to limit the potential for the leveraging of a
Fund's assets, as defined under the 1940 Act, the SEC has stated
that a Fund may use coverage or the segregation of a Fund's
assets. To the extent required by SEC guidelines, a Fund will
not enter into any such transactions unless it owns either: (i)
an offsetting ("covered") position in securities, options,
futures, or derivative instruments; or (ii) cash or liquid
securities positions with a value sufficient at all times to
cover its potential obligations to the extent that the position
is not "covered". The Funds will also set aside cash and/or
appropriate liquid assets in a segregated custodial account if
required to do so by the SEC and CFTC regulations. Assets used
as cover or held in a segregated account cannot be sold while the
derivative position is open, unless they are replaced with
similar assets. As a result, the commitment of a large portion
of a Fund's assets to segregated accounts could impede portfolio
management or the Fund's ability to meet redemption requests or
other current obligations.
In some cases a Fund may be required to maintain or limit
exposure to a specified percentage of its assets to a particular
asset class. In such cases, when a Fund uses a derivative
instrument to increase or decrease exposure to an asset class and
is required by applicable SEC guidelines to set aside liquid
assets in a segregated account to secure its obligations under
the derivative instruments, the Advisor may, where reasonable in
light of the circumstances, measure compliance with the
applicable percentage by reference to the nature of the economic
exposure created through the use of the derivative instrument and
not by reference to the nature of the exposure arising from the
liquid assets set aside in the segregated account (unless another
interpretation is specified by applicable regulatory
requirements).
Options. A Fund may use options for any lawful purpose
consistent with the Fund's investment objective such as hedging
or managing risk. An option is a contract in which the "holder"
(the buyer) pays a certain amount (the "premium") to the "writer"
(the seller) to obtain the right, but not the obligation, to buy
from the writer (in a "call") or sell to the writer (in a "put")
a specific asset at an agreed upon price (the "strike price" or
"exercise price") at or before a certain time (the "expiration
date"). The holder pays the premium at inception and has no
further financial obligation. The holder of an option will
benefit from favorable movements in the price of the underlying
asset but is not exposed to corresponding losses due to adverse
movements in the value of the underlying asset. The writer of an
option will receive fees or premiums but is exposed to losses due
to changes in the value of the underlying asset. A Fund may buy
or write (sell) put and call options on assets, such as
securities, currencies, commodities, and indices of debt and
equity securities ("underlying assets") and enter into closing
transactions with respect to such options to terminate an
existing position. Options used by the Funds may include
European, American, and Bermuda style options. If an option is
exercisable only at maturity, it is a "European" option; if it is
also exercisable prior to maturity, it is an "American" option.
If it is exercisable only at certain times, it is a "Bermuda"
option.
Each Fund may purchase (buy) and write (sell) put and call
options underlying assets and enter into closing transactions
with respect to such options to terminate an existing position.
The purchase of call options serves as a long hedge, and the
purchase of put options serves as a short hedge. Writing put or
call options can enable a Fund to enhance income by reason of the
premiums paid by the purchaser of such options. Writing call
options serves as a limited short hedge because declines in the
value of the hedged investment would be offset to the extent of
the premium received for writing the option. However, if the
security appreciates to a price higher than the exercise price of
the call option, it can be expected that the option will be
exercised and the Fund will be obligated to sell the security at
less than its market value or will be obligated to purchase the
security at a price greater than that at which the security must
be sold under the option. All or a portion of any assets used as
cover for OTC options written by a Fund would be considered
illiquid to the extent described under "Investment Policies and
Techniques - Illiquid Securities." Writing put options serves as
a limited long hedge because increases in the value of the hedged
investment would be offset to the extent of the premium received
for writing the option. However, if the security depreciates to
a price lower than the exercise price of the put option, it can
be expected that the put option will be exercised and the Fund
will be obligated to purchase the security at more than its
market value.
The value of an option position will reflect, among other
things, the historical price volatility of the underlying
investment, the current market value of the underlying
investment, the time remaining until expiration, the relationship
of the exercise price to the market price of the underlying
investment, and general market conditions.
A Fund may effectively terminate its right or obligation
under an option by entering into a closing transaction. For
example, a Fund may terminate its obligation under a call or put
option that it had written by purchasing an identical call or put
option; this is known as a closing purchase transaction.
Conversely, a Fund may terminate a position in a put or call
option it had purchased by writing an identical put or call
option; this is known as a closing sale transaction. Closing
transactions permit a Fund to realize the profit or limit the
loss on an option position prior to its exercise or expiration.
The Funds may purchase or write both exchange-traded and OTC
options. Exchange-traded options are issued by a clearing
organization affiliated with the exchange on which the option is
listed that, in effect, guarantees completion of every exchange-
traded option transaction. In contrast, OTC options are
contracts between a Fund and the other party to the transaction
("counter party") (usually a securities dealer or a bank) with no
clearing organization guarantee. Thus, when a Fund purchases or
writes an OTC option, it relies on the counter party to make or
take delivery of the underlying investment upon exercise of the
option. Failure by the counter party to do so would result in
the loss of any premium paid by the Fund as well as the loss of
any expected benefit of the transaction.
A Fund's ability to establish and close out positions in
exchange-listed options depends on the existence of a liquid
market. Each Fund intends to purchase or write only those
exchange-traded options for which there appears to be a liquid
secondary market. However, there can be no assurance that such a
market will exist at any particular time. Closing transactions
can be made for OTC options only by negotiating directly with the
counter party, or by a transaction in the secondary market if any
such market exists. Although each Fund will enter into OTC
options only with counter parties that are expected to be capable
of entering into closing transactions with the Funds, there is no
assurance that the Funds will in fact be able to close out an OTC
option at a favorable price prior to expiration. In the event of
insolvency of the counter party, a Fund might be unable to close
out an OTC option position at any time prior to its expiration.
If a Fund were unable to effect a closing transaction for an
option it had purchased, it would have to exercise the option to
realize any profit.
The Funds may engage in options transactions on indices in
much the same manner as the options on securities discussed
above, except the index options may serve as a hedge against
overall fluctuations in the securities market in general.
The writing and purchasing of options is a highly
specialized activity that involves investment techniques and
risks different from those associated with ordinary portfolio
securities transactions. Imperfect correlation between the
options and securities markets may detract from the effectiveness
of attempted hedging.
Spread Transactions. A Fund may use spread transactions for
any lawful purpose consistent with the Fund's investment
objective such as hedging or managing risk. A Fund may purchase
covered spread options from securities dealers. Such covered
spread options are not presently exchange-listed or exchange-
traded. The purchase of a spread option gives a Fund the right
to put, or sell, a security that it owns at a fixed dollar spread
or fixed yield spread in relationship to another security that
the Fund does not own, but which is used as a benchmark. The
risk to a Fund in purchasing covered spread options is the cost
of the premium paid for the spread option and any transaction
costs. In addition, there is no assurance that closing
transactions will be available. The purchase of spread options
will be used to protect a Fund against adverse changes in
prevailing credit quality spreads, i.e., the yield spread between
high quality and lower quality securities. Such protection is
only provided during the life of the spread option.
Futures Contracts. A Fund may use futures contracts for any
lawful purpose consistent with the Fund's investment objective
such as hedging or managing risk. A Fund may enter into futures
contracts, including interest rate, index, and currency futures.
Each Fund may also purchase put and call options, and write
covered put and call options, on futures in which it is allowed
to invest. The purchase of futures or call options thereon can
serve as a long hedge, and the sale of futures or the purchase of
put options thereon can serve as a short hedge. Writing covered
call options on futures contracts can serve as a limited short
hedge, and writing covered put options on futures contracts can
serve as a limited long hedge, using a strategy similar to that
used for writing covered options in securities. The Funds'
hedging may include purchases of futures as an offset against the
effect of expected increases in currency exchange rates and
securities prices and sales of futures as an offset against the
effect of expected declines in currency exchange rates and
securities prices. The Funds may also write put options on
futures contracts while at the same time purchasing call options
on the same futures contracts in order to create synthetically a
long futures contract position. Such options would have the same
strike prices and expiration dates. The Funds will engage in
this strategy only when the Advisor believes it is more
advantageous to the Funds than is purchasing the futures
contract.
To the extent required by regulatory authorities, the Funds
only enter into futures contracts that are traded on national
futures exchanges and are standardized as to maturity date and
underlying financial instrument. Futures exchanges and trading
are regulated under the CEA by the CFTC. Although techniques
other than sales and purchases of futures contracts could be used
to reduce a Fund's exposure to market, currency, or interest rate
fluctuations, a Fund may be able to hedge its exposure more
effectively and perhaps at a lower cost through using futures
contracts.
An interest rate futures contract provides for the future
sale by one party and purchase by another party of a specified
amount of a specific financial instrument (e.g., debt security)
or currency for a specified price at a designated date, time, and
place. An index futures contract is an agreement pursuant to
which the parties agree to take or make delivery of an amount of
cash equal to the difference between the value of the index at
the close of the last trading day of the contract and the price
at which the index futures contract was originally written.
Transaction costs are incurred when a futures contract is bought
or sold and margin deposits must be maintained. A futures
contract may be satisfied by delivery or purchase, as the case
may be, of the instrument, the currency or by payment of the
change in the cash value of the index. More commonly, futures
contracts are closed out prior to delivery by entering into an
offsetting transaction in a matching futures contract. Although
the value of an index might be a function of the value of certain
specified securities, no physical delivery of those securities is
made. If the offsetting purchase price is less than the original
sale price, a Fund realizes a gain; if it is more, a Fund
realizes a loss. Conversely, if the offsetting sale price is
more than the original purchase price, a Fund realizes a gain; if
it is less, a Fund realizes a loss. The transaction costs must
also be included in these calculations. There can be no
assurance, however, that a Fund will be able to enter into an
offsetting transaction with respect to a particular futures
contract at a particular time. If a Fund is not able to enter
into an offsetting transaction, the Fund will continue to be
required to maintain the margin deposits on the futures contract.
No price is paid by a Fund upon entering into a futures
contract. Instead, at the inception of a futures contract, a
Fund is required to deposit in a segregated account with its
custodian, in the name of the futures broker through whom the
transaction was effected, "initial margin" consisting of cash or
other appropriate liquid assets, in an amount generally equal to
10% or less of the contract value. Margin must also be deposited
when writing a call or put option on a futures contract, in
accordance with applicable exchange rules. Unlike margin in
securities transactions, initial margin on futures contracts does
not represent a borrowing, but rather is in the nature of a
performance bond or good-faith deposit that is returned to a Fund
at the termination of the transaction if all contractual
obligations have been satisfied. Under certain circumstances,
such as periods of high volatility, a Fund may be required by an
exchange to increase the level of its initial margin payment, and
initial margin requirements might be increased generally in the
future by regulatory action.
Subsequent "variation margin" payments are made to and from
the futures broker daily as the value of the futures position
varies, a process known as "marking to market." Variation margin
does not involve borrowing, but rather represents a daily
settlement of a Fund's obligations to or from a futures broker.
When a Fund purchases an option on a future, the premium paid
plus transaction costs is all that is at risk. In contrast, when
a Fund purchases or sells a futures contract or writes a call or
put option thereon, it is subject to daily variation margin calls
that could be substantial in the event of adverse price
movements. If a Fund has insufficient cash to meet daily
variation margin requirements, it might need to sell securities
at a time when such sales are disadvantageous. Purchasers and
sellers of futures positions and options on futures can enter
into offsetting closing transactions by selling or purchasing,
respectively, an instrument identical to the instrument held or
written. Positions in futures and options on futures may be
closed only on an exchange or board of trade that provides a
secondary market. The Funds intend to enter into futures
transactions only on exchanges or boards of trade where there
appears to be a liquid secondary market. However, there can be
no assurance that such a market will exist for a particular
contract at a particular time.
Under certain circumstances, futures exchanges may establish
daily limits on the amount that the price of a future or option
on a futures contract can vary from the previous day's settlement
price; once that limit is reached, no trades may be made that day
at a price beyond the limit. Daily price limits do not limit
potential losses because prices could move to the daily limit for
several consecutive days with little or no trading, thereby
preventing liquidation of unfavorable positions.
If a Fund were unable to liquidate a futures or option on a
futures contract position due to the absence of a liquid
secondary market or the imposition of price limits, it could
incur substantial losses. The Fund would continue to be subject
to market risk with respect to the position. In addition, except
in the case of purchased options, the Fund would continue to be
required to make daily variation margin payments and might be
required to maintain the position being hedged by the future or
option or to maintain cash or securities in a segregated account.
Certain characteristics of the futures market might increase
the risk that movements in the prices of futures contracts or
options on futures contracts might not correlate perfectly with
movements in the prices of the investments being hedged. For
example, all participants in the futures and options on futures
contracts markets are subject to daily variation margin calls and
might be compelled to liquidate futures or options on futures
contracts positions whose prices are moving unfavorably to avoid
being subject to further calls. These liquidations could
increase price volatility of the instruments and distort the
normal price relationship between the futures or options and the
investments being hedged. Also, because initial margin deposit
requirements in the futures markets are less onerous than margin
requirements in the securities markets, there might be increased
participation by speculators in the future markets. This
participation also might cause temporary price distortions. In
addition, activities of large traders in both the futures and
securities markets involving arbitrage, "program trading" and
other investment strategies might result in temporary price
distortions.
Foreign Currencies. The Funds may purchase and sell foreign
currency on a spot basis, and may use currency-related
derivatives instruments such as options on foreign currencies,
futures on foreign currencies, options on futures on foreign
currencies and forward currency contracts (i.e., an obligation to
purchase or sell a specific currency at a specified future date,
which may be any fixed number of days from the contract date
agreed upon by the parties, at a price set at the time the
contract is entered into). The Funds may use these instruments
for hedging or any other lawful purpose consistent with their
respective investment objectives, including transaction hedging,
anticipatory hedging, cross hedging, proxy hedging, and position
hedging. The Funds' use of currency-related derivative
instruments will be directly related to a Fund's current or
anticipated portfolio securities, and the Funds may engage in
transactions in currency-related derivative instruments as a
means to protect against some or all of the effects of adverse
changes in foreign currency exchange rates on their portfolio
investments. In general, if the currency in which a portfolio
investment is denominated appreciates against the U.S. dollar,
the dollar value of the security will increase. Conversely, a
decline in the exchange rate of the currency would adversely
affect the value of the portfolio investment expressed in U.S.
dollars.
For example, a Fund might use currency-related derivative
instruments to "lock in" a U.S. dollar price for a portfolio
investment, thereby enabling the Fund to protect itself against a
possible loss resulting from an adverse change in the
relationship between the U.S. dollar and the subject foreign
currency during the period between the date the security is
purchased or sold and the date on which payment is made or
received. A Fund also might use currency-related derivative
instruments when the Advisor believes that one currency may
experience a substantial movement against another currency,
including the U.S. dollar, and it may use currency-related
derivative instruments to sell or buy the amount of the former
foreign currency, approximating the value of some or all of the
Fund's portfolio securities denominated in such foreign currency.
Alternatively, where appropriate, a Fund may use currency-related
derivative instruments to hedge all or part of its foreign
currency exposure through the use of a basket of currencies or a
proxy currency where such currency or currencies act as an
effective proxy for other currencies. The use of this basket
hedging technique may be more efficient and economical than using
separate currency-related derivative instruments for each
currency exposure held by the Fund. Furthermore, currency-
related derivative instruments may be used for short hedges - for
example, a Fund may sell a forward currency contract to lock in
the U.S. dollar equivalent of the proceeds from the anticipated
sale of a security denominated in a foreign currency.
In addition, a Fund may use a currency-related derivative
instrument to shift exposure to foreign currency fluctuations
from one foreign country to another foreign country where the
Advisor believes that the foreign currency exposure purchased
will appreciate relative to the U.S. dollar and thus better
protect the Fund against the expected decline in the foreign
currency exposure sold. For example, if a Fund owns securities
denominated in a foreign currency and the Advisor believes that
currency will decline, it might enter into a forward contract to
sell an appropriate amount of the first foreign currency, with
payment to be made in a second foreign currency that the Advisor
believes would better protect the Fund against the decline in the
first security than would a U.S. dollar exposure. Hedging
transactions that use two foreign currencies are sometimes
referred to as "cross hedges." The effective use of currency-
related derivative instruments by a Fund in a cross hedge is
dependent upon a correlation between price movements of the two
currency instruments and the underlying security involved, and
the use of two currencies magnifies the risk that movements in
the price of one instrument may not correlate or may correlate
unfavorably with the foreign currency being hedged. Such a lack
of correlation might occur due to factors unrelated to the value
of the currency instruments used or investments being hedged,
such as speculative or other pressures on the markets in which
these instruments are traded.
A Fund also might seek to hedge against changes in the value
of a particular currency when no hedging instruments on that
currency are available or such hedging instruments are more
expensive than certain other hedging instruments. In such cases,
the Fund may hedge against price movements in that currency by
entering into transactions using currency-related derivative
instruments on another foreign currency or a basket of
currencies, the values of which the Advisor believes will have a
high degree of positive correlation to the value of the currency
being hedged. The risk that movements in the price of the
hedging instrument will not correlate perfectly with movements in
the price of the currency being hedged is magnified when this
strategy is used.
The use of currency-related derivative instruments by a Fund
involves a number of risks. The value of currency-related
derivative instruments depends on the value of the underlying
currency relative to the U.S. dollar. Because foreign currency
transactions occurring in the interbank market might involve
substantially larger amounts than those involved in the use of
such derivative instruments, a Fund could be disadvantaged by
having to deal in the odd lot market (generally consisting of
transactions of less than $1 million) for the underlying foreign
currencies at prices that are less favorable than for round lots
(generally consisting of transactions of greater than $1
million).
There is no systematic reporting of last sale information
for foreign currencies or any regulatory requirement that
quotations available through dealers or other market sources be
firm or revised on a timely basis. Quotation information
generally is representative of very large transactions in the
interbank market and thus might not reflect odd-lot transactions
where rates might be less favorable. The interbank market in
foreign currencies is a global, round-the-clock market. To the
extent the U.S. options or futures markets are closed while the
markets for the underlying currencies remain open, significant
price and rate movements might take place in the underlying
markets that cannot be reflected in the markets for the
derivative instruments until they re-open.
Settlement of transactions in currency-related derivative
instruments might be required to take place within the country
issuing the underlying currency. Thus, a Fund might be required
to accept or make delivery of the underlying foreign currency in
accordance with any U.S. or foreign regulations regarding the
maintenance of foreign banking arrangements by U.S. residents
and might be required to pay any fees, taxes and charges
associated with such delivery assessed in the issuing country.
When a Fund engages in a transaction in a currency-related
derivative instrument, it relies on the counterparty to make or
take delivery of the underlying currency at the maturity of the
contract or otherwise complete the contract. In other words, the
Fund will be subject to the risk that a loss may be sustained by
the Fund as a result of the failure of the counterparty to comply
with the terms of the transaction. The counterparty risk for
exchange-traded instruments is generally less than for privately-
negotiated or OTC currency instruments, since generally a
clearing agency, which is the issuer or counterparty to each
instrument, provides a guarantee of performance. For privately-
negotiated instruments, there is no similar clearing agency
guarantee. In all transactions, the Fund will bear the risk that
the counterparty will default, and this could result in a loss of
the expected benefit of the transaction and possibly other losses
to the Fund. The Funds will enter into transactions in currency-
related derivative instruments only with counterparties that the
Advisor reasonably believes are capable of performing under the
contract.
Purchasers and sellers of currency-related derivative
instruments may enter into offsetting closing transactions by
selling or purchasing, respectively, an instrument identical to
the instrument purchased or sold. Secondary markets generally do
not exist for forward currency contracts, with the result that
closing transactions generally can be made for forward currency
contracts only by negotiating directly with the counterparty.
Thus, there can be no assurance that a Fund will in fact be able
to close out a forward currency contract (or any other currency-
related derivative instrument) at a time and price favorable to a
Fund. In addition, in the event of insolvency of the
counterparty, a Fund might be unable to close out a forward
currency contract at any time prior to maturity. In the case of
an exchange-traded instrument, a Fund will be able to close the
position out only on an exchange which provides a market for the
instruments. The ability to establish and close out positions on
an exchange is subject to the maintenance of a liquid market, and
there can be no assurance that a liquid market will exist for any
instrument at any specific time. In the case of a privately-
negotiated instrument, a Fund will be able to realize the value
of the instrument only by entering into a closing transaction
with the issuer or finding a third party buyer for the
instrument. While a Fund will enter into privately-negotiated
transactions only with entities who are expected to be capable of
entering into a closing transaction, there can be no assurance
that a Fund will in fact be able to enter into such closing
transactions.
The precise matching of currency-related derivative
instrument amounts and the value of the portfolio securities
involved generally will not be possible because the value of such
securities, measured in the foreign currency, will change after
the currency-related derivative instrument position has been
established. Thus, a Fund might need to purchase or sell foreign
currencies in the spot (cash) market. The projection of short-
term currency market movements is extremely difficult, and the
successful execution of a short-term hedging strategy is highly
uncertain.
Permissible foreign currency options will include options
traded primarily in the OTC market. Although options on foreign
currencies are traded primarily in the OTC market, the Funds will
normally purchase or sell OTC options on foreign currency only
when the Advisor reasonably believes a liquid secondary market
will exist for a particular option at any specific time.
There will be a cost to a Fund of engaging in transactions
in currency-related derivative instruments that will vary with
factors such as the contract or currency involved, the length of
the contract period and the market conditions then prevailing. A
Fund using these instruments may have to pay a fee or commission
or, in cases where the instruments are entered into on a
principal basis, foreign exchange dealers or other counterparties
will realize a profit based on the difference ("spread") between
the prices at which they are buying and selling various
currencies. Thus, for example, a dealer may offer to sell a
foreign currency to a Fund at one rate, while offering a lesser
rate of exchange should the Fund desire to resell that currency
to the dealer.
When required by the SEC guidelines, the Funds will set
aside permissible liquid assets in segregated accounts or
otherwise cover their respective potential obligations under
currency-related derivatives instruments. To the extent a Fund's
assets are so set aside, they cannot be sold while the
corresponding currency position is open, unless they are replaced
with similar assets. As a result, if a large portion of a Fund's
assets are so set aside, this could impede portfolio management
or the Fund's ability to meet redemption requests or other
current obligations.
The Advisor's decision to engage in a transaction in a
particular currency-related derivative instrument will reflect
the Advisor's judgment that the transaction will provide value to
the Fund and its shareholders and is consistent with the Fund's
objectives and policies. In making such a judgment, the Advisor
will analyze the benefits and risks of the transaction and weigh
them in the context of the Fund's entire portfolio and
objectives. The effectiveness of any transaction in a currency-
related derivative instrument is dependent on a variety of
factors, including the Advisor's skill in analyzing and
predicting currency values and upon a correlation between price
movements of the currency instrument and the underlying security.
There might be imperfect correlation, or even no correlation,
between price movements of an instrument and price movements of
investments being hedged. Such a lack of correlation might occur
due to factors unrelated to the value of the investments being
hedged, such as speculative or other pressures on the markets in
which these instruments are traded. In addition, a Fund's use of
currency-related derivative instruments is always subject to the
risk that the currency in question could be devalued by the
foreign government. In such a case, any long currency positions
would decline in value and could adversely affect any hedging
position maintained by the Fund.
The Funds' dealing in currency-related derivative
instruments will generally be limited to the transactions
described above. However, the Funds reserve the right to use
currency-related derivatives instruments for different purposes
and under different circumstances. Of course, the Funds are not
required to use currency-related derivatives instruments and will
not do so unless deemed appropriate by the Advisor. It also
should be realized that use of these instruments does not
eliminate, or protect against, price movements in the Funds'
securities that are attributable to other (i.e., non-currency
related) causes. Moreover, while the use of currency-related
derivatives instruments may reduce the risk of loss due to a
decline in the value of a hedged currency, at the same time the
use of these instruments tends to limit any potential gain which
may result from an increase in the value of that currency.
Swap Agreements. The Funds may enter into interest rate,
securities index, commodity, or security and currency exchange
rate swap agreements for any lawful purpose consistent with each
Fund's investment objective, such as for the purpose of
attempting to obtain or preserve a particular desired return or
spread at a lower cost to the Fund than if the Fund had invested
directly in an instrument that yielded that desired return or
spread. A Fund also may enter into swaps in order to protect
against an increase in the price of, or the currency exchange
rate applicable to, securities that the Fund anticipates
purchasing at a later date. Swap agreements are two-party
contracts entered into primarily by institutional investors for
periods ranging from a few weeks to several years. In a standard
"swap" transaction, two parties agree to exchange the returns (or
differentials in rates of return) earned or realized on
particular predetermined investments or instruments. The gross
returns to be exchanged or "swapped" between the parties are
calculated with respect to a "notional amount," i.e., the return
on or increase in value of a particular dollar amount invested at
a particular interest rate, in a particular foreign currency, or
in a ""basket" of securities representing a particular index.
Swap agreements may include interest rate caps, under which, in
return for a premium, one party agrees to make payments to the
other to the extent that interest rates exceed a specified rate,
or "cap;" interest rate floors, under which, in return for a
premium, one party agrees to make payments to the other to the
extent that interest rates fall below a specified level, or
"floor;" and interest rate collars, under which a party sells a
cap and purchases a floor, or vice versa, in an attempt to
protect itself against interest rate movements exceeding given
minimum or maximum levels.
The "notional amount" of the swap agreement is the agreed
upon basis for calculating the obligations that the parties to a
swap agreement have agreed to exchange. Under most swap
agreements entered into by a Fund, the obligations of the parties
would be exchanged on a "net basis." Consequently, a Fund's
obligation (or rights) under a swap agreement will generally be
equal only to the net amount to be paid or received under the
agreement based on the relative values of the positions held by
each party to the agreement (the "net amount"). A Fund's
obligation under a swap agreement will be accrued daily (offset
against amounts owed to the Fund) and any accrued but unpaid net
amounts owed to a swap counterparty will be covered by the
maintenance of a segregated account consisting of cash, or liquid
high grade debt obligations.
Whether a Fund's use of swap agreements will be successful
in furthering its investment objective will depend, in part, on
the Advisor's ability to predict correctly whether certain types
of investments are likely to produce greater returns than other
investments. Swap agreements may be considered to be illiquid.
Moreover, a Fund bears the risk of loss of the amount expected to
be received under a swap agreement in the event of the default or
bankruptcy of a swap agreement counterparty. Certain
restrictions imposed on the Funds by the Internal Revenue Code
may limit the Funds' ability to use swap agreements. The swaps
market is largely unregulated.
The Funds will enter swap agreements only with
counterparties that the Advisor reasonably believes are capable
of performing under the swap agreements. If there is a default
by the other party to such a transaction, a Fund will have to
rely on its contractual remedies (which may be limited by
bankruptcy, insolvency or similar laws) pursuant to the
agreements related to the transaction.
Additional Derivative Instruments and Strategies. In
addition to the derivative instruments and strategies described
above and in the Funds' Prospectus, the Advisor expects to
discover additional derivative instruments and other hedging or
risk management techniques. The Advisor may utilize these new
derivative instruments and techniques to the extent that they are
consistent with a Fund's investment objective and permitted by
the Fund's investment limitations, operating policies, and
applicable regulatory authorities.
Foreign Investment Companies
(All Funds)
The Funds may invest, to a limited extent, in foreign
investment companies. Some of the countries in which the Funds
invest may not permit direct investment by outside investors.
Investments in such countries may only be permitted through
foreign government-approved or -authorized investment vehicles,
which may include other investment companies. In addition, it
may be less expensive and more expedient for a Fund to invest in
a foreign investment company in a country which permits direct
foreign investment. Investing through such vehicles may involve
frequent or layered fees or expenses and may also be subject to
limitation under the 1940 Act. Under the 1940 Act, a Fund may
invest up to 10% of its assets in shares of other investment
companies and up to 5% of its assets in any one investment
company as long as the investment does not represent more than
3% of the voting stock of the acquired investment company. Each
Fund does not intend to invest in such investment companies
unless, in the judgment of the Advisor, the potential benefits
of such investments justify the payment of any associated fees
and expenses.
Foreign Securities
(All Funds)
Investing in foreign securities involves a series of risks
not present in investing in U.S. securities. Many of the
foreign securities held by the Fund will not be registered with
the Securities and Exchange Commission (the "SEC"), nor will the
foreign issuers be subject to SEC reporting requirements.
Accordingly, there may be less publicly available information
concerning foreign issuers of securities held by the Funds than
is available concerning U.S. companies. Disclosure and
regulatory standards in many respects are less stringent in
emerging market countries than in the U.S. and other major
markets. There also may be a lower level of monitoring and
regulation of emerging markets and the activities of investors in
such markets, and enforcement of existing regulations may be
extremely limited. Foreign companies, and in particular,
companies in smaller and emerging capital markets are not
generally subject to uniform accounting, auditing and financial
reporting standards, or to other regulatory requirements
comparable to those applicable to U.S. companies. The Fund's
net investment income and capital gains from its foreign
investment activities may be subject to non-U.S. withholding
taxes.
The costs attributable to foreign investing that the Funds
must bear frequently are higher than those attributable to
domestic investing; this is particularly true with respect to
emerging capital markets. For example, the cost of maintaining
custody of foreign securities exceeds custodian costs for
domestic securities, and transaction and settlement costs of
foreign investing also frequently are higher than those
attributable to domestic investing. Costs associated with the
exchange of currencies also make foreign investing more expensive
than domestic investing. Investment income on certain foreign
securities in which the Funds may invest may be subject to
foreign withholding or other government taxes that could reduce
the return of these securities. Tax treaties between the United
States and foreign countries, however, may reduce or eliminate
the amount of foreign tax to which the Funds would be subject.
Foreign markets also have different clearance and settlement
procedures, and in certain markets there have been times when
settlements have failed to keep pace with the volume of
securities transactions, making it difficult to conduct such
transactions. Delays in settlement could result in temporary
periods when assets of a Fund are uninvested and no return is
earned thereon. The inability of a Fund to make intended
security purchases due to settlement problems could cause the
Fund to miss investment opportunities. Inability to dispose of a
portfolio security due to settlement problems could result either
in losses to a Fund due to subsequent declines in the value of
such portfolio security or, if the Fund has entered into a
contract to sell the security, could result in possible liability
to the purchaser.
High-Yield (High-Risk) Securities
(Short-Term Bond, Corporate Bond, and High-Yield Funds)
In General. The Short-Term Bond Fund may invest up to 25%
of its net assets only in non-investment grade debt obligations
rated in the fifth highest rating category (e.g., BB by S&P) or
comparable unrated securities. The Corporate Bond Fund may
invest up to 25% of its net assets, and the High-Yield Bond Fund
may invest without limitation, in non-investment grade debt
obligations. Non-investment grade debt obligations (hereinafter
referred to as "lower-quality securities") include (i) bonds
rated as low as C by Moody's Investors Service, Inc.
("Moody's"), Standard & Poor's Ratings Group ("S&P"), or Fitch
Investors Service, Inc. ("Fitch"), or CCC by Duff & Phelps, Inc.
("D&P"); (ii) commercial paper rated as low as C by S&P, Not
Prime by Moody's, or Fitch 4 by Fitch; and (iii) unrated debt
obligations of comparable quality. Lower-quality securities,
while generally offering higher yields than investment grade
securities with similar maturities, involve greater risks,
including the possibility of default or bankruptcy. They are
regarded as predominantly speculative with respect to the
issuer's capacity to pay interest and repay principal. The
special risk considerations in connection with investments in
these securities are discussed below. Refer to the Appendix for
a discussion of securities ratings.
Effect of Interest Rates and Economic Changes. The lower-
quality and comparable unrated security market is relatively new
and its growth has paralleled a long economic expansion. As a
result, it is not clear how this market may withstand a prolonged
recession or economic downturn. Such conditions could severely
disrupt the market for and adversely affect the value of such
securities.
All interest-bearing securities typically experience
appreciation when interest rates decline and depreciation when
interest rates rise. The market values of lower-quality and
comparable unrated securities tend to reflect individual
corporate developments to a greater extent than do higher rated
securities, which react primarily to fluctuations in the general
level of interest rates. Lower-quality and comparable unrated
securities also tend to be more sensitive to economic conditions
than are higher-rated securities. As a result, they generally
involve more credit risks than securities in the higher-rated
categories. During an economic downturn or a sustained period of
rising interest rates, highly leveraged issuers of lower-quality
and comparable unrated securities may experience financial stress
and may not have sufficient revenues to meet their payment
obligations. The issuer's ability to service its debt
obligations may also be adversely affected by specific corporate
developments, the issuer's inability to meet specific projected
business forecasts or the unavailability of additional financing.
The risk of loss due to default by an issuer of these securities
is significantly greater than issuers of higher-rated securities
because such securities are generally unsecured and are often
subordinated to other creditors. Further, if the issuer of a
lower-quality or comparable unrated security defaulted, a Fund
might incur additional expenses to seek recovery. Periods of
economic uncertainty and changes would also generally result in
increased volatility in the market prices of these securities and
thus in a Fund's net asset value.
As previously stated, the value of a lower-quality or
comparable unrated security will decrease in a rising interest
rate market and accordingly, so will a Fund's net asset value.
If a Fund experiences unexpected net redemptions in such a
market, it may be forced to liquidate a portion of its portfolio
securities without regard to their investment merits. Due to the
limited liquidity of lower-quality and comparable unrated
securities (discussed below), a Fund may be forced to liquidate
these securities at a substantial discount. Any such liquidation
would force the Fund to sell the more liquid portion of its
portfolio.
Payment Expectations. Lower-quality and comparable unrated
securities typically contain redemption, call or prepayment
provisions which permit the issuer of such securities containing
such provisions to, at its discretion, redeem the securities.
During periods of falling interest rates, issuers of these
securities are likely to redeem or prepay the securities and
refinance them with debt securities with a lower interest rate.
To the extent an issuer is able to refinance the securities, or
otherwise redeem them, a Fund may have to replace the securities
with a lower yielding security, which would result in a lower
return for the Fund.
Credit Ratings. Credit ratings issued by credit rating
agencies are designed to evaluate the safety of principal and
interest payments of rated securities. They do not, however,
evaluate the market value risk of lower-quality securities and,
therefore, may not fully reflect the true risks of an investment.
In addition, credit rating agencies may or may not make timely
changes in a rating to reflect changes in the economy or in the
condition of the issuer that affect the market value of the
security. Consequently, credit ratings are used only as a
preliminary indicator of investment quality. Investments in
lower-quality and comparable unrated obligations will be more
dependent on the Advisor's credit analysis than would be the case
with investments in investment-grade debt obligations. The
Advisor employs its own credit research and analysis, which
includes a study of existing debt, capital structure, ability to
service debt and to pay dividends, the issuer's sensitivity to
economic conditions, its operating history and the current trend
of earnings. The Advisor continually monitors the investments in
each Fund's portfolio and carefully evaluates whether to dispose
of or to retain lower-quality and comparable unrated securities
whose credit ratings or credit quality may have changed.
Liquidity and Valuation. A Fund may have difficulty
disposing of certain lower-quality and comparable unrated
securities because there may be a thin trading market for such
securities. Because not all dealers maintain markets in all
lower-quality and comparable unrated securities, there is no
established retail secondary market for many of these securities.
The Funds anticipate that such securities could be sold only to a
limited number of dealers or institutional investors. To the
extent a secondary trading market does exist, it is generally not
as liquid as the secondary market for higher-rated securities.
The lack of a liquid secondary market may have an adverse impact
on the market price of the security. As a result, a Fund's asset
value and ability to dispose of particular securities, when
necessary to meet the Fund's liquidity needs or in response to a
specific economic event, may be impacted. The lack of a liquid
secondary market for certain securities may also make it more
difficult for a Fund to obtain accurate market quotations for
purposes of valuing the Fund's portfolio. Market quotations are
generally available on many lower-quality and comparable unrated
issues only from a limited number of dealers and may not
necessarily represent firm bids of such dealers or prices for
actual sales. During periods of thin trading, the spread between
bid and asked prices is likely to increase significantly. In
addition, adverse publicity and investor perceptions, whether or
not based on fundamental analysis, may decrease the values and
liquidity of lower-quality and comparable unrated securities,
especially in a thinly traded market.
Legislation. Legislation may be adopted, from time to time
designed to limit the use of certain lower-quality and comparable
unrated securities by certain issuers. It is anticipated that if
additional legislation is enacted or proposed, it could have a
material affect on the value of these securities and the
existence of a secondary trading market for the securities.
Illiquid Securities
(All Funds)
The Funds may invest in illiquid securities (i.e.,
securities that are not readily marketable). However, a Fund
will not acquire illiquid securities if, as a result, they would
comprise more than 15%, or with respect to the Money Fund, 10%,
of the value of the Fund's net assets (or such other amounts as
may be permitted under the 1940 Act). However, as a matter of
internal policy, the Advisor intends to limit each Fund's
investments in illiquid securities to 10% of its net assets.
The Board of Directors of each Fund, or its delegate, has
the ultimate authority to determine, to the extent permissible
under the federal securities laws, which securities are illiquid
for purposes of this limitation. Certain securities exempt from
registration or issued in transactions exempt from registration
under the Securities Act of 1933, as amended (the "Securities
Act"), such as securities that may be resold to institutional
investors under Rule 144A under the Securities Act and Section
4(2) commercial paper, may be considered liquid under guidelines
adopted by the Funds' Board of Directors.
The Board of Directors of each Fund has delegated to the
Advisor the day-to-day determination of the liquidity of a
security, although it has retained oversight and ultimate
responsibility for such determinations. The Board of Directors
has directed the Advisor to look to such factors as (i) the
frequency of trades or quotes for a security, (ii) the number of
dealers willing to purchase or sell the security and number of
potential buyers, (iii) the willingness of dealers to undertake
to make a market in the security, (iv) the nature of the security
and nature of the marketplace trades, such as the time needed to
dispose of the security, the method of soliciting offers, and the
mechanics of transfer, (v) the likelihood that the security's
marketability will be maintained throughout the anticipated
holding period, and (vi) any other relevant factors. The Advisor
may determine 4(2) commercial paper to be liquid if (i) the 4(2)
commercial paper is not traded flat or in default as to principal
and interest, (ii) the 4(2) commercial paper is rated in one of
the two highest rating categories by at least two nationally
rated statistical rating organizations ("NRSRO"), or if only one
NRSRO rates the security, by that NRSRO, or is determined by the
Advisor to be of equivalent quality, and (iii) the Advisor
considers the trading market for the specific security taking
into account all relevant factors. With respect to the Short-
Term Bond, Corporate Bond, and High-Yield Funds' foreign
holdings, a foreign security may be considered liquid by the
Advisor (despite its restricted nature under the Securities Act)
if the security can be freely traded in a foreign securities
market and all the facts and circumstances support a finding of
liquidity.
Restricted securities may be sold only in privately
negotiated transactions or in a public offering with respect to
which a registration statement is in effect under the Securities
Act. Where registration is required, a Fund may be obligated to
pay all or part of the registration expenses and a considerable
period may elapse between the time of the decision to sell and
the time the Fund may be permitted to sell a security under an
effective registration statement. If, during such a period,
adverse market conditions were to develop, a Fund might obtain a
less favorable price than prevailed when it decided to sell.
Restricted securities will be priced at fair value as determined
in good faith by the Board of Directors of the Funds. If through
the appreciation of restricted securities or the depreciation of
unrestricted securities, a Fund should be in a position where
more than 15% of the value of its net assets are invested in
illiquid securities, including restricted securities which are
not readily marketable (except for 144A Securities and 4(2)
commercial paper deemed to be liquid by the Advisor), the Fund
will take such steps as is deemed advisable, if any, to protect
liquidity.
Each Fund may sell over-the-counter ("OTC") options and, in
connection therewith, segregate assets or cover its obligations
with respect to OTC options written by the Fund. The assets used
as cover for OTC options written by the Fund will be considered
illiquid unless the OTC options are sold to qualified dealers who
agree that the Fund may repurchase any OTC option it writes at a
maximum price to be calculated by a formula set forth in the
option agreement. The cover for an OTC option written subject to
this procedure would be considered illiquid only to the extent
that the maximum repurchase price under the formula exceeds the
intrinsic value of the option.
Lending of Portfolio Securities
(All Funds)
Each Fund is authorized to lend up to 33 1/3% of the total
value of its portfolio securities to broker-dealers or
institutional investors that the Advisor deems qualified, but
only when the borrower maintains with the Fund's custodian bank
collateral either in cash or money market instruments in an
amount at least equal to the market value of the securities
loaned, plus accrued interest and dividends, determined on a
daily basis and adjusted accordingly. Although the Funds are
authorized to lend, the Funds do not presently intend to engage
in lending. In determining whether to lend securities to a
particular broker-dealer or institutional investor, the Advisor
will consider, and during the period of the loan will monitor,
all relevant facts and circumstances, including the
creditworthiness of the borrower. The Funds will retain
authority to terminate any loans at any time. The Funds 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 money market instruments held as collateral to the
borrower or placing broker. The Funds will receive reasonable
interest on the loan or a flat fee from the borrower and amounts
equivalent to any dividends, interest or other distributions on
the securities loaned. The Funds will retain record ownership of
loaned securities to exercise beneficial rights, such as voting
and subscription rights and rights to dividends, interest or
other distributions, when retaining such rights is considered to
be in a Fund's interest.
Loan Interests
(Short-Term Bond and Corporate Bond Funds)
Each Fund may acquire a loan interest (a "Loan Interest").
A Loan Interest is typically originated, negotiated, and
structured by a U.S. or foreign commercial bank, insurance
company, finance company, or other financial institution (the
"Agent") for a lending syndicate of financial institutions. The
Agent typically administers and enforces the loan on behalf of
the other lenders in the syndicate. In addition, an institution,
typically but not always the Agent (the "Collateral Bank"), holds
collateral (if any) on behalf of the lenders. These Loan
Interests may take the form of participation interests in,
assignments of or novations of a loan during its secondary
distribution, or direct interests during a primary distribution.
Such Loan Interests may be acquired from U.S. or foreign banks,
insurance companies, finance companies, or other financial
institutions who have made loans or are members of a lending
syndicate or from other holders of Loan Interests. A Fund may
also acquire Loan Interests under which the Fund derives its
rights directly from the borrower. Such Loan Interests are
separately enforceable by a Fund against the borrower and all
payments of interest and principal are typically made directly to
a Fund from the borrower. In the event that a Fund and other
lenders become entitled to take possession of shared collateral,
it is anticipated that such collateral would be held in the
custody of a Collateral Bank for their mutual benefit. The Funds
may not act as an Agent, a Collateral Bank, a guarantor or sole
negotiator or structurer with respect to a loan.
The Advisor will analyze and evaluate the financial
condition of the borrower in connection with the acquisition of
any Loan Interest. The Advisor also analyzes and evaluates the
financial condition of the Agent and, in the case of Loan
Interests in which the Fund does not have privity with the
borrower, those institutions from or through whom the Fund
derives its rights in a loan (the "Intermediate Participants").
In a typical loan the Agent administers the terms of the
loan agreement. In such cases, the Agent is normally responsible
for the collection of principal and interest payments from the
borrower and the apportionment of these payments to the credit of
all institutions which are parties to the loan agreement. A Fund
will generally rely upon the Agent or an Intermediate Participant
to receive and forward to the Fund its portion of the principal
and interest payments on the loan. Furthermore, unless under the
terms of a participation agreement a Fund has direct recourse
against the borrower, the Fund will rely on the Agent and the
other members of the lending syndicate to use appropriate credit
remedies against the borrower. The Agent is typically
responsible for monitoring compliance with covenants contained in
the loan agreement based upon reports prepared by the borrower.
The seller of the Loan Interest usually does, but is often not
obligated to, notify holders of Loan Interests of any failures of
compliance. The Agent may monitor the value of the collateral
and, if the value of the collateral declines, may accelerate the
loan, may give the borrower an opportunity to provide additional
collateral or may seek other protection for the benefit of the
participants in the loan. The Agent is compensated by the
borrower for providing these services under a loan agreement, and
such compensation may include special fees paid upon structuring
and funding the loan and other fees paid on a continuing basis.
With respect to Loan Interests for which the Agent does not
perform such administrative and enforcement functions, a Fund
will perform such tasks on its own behalf, although a Collateral
Bank will typically hold any collateral on behalf of the Fund and
the other lenders pursuant to the applicable loan agreement.
A financial institution's appointment as Agent may usually
be terminated in the event that it fails to observe the requisite
standard of care or becomes insolvent, enters Federal Deposit
Insurance Corporation ("FDIC") receivership, or, if not FDIC
insured, enters into bankruptcy proceedings. A successor Agent
would generally be appointed to replace the terminated Agent, and
assets held by the Agent under the loan agreement should remain
available to holders of Loan Interests. However, if assets held
by the Agent for the benefit of the Fund were determined to be
subject to the claims of the Agent's general creditors, the Fund
might incur certain costs and delays in realizing payment on a
loan interest, or suffer a loss of principal and/or interest. In
situations involving Intermediate Participants similar risks may
arise.
Purchasers of Loan Interests depend primarily upon the
creditworthiness of the borrower for payment of principal and
interest. If a Fund does not receive scheduled interest or
principal payments on such indebtedness, the Fund's share price
and yield could be adversely affected. Loans that are fully
secured offer a Fund more protections than an unsecured loan in
the event of non-payment of scheduled interest or principal.
However, there is no assurance that the liquidation of collateral
from a secured loan would satisfy the borrower's obligation, or
that the collateral can be liquidated. Indebtedness of borrowers
whose creditworthiness is poor involves substantially greater
risks, and may be highly speculative. Borrowers that are in
bankruptcy or restructuring may never pay off their indebtedness,
or may pay only a small fraction of the amount owed. Direct
indebtedness of developing countries will also involve a risk
that the governmental entities responsible for the repayment of
the debt may be unable, or unwilling, to pay interest and repay
principal when due.
Maturity
(All Funds)
A Fund's average portfolio maturity represents an average
based on the actual stated maturity dates of the debt securities
in a Fund's portfolio, except that (i) variable-rate securities
are deemed to mature at the next interest-rate adjustment date,
(ii) debt securities with put features are deemed to mature at
the next put-exercise date, (iii) the maturity of mortgage-backed
securities is determined on an "expected life" basis as
determined by the Advisor, and (iv) securities being hedged with
futures contracts may be deemed to have a longer maturity, in the
case of purchases of futures contracts, and a shorter maturity,
in the case of sales of futures contracts, than they would
otherwise be deemed to have. In addition, a security that is
subject to redemption at the option of the issuer on a particular
date (the "call date"), which is prior to the security's stated
maturity, may be deemed to mature on the call date rather than on
its stated maturity date. The call date of a security will be
used to calculate average portfolio maturity when the Advisor
reasonably anticipates, based upon information available to it,
that the issuer will exercise its right to redeem the security.
The average portfolio maturity of a Fund is dollar-weighted based
upon the market value of a Fund's securities at the time of the
calculation.
Mortgage- and Asset-Backed Securities
(All Funds)
Mortgage-backed securities represent direct or indirect
participations in, or are secured by and payable from, mortgage
loans secured by real property, and include single- and multi-
class pass-through securities and collateralized mortgage
obligations. Such securities may be issued or guaranteed by U.S.
government agencies or instrumentalities, such as the Government
National Mortgage Association and the Federal National Mortgage
Association, or by private issuers, generally originators and
investors in mortgage loans, including savings associations,
mortgage bankers, commercial banks, investment bankers, and
special purpose entities (collectively, "private lenders").
Mortgage-backed securities issued by private lenders may be
supported by pools of mortgage loans or other mortgage-backed
securities that are guaranteed, directly or indirectly, by the
U.S. government or one of its agencies or instrumentalities, or
they may be issued without any governmental guarantee of the
underlying mortgage assets but with some form of non-governmental
credit enhancement.
Asset-backed securities have structural characteristics
similar to mortgage-backed securities. Asset-backed debt
obligations represent direct or indirect participation in, or
secured by and payable from, assets such as motor vehicle
installment sales contracts, other installment loan contracts,
home equity loans, leases of various types of property, and
receivables from credit card or other revolving credit
arrangements. The credit quality of most asset-backed securities
depends primarily on the credit quality of the assets underlying
such securities, how well the entity issuing the security is
insulated from the credit risk of the originator or any other
affiliated entities, and the amount and quality of any credit
enhancement of the securities. Payments or distributions of
principal and interest on asset-backed debt obligations may be
supported by non-governmental credit enhancements including
letters of credit, reserve funds, overcollateralization, and
guarantees by third parties. The market for privately issued
asset-backed debt obligations is smaller and less liquid than the
market for government sponsored mortgage-backed securities.
The rate of principal payment on mortgage- and asset-backed
securities generally depends on the rate of principal payments
received on the underlying assets which in turn may be affected
by a variety of economic and other factors. As a result, the
yield on any mortgage- and asset-backed security is difficult to
predict with precision and actual yield to maturity may be more
or less than the anticipated yield to maturity. The yield
characteristics of mortgage- and asset-backed securities differ
from those of traditional debt securities. Among the principal
differences are that interest and principal payments are made
more frequently on mortgage-and asset-backed securities, usually
monthly, and that principal may be prepaid at any time because
the underlying mortgage loans or other assets generally may be
prepaid at any time. As a result, if a Fund purchases these
securities at a premium, a prepayment rate that is faster than
expected will reduce yield to maturity, while a prepayment rate
that is slower than expected will have the opposite effect of
increasing the yield to maturity. Conversely, if a Fund
purchases these securities at a discount, a prepayment rate that
is faster than expected will increase yield to maturity, while a
prepayment rate that is slower than expected will reduce yield to
maturity. Amounts available for reinvestment by a Fund are
likely to be greater during a period of declining interest rates
and, as a result, are likely to be reinvested at lower interest
rates than during a period of rising interest rates. Accelerated
prepayments on securities purchased by a Fund at a premium also
impose a risk of loss of principal because the premium may not
have been fully amortized at the time the principal is prepaid in
full. The market for privately issued mortgage - and asset-
backed securities is smaller and less liquid than the market for
government-sponsored mortgage-backed securities.
While many mortgage- and asset-backed securities are issued
with only one class of security, many are issued in more than one
class, each with different payment terms. Multiple class
mortgage- and asset-backed securities are issued for two main
reasons. First, multiple classes may be used as a method of
providing credit support. This is accomplished typically through
creation of one or more classes whose right to payments on the
security is made subordinate to the right to such payments of the
remaining class or classes. Second, multiple classes may permit
the issuance of securities with payment terms, interest rates, or
other characteristics differing both from those of each other and
from those of the underlying assets. Examples include so-called
"strips" (mortgage - and asset-backed securities entitling the
holder to disproportionate interests with respect to the
allocation of interest and principal of the assets backing the
security), and securities with class or classes having
characteristics which mimic the characteristics of non-mortgage-
or asset-backed securities, such as floating interest rates
(i.e., interest rates which adjust as a specified benchmark
changes) or scheduled amortization of principal.
The Funds may invest in stripped mortgage- or asset-backed
securities, which receive differing proportions of the interest
and principal payments from the underlying assets. The market
value of such securities generally is more sensitive to changes
in prepayment and interest rates than is the case with
traditional mortgage- and asset-backed securities, and in some
cases such market value may be extremely volatile. With respect
to certain stripped securities, such as interest only and
principal only classes, a rate of prepayment that is faster or
slower than anticipated may result in a Fund failing to recover
all or a portion of its investment, even though the securities
are rated investment grade.
Mortgage- and asset-backed securities backed by assets,
other than as described above, or in which the payment streams on
the underlying assets are allocated in a manner different than
those described above may be issued in the future. A Fund may
invest in such securities if such investment is otherwise
consistent with its investment objectives and policies and with
the investment restrictions of a Fund.
Mortgage Dollar Rolls and Reverse Repurchase Agreements
(All Funds)
The Funds may engage in reverse repurchase agreements to
facilitate portfolio liquidity, a practice common in the mutual
fund industry, or for arbitrage transactions discussed below. In
a reverse repurchase agreement, a Fund would sell a security and
enter into an agreement to repurchase the security at a specified
future date and price. The Fund generally retains the right to
interest and principal payments on the security. Since the Fund
receives cash upon entering into a reverse repurchase agreement,
it may be considered a borrowing. (See "Borrowing".) When
required by guidelines of the SEC, a Fund will set aside
permissible liquid assets in a segregated account to secure its
obligations to repurchase the security.
Each Fund may also enter into mortgage dollar rolls, in
which the Fund would sell mortgage-backed securities for delivery
in the current month and simultaneously contract to purchase
substantially similar securities on a specified future date.
While a Fund would forego principal and interest paid on the
mortgage-backed securities during the roll period, the Fund would
be compensated by the difference between the current sales price
and the lower price for the future purchase as well as by any
interest earned on the proceeds of the initial sale. The Fund
also could be compensated through the receipt of fee income
equivalent to a lower forward price. At the time the Fund would
enter into a mortgage dollar roll, it would set aside permissible
liquid assets in a segregated account to secure its obligation
for the forward commitment to buy mortgage-backed securities.
Mortgage dollar roll transactions may be considered a borrowing
by the Funds. (See "Borrowing".)
The mortgage dollar rolls and reverse repurchase agreements
entered into by the Funds may be used as arbitrage transactions
in which a Fund will maintain an offsetting position in
investment grade debt obligations or repurchase agreements that
mature on or before the settlement date on the related mortgage
dollar roll or reverse repurchase agreements. Since a Fund will
receive interest on the securities or repurchase agreements in
which it invests the transaction proceeds, such transactions may
involve leverage. However, since such securities or repurchase
agreements will be high quality and will mature on or before the
settlement date of the mortgage dollar roll or reverse repurchase
agreement, the Advisor believes that such arbitrage transactions
do not present the risks to the Funds that are associated with
other types of leverage.
Municipal Obligations
(All Funds)
General obligation bonds are secured by the issuer's pledge
of its full faith, credit, and taxing power for the payment of
interest and principal. Revenue bonds are payable only from the
revenues derived from a project or facility or from the proceeds
of a specified revenue source. Industrial development bonds are
generally revenue bonds secured by payments from and the credit
of private users. Municipal notes are issued to meet the short-
term funding requirements of state, regional, and local
governments. Municipal notes include tax anticipation notes,
bond anticipation notes, revenue anticipation notes, tax and
revenue anticipation notes, construction loan notes, short-term
discount notes, tax-exempt commercial paper, demand notes, and
similar instruments. Municipal obligations include obligations,
the interest on which is exempt from federal income tax, that may
become available in the future as long as the Board of Directors
of a Fund determines that an investment in any such type of
obligation is consistent with that Fund's investment objective.
Municipal lease obligations may take the form of a lease, an
installment purchase, or a conditional sales contract. They are
issued by state and local governments and authorities to acquire
land, equipment, and facilities, such as state and municipal
vehicles, telecommunications and computer equipment, and other
capital assets. The Fund may purchase these obligations
directly, or it may purchase participation interests in such
obligations. Municipal leases are generally subject to greater
risks than general obligation or revenue bonds. State
constitutions and statutes set forth requirements that states or
municipalities must meet in order to issue municipal obligations.
Municipal leases may contain a covenant by the state or
municipality to budget for, appropriate, and make payments due
under the obligation. Certain municipal leases may, however,
contain "non-appropriation" clauses which provide that the issuer
is not obligated to make payments on the obligation in future
years unless funds have been appropriated for this purpose each
year. Accordingly, such obligations are subject to "non-
appropriation" risk. While municipal leases are secured by the
underlying capital asset, it may be difficult to dispose of any
such asset in the event of non-appropriation or other default.
Repurchase Agreements
(All Funds)
Each Fund may enter into repurchase agreements with certain
banks or non-bank dealers. In a repurchase agreement, a Fund
buys a security at one price, and at the time of sale, the seller
agrees to repurchase the obligation at a mutually agreed upon
time and price (usually within seven days). The repurchase
agreement, thereby, determines the yield during the purchaser's
holding period, while the seller's obligation to repurchase is
secured by the value of the underlying security. The Advisor
will monitor, on an ongoing basis, the value of the underlying
securities to ensure that the value always equals or exceeds the
repurchase price plus accrued interest. Repurchase agreements
could involve certain risks in the event of a default or
insolvency of the other party to the agreement, including
possible delays or restrictions upon a Fund's ability to dispose
of the underlying securities. Although no definitive
creditworthiness criteria are used, the Advisor reviews the
creditworthiness of the banks and non-bank dealers with which the
Funds enter into repurchase agreements to evaluate those risks.
A Fund may, under certain circumstances, deem repurchase
agreements collateralized by U.S. government securities to be
investments in U.S. government securities.
Short Sales Against the Box
(All Funds)
Each Fund may sell securities short against the box to hedge
unrealized gains on portfolio securities. Selling securities
short against the box involves selling a security that a Fund
owns or has the right to acquire, for delivery at a specified
date in the future. If a Fund sells securities short against the
box, it may protect unrealized gains, but will lose the
opportunity to profit on such securities if the price rises.
Temporary Defensive Position
(All Funds)
When the Advisor determines that market conditions warrant a
temporary defensive position, the Funds may invest without
limitation in cash and short-term fixed income securities,
including U.S. government securities, commercial paper, banker's
acceptances, certificates of deposit, and time deposits.
Variable- or Floating-Rate Securities
(All Funds)
The Fund may invest in securities which offer a variable- or
floating-rate of interest. Variable-rate securities provide for
automatic establishment of a new interest rate at fixed intervals
(e.g., daily, monthly, semi-annually, etc.). Floating-rate
securities generally provide for automatic adjustment of the
interest rate whenever some specified interest rate index
changes. The interest rate on variable- or floating-rate
securities is ordinarily determined by reference to or is a
percentage of a bank's prime rate, the 90-day U.S. Treasury bill
rate, the rate of return on commercial paper or bank certificates
of deposit, an index of short-term interest rates, or some other
objective measure.
Variable- or floating-rate securities frequently include a
demand feature entitling the holder to sell the securities to the
issuer at par. In many cases, the demand feature can be
exercised at any time on 7 days notice; in other cases, the
demand feature is exercisable at any time on 30 days notice or on
similar notice at intervals of not more than one year. Some
securities which do not have variable or floating interest rates
may be accompanied by puts producing similar results and price
characteristics. When considering the maturity of any instrument
which may be sold or put to the issuer or a third party, the Fund
may consider that instrument's maturity to be shorter than its
stated maturity. Any such determination by the Money Fund will
be made in accordance with Rule 2a-7.
Variable-rate demand notes include master demand notes which
are obligations that permit the Fund to invest fluctuating
amounts, which may change daily without penalty, pursuant to
direct arrangements between the Fund, as lender, and the
borrower. The interest rates on these notes fluctuate from time
to time. The issuer of such obligations normally has a
corresponding right, after a given period, to prepay in its
discretion the outstanding principal amount of the obligations
plus accrued interest upon a specified number of days' notice to
the holders of such obligations. The interest rate on a floating-
rate demand obligation is based on a known lending rate, such as
a bank's prime rate, and is adjusted automatically each time such
rate is adjusted. The interest rate on a variable-rate demand
obligation is adjusted automatically at specified intervals.
Frequently, such obligations are secured by letters of credit or
other credit support arrangements provided by banks. Because
these obligations are direct lending arrangements between the
lender and borrower, it is not contemplated that such instruments
will generally be traded. There generally is not an established
secondary market for these obligations, although they are
redeemable at face value. Accordingly, where these obligations
are not secured by letters of credit or other credit support
arrangements, the Fund's right to redeem is dependent on the
ability of the borrower to pay principal and interest on demand.
Such obligations frequently are not rated by credit rating
agencies and, if not so rated, the Fund may invest in them only
if the Advisor determines that at the time of investment the
obligations are of comparable quality to the other obligations in
which the Fund may invest. The Advisor, on behalf of the Fund,
will consider on an ongoing basis the creditworthiness of the
issuers of the floating- and variable-rate demand obligations in
the Fund's portfolio.
The Fund will not invest more than 10% of its net assets in
variable- and floating-rate demand obligations that are not
readily marketable (a variable- or floating-rate demand
obligation that may be disposed of on not more than seven days
notice will be deemed readily marketable and will not be subject
to this limitation). (See "Illiquid Securities" and "Investment
Restrictions.") In addition, each variable- or floating-rate
obligation must meet the credit quality requirements applicable
to all the Fund's investments at the time of purchase. When
determining whether such an obligation meets the Fund's credit
quality requirements, the Fund may look to the credit quality of
the financial guarantor providing a letter of credit or other
credit support arrangement.
In determining the Fund's weighted average portfolio
maturity, the Fund will consider a floating or variable rate
security to have a maturity equal to its stated maturity (or
redemption date if it has been called for redemption), except
that it may consider (i) variable rate securities to have a
maturity equal to the period remaining until the next
readjustment in the interest rate, unless subject to a demand
feature, (ii) variable rate securities subject to a demand
feature to have a remaining maturity equal to the longer of (a)
the next readjustment in the interest rate or (b) the period
remaining until the principal can be recovered through demand,
and (iii) floating rate securities subject to a demand feature to
have a maturity equal to the period remaining until the principal
can be recovered through demand. Variable and floating rate
securities generally are subject to less principal fluctuation
than securities without these attributes since the securities
usually trade at amortized cost following the readjustment in the
interest rate.
Warrants
(All Funds)
Each Fund may acquire warrants. Warrants are securities
giving the holder the right, but not the obligation, to buy the
stock of an issuer at a given price (generally higher than the
value of the stock at the time of issuance) during a specified
period or perpetually. Warrants may be acquired separately or in
connection with the acquisition of securities. Warrants acquired
by a Fund in units or attached to securities are not subject to
these restrictions. Warrants do not carry with them the right to
dividends or voting rights with respect to the securities that
they entitle their holder to purchase, and they do not represent
any rights in the assets of the issuer. As a result, warrants
may be considered to have more speculative characteristics than
certain other types of investments. In addition, the value of a
warrant does not necessarily change with the value of the
underlying securities, and a warrant ceases to have value if it
is not exercised prior to its expiration date.
When-Issued Securities
(All Funds)
Each Fund may from time to time purchase securities on a
"when-issued" basis. The price of debt obligations purchased on
a when-issued basis, which may be expressed in yield terms,
generally is fixed at the time the commitment to purchase is
made, but delivery and payment for the securities take place at a
later date. Normally, the settlement date occurs within 45 days
of the purchase although in some cases settlement may take
longer. During the period between the purchase and settlement,
no payment is made by a Fund to the issuer and no interest on the
debt obligations accrues to the Fund. Forward commitments
involve a risk of loss if the value of the security to be
purchased declines prior to the settlement date, which risk is in
addition to the risk of decline in value of the Fund's other
assets. While when-issued securities may be sold prior to the
settlement date, the Funds intend to purchase such securities
with the purpose of actually acquiring them unless a sale appears
desirable for investment reasons. At the time a Fund makes the
commitment to purchase a security on a when-issued basis, it will
record the transaction and reflect the value of the security in
determining its net asset value. The Funds do not believe that
their net asset values will be adversely affected by purchases of
securities on a when-issued basis.
To the extent required by the SEC, the Funds will maintain
cash and marketable securities equal in value to commitments for
when-issued securities. Such segregated securities either will
mature or, if necessary, be sold on or before the settlement
date. When the time comes to pay for when-issued securities, a
Fund will meet its obligations from then-available cash flow,
sale of the securities held in the separate account, described
above, sale of other securities or, although it would not
normally expect to do so, from the sale of the when-issued
securities themselves (which may have a market value greater or
less than the Fund's payment obligation).
Zero-Coupon, Step-Coupon and Pay-in-Kind Securities
(All Funds)
The Funds may invest in zero-coupon, step-coupon, and pay-in-
kind securities. These securities are debt securities that do
not make regular cash interest payments. Zero-coupon and step-
coupon securities are sold at a deep discount to their face
value. Pay-in-kind securities pay interest through the issuance
of additional securities. Because such securities do not pay
current cash income, the price of these securities can be
volatile when interest rates fluctuate. While these securities
do not pay current cash income, federal income tax law requires
the holders of zero-coupon, step-coupon, and pay-in-kind
securities to include in income each year the portion of the
original issue discount (or deemed discount) and other non-cash
income on such securities accruing that year. In order to
continue to qualify as a "regulated investment company" under the
Internal Revenue Code and avoid a certain excise tax, each Fund
may be required to distribute a portion of such discount and
income and may be required to dispose of other portfolio
securities, which may occur in periods of adverse market prices,
in order to generate cash to meet these distribution
requirements.
DIRECTORS AND OFFICERS OF THE FUNDS
Directors and officers of the Funds, together with
information as to their principal business occupations during the
last five years, and other information are shown below. Each
director who is deemed an "interested person," as defined in the
1940 Act, is indicated by an asterisk (*). Each officer and
director holds the same position with the 25 registered open-end
management investment companies consisting of 38 mutual funds,
which are managed by the Advisor (the "Strong Funds"). The
Strong Funds, in the aggregate, pays each Director who is not a
director, officer, or employee of the Advisor, or any affiliated
company (a "disinterested director") an annual fee of $50,000,
plus $100 per Board meeting for each Strong Fund. In addition,
each disinterested director is reimbursed by the Strong Funds for
travel and other expenses incurred in connection with attendance
at such meetings. Other officers and directors of the Strong
Funds receive no compensation or expense reimbursement from the
Strong Funds.
*Richard S. Strong (DOB 5/12/42), Chairman of the Board and
Director of the Funds.
Prior to August 1985, Mr. Strong was Chief Executive Officer
of the Advisor, which he founded in 1974. Since August 1985, Mr.
Strong has been a Security Analyst and Portfolio Manager of the
Advisor. In October 1991, Mr. Strong also became the Chairman of
the Advisor. Mr. Strong is a Director of the Advisor. Mr.
Strong has been in the investment management business since 1967.
Mr. Strong has served the Funds as follows:
Director - Short-Term Bond Fund (since August 1987);
Government Fund (since October 1986); Corporate Bond Fund
(since December 1985); and High-Yield Fund (since October
1995).
Chairman - Short-Term Bond Fund (since August 1987);
Government Fund (since October 1986); Corporate Bond Fund
(since December 1985); and High-Yield Fund (since October
1995).
Marvin E. Nevins (DOB 7/9/18), Director of the Funds.
Private Investor. From 1945 to 1980, Mr. Nevins was
Chairman of Wisconsin Centrifugal Inc., a foundry. From July
1983 to December 1986, he was Chairman of General Casting Corp.,
Waukesha, Wisconsin, a foundry. Mr. Nevins is a former Chairman
of the Wisconsin Association of Manufacturers & Commerce. He was
also a regent of the Milwaukee School of Engineering and a member
of the Board of Trustees of the Medical College of Wisconsin.
Mr. Nevins has served the Funds as follows:
Director - Short-Term Bond Fund (since August 1987);
Government Fund (since October 1986); Corporate Bond Fund
(since December 1985); and High-Yield Fund (since October
1995).
Willie D. Davis (DOB 7/24/34), Director of the Funds.
Mr. Davis has been director of Alliance Bank since 1980,
Sara Lee Corporation (a food/consumer products company) since
1983, KMart Corporation (a discount consumer products company)
since 1985, YMCA Metropolitan - Los Angeles since 1985, Dow
Chemical Company since 1988, MGM Grand, Inc. (an
entertainment/hotel company) since 1990, WICOR, Inc. (a utility
company) since 1990, Johnson Controls, Inc. (an industrial
company) since 1992, L.A. Gear (a footwear/sportswear company)
since 1992, and Rally's Hamburger, Inc. since 1994. Mr. Davis
has been a trustee of the University of Chicago since 1980,
Marquette University since 1988, and Occidental College since
1990. Since 1977, Mr. Davis has been President and Chief
Executive Officer of All Pro Broadcasting, Inc. Mr. Davis was a
director of the Fireman's Fund (an insurance company) from 1975
until 1990. Mr. Davis has served the Funds as follows:
Director - Short-Term Bond Fund (since July 1994);
Government Fund (since July 1994); Corporate Bond Fund
(since July 1994); and High-Yield Fund (since October 1995).
*John Dragisic (DOB 11/26/40), President and Director of the
Funds.
Mr. Dragisic has been President of the Advisor since October
1995, and a Director of the Advisor since July 1994. Mr.
Dragisic served as Vice Chairman of the Advisor from July 1994
until October 1995. Mr. Dragisic was the President and Chief
Executive Officer of Grunau Company, Inc. (a mechanical
contracting and engineering firm), Milwaukee, Wisconsin from 1987
until July 1994. From 1981 to 1987, he was an Executive Vice
President with Grunau Company, Inc. From 1969 until 1973, Mr.
Dragisic worked for the InterAmerican Development Bank. Mr.
Dragisic received his Ph.D. in Economics in 1971 from the
University of Wisconsin - Madison and his B.A. degree in
Economics in 1962 from Lake Forest College. Mr. Dragisic has
served the Funds as follows:
Director - Short-Term Bond Fund (July 1991 until July 1994,
and since April 1995); Government Fund (July 1991 until July
1994, and since April 1995); Corporate Bond Fund (July 1991
until July 1994, and since April 1995); and High-Yield Fund
(since October 1995).
Vice Chairman - Short-Term Bond Fund (July 1994 until
October 1995); Government Fund (July 1994 until October
1995); and Corporate Bond Fund (July 1994 until October
1995)
President - Short-Term Bond Fund (since October 1995);
Government Fund (since October 1995); Corporate Bond Fund
(since October 1995); and High-Yield Fund (since October
1995)
Stanley Kritzik (DOB 1/9/30), Director of the Funds.
Mr. Kritzik has been a Partner of Metropolitan Associates
since 1962, a Director of Aurora Health Care since 1987, and
Health Network Ventures, Inc. since 1992. Mr. Kritzik has served
the Funds as follows:
Director - Short-Term Bond Fund (since April 1995);
Government Fund (since April 1995); Corporate Bond Fund
(since April 1995); and High-Yield Fund (since October
1995).
William F. Vogt (DOB 7/19/47), Director of the Funds.
Mr. Vogt has been the President of Vogt Management
Consulting, Inc. since 1990. From 1982 until 1990, he served as
Executive Director of University Physicians of the University of
Colorado. Mr. Vogt is the Past President of the Medical Group
Management Association and a Fellow of the American College of
Medical Practice Executives. He has served the Funds as follows:
Director - Short-Term Bond Fund (since April 1995);
Government Fund (since April 1995); Corporate Bond Fund
(since April 1995); and High-Yield Fund (since October
1995).
Lawrence A. Totsky (DOB 5/6/59), C.P.A., Vice President of the
Funds.
Mr. Totsky has been Senior Vice President of the Advisor
since September 1994. Mr. Totsky served as Vice President of the
Advisor from December 1992 to September 1994. Mr. Totsky acted
as the Advisor's Manager of Shareholder Accounting and Compliance
from June 1987 to June 1991 when he was named Director of Mutual
Fund Administration. Mr. Totsky has served the Funds as follows:
Vice President - Short-Term Bond Fund (since May 1993);
Government Fund (since May 1993); Corporate Bond Fund (since
May 1993); and High-Yield Fund (since October 1995).
Thomas P. Lemke (DOB 7/30/54), Vice President of the Funds.
Mr. Lemke has been Senior Vice President, Secretary, and
General Counsel of the Advisor since September 1994. For two
years prior to joining the Advisor, Mr. Lemke acted as Resident
Counsel for Funds Management at J.P. Morgan & Co., Inc. From
February 1989 until April 1992, Mr. Lemke acted as Associate
General Counsel to Sanford C. Bernstein Co., Inc. For two years
prior to that, Mr. Lemke was Of Counsel at the Washington, D.C.
law firm of Tew Jorden & Schulte, a successor of Finley, Kumble &
Wagner. From August 1979 until December 1986, Mr. Lemke worked
at the Securities and Exchange Commission, most notably as the
Chief Counsel to the Division of Investment Management (November
1984 - December 1986), and as Special Counsel to the Office of
Insurance Products, Division of Investment Management (April 1982
- - October 1984). Mr. Lemke has served the Funds as follows:
Vice President - Short-Term Bond Fund (since October 1994),
Government Fund (since October 1994); Corporate Bond Fund
(since October 1994); and High-Yield Fund (since October
1995).
Stephen J. Shenkenberg (DOB 6/14/58), Vice President and
Secretary of the Funds.
Mr. Shenkenberg has been Deputy General Counsel to the
Advisor since November 1996. From December 1992 until November
1996, Mr. Shenkenberg acted as Associate Counsel to the Advisor.
From June 1987 until December 1992, Mr. Shenkenberg was an
attorney for Godfrey & Kahn, S.C., a Milwaukee law firm. Mr.
Shenkenberg has served the Funds as follows:
Vice President - Short-Term Bond Fund (since April 1996);
Government Fund (since April 1996); Corporate Bond Fund
(since April 1996); and High-Yield Fund (since April 1996).
Secretary - Short-Term Bond Fund (since October 1996);
Government Fund (since October 1996); Corporate Bond Fund
(since October 1996); and High-Yield Fund (since October
1996).
John S. Weitzer (DOB 10/31/67), Vice President of the Funds.
Mr. Weitzer has been an Associate Counsel to the Advisor
since July 1993. Mr. Weitzer has served the Funds as follows:
Vice President - Short-Term Bond Fund (since January 1996);
Government Fund (since January 1996); Corporate Bond Fund
(since January 1996); and High-Yield Fund (since January
1996).
Except for Messrs. Nevins, Davis, Kritzik and Vogt, the
address of all of the above persons is P.O. Box 2936, Milwaukee,
Wisconsin 53201. Mr. Nevins' address is 6075 Pelican Bay
Boulevard, Naples, Florida 34108. Mr. Davis' address is 161
North La Brea, Inglewood, California 90301. Mr. Kritzik's
address is 1123 North Astor Street, P.O. Box 92547, Milwaukee,
Wisconsin 53202-0547. Mr. Vogt's address is 2830 East Third
Avenue, Denver, Colorado 80206.
In addition to the positions listed above, the following
individuals also hold the following positions with Strong
Holdings, Inc. ("Holdings"), a Wisconsin corporation and
subsidiary of the Advisor; Strong Funds Distributors, Inc., the
Fund's underwriter ("Distributors"), Heritage Reserve
Development Corporation ("Heritage"), and Strong Service
Corporation ("SSC"), each of which is a Wisconsin corporation and
subsidiary of Holdings; Fussville Real Estate Holdings L.L.C.
("Real Estate Holdings") and Sherwood Development L.L.C.
("Sherwood"), each of which is a Wisconsin Limited Liability
Company and subsidiary of the Advisor and Heritage; and Fussville
Development L.L.C. ("Fussville Development"), a Wisconsin Limited
Liability Company and subsidiary of the Advisor and Real Estate
Holdings:
Richard S. Strong:
Chairman and a Director - Holdings and Distributors (since
October 1993); Heritage (since January 1994); and SSC (since
November 1995).
Chairman and a Member of the Managing Board - Real Estate
Holdings and Fussville Development (since December 1995 and
February 1994, respectively); and Sherwood (since October
1994).
John Dragisic:
President and a Director - Holdings (since December 1995 and
July 1994, respectively); Distributors (since September 1996
and July 1994, respectively); Heritage (since May 1994 and
August 1994, respectively); and SSC (since November 1995).
Vice Chairman and a Member of the Managing Board - Real
Estate and Fussville Development (since December 1995 and
August 1994, respectively); and Sherwood (since October
1994).
Thomas P. Lemke:
Vice President - Holdings, Heritage, Real Estate Holdings,
and Fussville Development (since December 1995);
Distributors (since October 1996); Sherwood (since October
1994); and SSC (since November 1995).
Stephen J. Shenkenberg:
Vice President and Secretary - Distributors (since
December 1995).
Secretary - Holdings, Heritage, Fussville Development, Real
Estate Holdings, and Sherwood (since December 1995); and SSC
(since November 1995).
As of January 31, 1997, the officers and directors of the
Funds in the aggregate beneficially owned less than 1% of each
Fund's then outstanding shares.
PRINCIPAL SHAREHOLDERS
As of January 31, 1997, no persons owned of record or are
known by the Funds to own of record or beneficially, more than 5%
of a Fund's outstanding shares.
INVESTMENT ADVISOR AND DISTRIBUTOR
The Advisor to the Funds is Strong Capital Management, Inc.
Mr. Richard S. Strong controls the Advisor. Mr. Strong is the
Chairman and a director of the Advisor, Mr. Dragisic is the
President and a director of the Advisor, Mr. Totsky is a Senior
Vice President of the Advisor, Mr. Lemke is a Senior Vice
President, Secretary and General Counsel of the Advisor, Mr.
Shenkenberg is Vice President, Assistant Secretary, and Deputy
General Counsel of the Advisor, and Mr. Weitzer is Associate
Counsel of the Advisor. A brief description of each Fund's
investment advisory agreement ("Advisory Agreement") is set forth
in the Prospectus under "About the Funds - Management."
The Advisory Agreements for the Short-Term Bond, Government,
and Corporate Bond Funds, dated May 1, 1995, were last approved
by shareholders at the annual meeting of shareholders held on
April 13, 1995. The High-Yield Fund's Advisory Agreement, dated
December 27, 1995, was last approved by the sole shareholder on
December 27, 1995, and will remain in effect as to the Fund for a
period of two years. Each Advisory Agreement is required to be
approved annually by either the Board of Directors of the Fund or
by vote of a majority of the Fund's outstanding voting securities
(as defined in the 1940 Act). In either case, each annual
renewal must be approved by the vote of a majority of the Fund's
directors who are not parties to the Advisory Agreement or
interested persons of any such party, cast in person at a meeting
called for the purpose of voting on such approval. Each Advisory
Agreement is terminable, without penalty, on 60 days' written
notice by the Board of Directors of the Fund, by vote of a
majority of the Fund's outstanding voting securities, or by the
Advisor. In addition, an Advisory Agreement will terminate
automatically in the event of its assignment.
Under the terms of each Advisory Agreement, the Advisor
manages the Fund's investments subject to the supervision of the
Fund's Board of Directors. The Advisor is responsible for
investment decisions and supplies investment research and
portfolio management. At its expense, the Advisor provides
office space and all necessary office facilities, equipment and
personnel for servicing the investments of the Fund. The Advisor
places all orders for the purchase and sale of the Fund's
portfolio securities at the Fund's expense.
Except for expenses assumed by the Advisor as set forth
above or by the Distributor as described below with respect to
the distribution of a Fund's shares, a Fund is responsible for
all its other expenses, including, without limitation, interest
charges, taxes, brokerage commissions, and similar expenses;
expenses of issue, sale, repurchase, or redemption of shares;
expenses of registering or qualifying shares for sale; expenses
for printing and distribution costs of Prospectuses and quarterly
financial statements mailed to existing shareholders; and charges
of custodians, transfer agents (including the printing and
mailing of reports and notices to shareholders), registrars,
auditing and legal services, clerical services related to
recordkeeping and shareholder relations, printing stock
certificates; and fees for directors who are not "interested
persons" of the Advisor.
As compensation for its services, each Fund pays to the
Advisor monthly management fees at the following annual rates:
(1) Short-Term Bond Fund: .625% of average daily net assets; (2)
Government Fund: .60% of average daily net assets; and (3)
Corporate Bond and High-Yield Funds: .625% of average daily net
assets. (See "Shareholder Manual - Determining Your Share Price"
in the Prospectus.) From time to time, the Advisor may
voluntarily waive all or a portion of its management fee for a
Fund. The organizational expenses of the High-Yield Fund, which
were $20,316, were advanced by the Advisor and will be reimbursed
by the Fund over a period of not more than 60 months from each
Fund's date of inception.
The following table sets forth certain information
concerning management fees for each Fund for the fiscal year
ended October 31, 1996, the ten-month fiscal year ended October
31, 1995, and for the fiscal years ended December 31, 1994 and
December 31, 1993:
Management Fee
Incurred Management Fee Management Fee
by Fund Waiver Paid by Fund
Short-Term Bond Fund
1993 $6,876,818 $ 659,797 $6,217,021
1994 $8,715,270 $ 0 $8,715,270
1995* $5,395,150 $ 0 $5,395,150
1996 $7,007,561 $ 0 $7,007,561
Government Fund
1993 $ 922,030 $ 205,059 $ 716,971
1994 $ 1,537,259 $ 150,180 $1,387,079
1995* $ 1,709,928 $ 0 $1,709,928
1996 $ 3,378,889 $ 0 $3,778,889
Corporate Bond Fund
1993 $ 724,883 $ 0 $ 724,883
1994 $ 773,759 $ 0 $ 773,759
1995* $ 858,786 $ 0 $ 858,786
1996 $ 1,702,234 $ 0 $1,702,234
High-Yield Fund
1996 $ 423,481 $ 423,481 $ 0
_________________________________________________________
* For the ten-month fiscal year ended October 31, 1995.
Each Advisory Agreement requires the Advisor to reimburse a
Fund in the event that the expenses and charges payable by the
Fund in any fiscal year, including the management fee but
excluding taxes, interest, brokerage commissions, and similar
fees and to the extent permitted extraordinary expenses, exceed
two percent (2%) of the average net asset value of the Fund for
such year, as determined by valuations made as of the close of
each business day of the year. Reimbursement of expenses in
excess of the applicable limitation will be made on a monthly
basis and will be paid to the Fund by reduction of the Advisor's
fee, subject to later adjustment, month by month, for the
remainder of the Fund's fiscal year. The Advisor may from time
to time voluntarily absorb expenses for a Fund in addition to the
reimbursement of expenses in excess of application limitations.
On July 12, 1994, the Securities and Exchange Commission
(the "SEC") filed an administrative action (the "Order") against
the Advisor, Mr. Strong, and another employee of the Advisor in
connection with conduct that occurred between 1987 and early
1990. In re Strong/Corneliuson Capital Management, Inc., et al.
Admin. Proc. File No. 3-8411. The proceeding was settled by
consent without admitting or denying the allegations in the
Order. The Order found that the Advisor and Mr. Strong aided and
abetted violations of Section 17(a) of the 1940 Act by effecting
trades between mutual funds, and between mutual funds and Harbour
Investments Ltd. ("Harbour"), without complying with the
exemptive provisions of SEC Rule 17a-7 or otherwise obtaining an
exemption. It further found that the Advisor violated, and Mr.
Strong aided and abetted violations of, the disclosure provisions
of the 1940 Act and the Investment Advisers Act of 1940 by
misrepresenting the Advisor's policy on personal trading and by
failing to disclose trading by Harbour, an entity in which
principals of the Advisor owned between 18 and 25 percent of the
voting stock. As part of the settlement, the respondents agreed
to a censure and a cease and desist order and the Advisor agreed
to various undertakings, including adoption of certain procedures
and a limitation for six months on accepting certain types of new
advisory clients.
On June 6, 1996, the Department of Labor (the "DOL") filed
an action against the Advisor for equitable relief alleging
violations of the Employee Retirement Income Security Act of 1974
("ERISA") in connection with cross trades that occurred between
1987 and late 1989 involving certain pension accounts managed by
the Advisor. Contemporaneous with this filing, the Advisor,
without admitting or denying the DOL's allegations, agreed to the
entry of a consent judgment resolving all matters relating to the
allegations. Reich v. Strong Capital Management, Inc., (U.S.D.C.
E.D. WI) (the "Consent Judgment"). Under the terms of the
Consent Judgment, the Advisor agreed to reimburse the affected
accounts a total of $5.9 million. The settlement did not have
any material impact on the Advisor's financial position or
operations.
The Funds and the Advisor have adopted a Code of Ethics (the
"Code") which governs the personal trading activities of all
"Access Persons" of the Advisor. Access Persons include every
director and officer of the Advisor and the investment companies
managed by the Advisor, including the Funds, as well as certain
employees of the Advisor who have access to information relating
to the purchase or sale of securities by the Advisor on behalf of
accounts managed by it. The Code is based upon the principal
that such Access Persons have a fiduciary duty to place the
interests of the Funds and the Advisor's other clients ahead of
their own.
The Code requires Access Persons (other than Access Persons
who are independent directors of the investment companies managed
by the Advisor, including the Funds) to, among other things,
preclear their securities transactions (with limited exceptions,
such as transactions in shares of mutual funds, direct
obligations of the U.S. government, and certain options on broad-
based securities market indexes) and to execute such transactions
through the Advisor's trading department. The Code, which applies
to all Access Persons (other than Access Persons who are
independent directors of the investment companies managed by the
Advisor, including the Funds), includes a ban on acquiring any
securities in an initial public offering, other than a new
offering of a registered open-end investment company, and a
prohibition from profiting on short-term trading in securities.
In addition, no Access Person may purchase or sell any security
which is contemporaneously being purchased or sold, or to the
knowledge of the Access Person, is being considered for purchase
or sale, by the Advisor on behalf of any mutual fund or other
account managed by it. Finally, the Code provides for trading
"black out" periods of seven calendar days during which time
Access Persons who are portfolio managers may not trade in
securities which have been purchased or sold by any mutual fund
or other account managed by the portfolio manager.
From time to time the Advisor votes the shares owned by the
Funds according to its Statement of General Proxy Voting Policy
("Proxy Voting Policy"). The general principal of the Proxy
Voting Policy is to vote any beneficial interest in an equity
security prudently and solely in the best long-term economic
interest of the Fund and its beneficiaries considering all
relevant factors and without undue influence from individuals or
groups who may have an economic interest in the outcome of a
proxy vote. Shareholders may obtain a copy of the Proxy Voting
Policy upon request from the Advisor.
The Advisor provides investment advisory services for
multiple clients and may give advice and take action, with
respect to any client, that may differ from the advice given, or
the timing or nature of action taken, with respect to any one
account. However, the Advisor will allocate over a period of
time, to the extent practical, investment opportunities to each
account on a fair and equitable basis relative to other similarly-
situated client accounts. The Advisor, its principals and
associates (to the extent not prohibited by the Code), and other
clients of the Advisor may have, acquire, increase, decrease, or
dispose of securities or interests therein for an account that
are or may be deemed to be inconsistent with the actions taken by
such persons.
Under a Distribution Agreement dated December 1, 1993 with
the Short-Term Bond, Government, and Corporate Bond Funds, and a
Distribution Agreement dated December 27, 1995 for the High-Yield
Fund (the "Distribution Agreements"), Strong Funds Distributors,
Inc. ("Distributor"), a subsidiary of the Advisor, acts as
underwriter of each Fund's shares. The Distribution Agreements
provide that the Distributor will use its best efforts to
distribute the Fund's shares. Since the Funds are "no-load"
funds, no sales commissions are charged on the purchase of Fund
shares. Each Distribution Agreement further provides that the
Distributor will bear the additional costs of printing
Prospectuses and shareholder reports which are used for selling
purposes, as well as advertising and any other costs attributable
to the distribution of a Fund's shares. The Distributor is an
indirect subsidiary of the Advisor and controlled by the Advisor
and Richard S. Strong. Prior to December 1, 1993, the Advisor
acted as underwriter for the Money, Short-Term Bond, Government,
and Corporate Bond Funds. On December 1, 1993, the Distributor
succeeded to the broker-dealer registration of the Advisor and,
in connection therewith, the Distribution Agreements for the
Money, Short-Term Bond, Government, and Corporate Bond Funds were
executed on substantially identical terms as the former
distribution agreements with the Advisor as distributor. The
Distribution Agreements are subject to the same termination and
renewal provisions as are described above with respect to the
Advisory Agreements.
From time to time, the Distributor may hold in-house sales
incentive programs for its associated persons under which these
persons may receive non-cash compensation awards in connection
with the sale and distribution of a Fund's shares. These awards
may include items such as, but not limited to, gifts,
merchandise, gift certificates, and payment of travel expenses,
meals and lodging. As required by the National Association of
Securities Dealers, Inc. or NASD's proposed rule amendments in
this area, any in-house sales incentive program will be multi-
product oriented, i.e., any incentive will be based on an
associated person's gross production of all securities within a
product type and will not be based on the sales of shares of any
specifically designated mutual fund.
PORTFOLIO TRANSACTIONS AND BROKERAGE
The Advisor is responsible for decisions to buy and sell
securities for the Funds and for the placement of the Funds'
portfolio business and the negotiation of the commissions to be
paid on such transactions. It is the policy of the Advisor to
seek the best execution at the best security price available with
respect to each transaction, in light of the overall quality of
brokerage and research services provided to the Advisor or the
Funds. In over-the-counter transactions, orders are placed
directly with a principal market maker unless it is believed that
a better price and execution can be obtained using a broker. The
best price to the Funds means the best net price without regard
to the mix between purchase or sale price and commissions, if
any. In selecting broker-dealers and in negotiating commissions,
the Advisor considers a variety of factors, including best price
and execution, the full range of brokerage services provided by
the broker, as well as its capital strength and stability, and
the quality of the research and research services provided by the
broker. Brokerage will not be allocated based on the sale of any
shares of the Strong Funds.
The Advisor has adopted procedures that provide generally
for the Advisor to seek to bunch orders for the purchase or sale
of the same security for the Fund, other mutual funds managed by
the Advisor, and other advisory clients (collectively, the
"client accounts"). The Advisor will bunch orders when it deems
it to be appropriate and in the best interests of the client
accounts. When a bunched order is filled in its entirety, each
participating client account will participate at the average
share price for the bunched order on the same business day, and
transaction costs shall be shared pro rata based on each client's
participation in the bunched order. When a bunched order is only
partially filled, the securities purchased will be allocated on a
pro rata basis to each client account participating in the
bunched order based upon the initial amount requested for the
account, subject to certain exceptions, and each participating
account will participate at the average share price for the
bunched order on the same business day.
Section 28(e) of the Securities Exchange Act of 1934
("Section 28(e)") permits an investment advisor, under certain
circumstances, to cause an account to pay a broker or dealer a
commission for effecting a transaction in excess of the amount of
commission another broker or dealer would have charged for
effecting the transaction in recognition of the value of the
brokerage and research services provided by the broker or dealer.
Brokerage and research services include (a) furnishing advice as
to the value of securities, the advisability of investing in,
purchasing or selling securities, and the availability of
securities or purchasers or sellers of securities; (b) furnishing
analyses and reports concerning issuers, industries, securities,
economic factors and trends, portfolio strategy, and the
performance of accounts; and (c) effecting securities
transactions and performing functions incidental thereto (such as
clearance, settlement, and custody).
In carrying out the provisions of the Advisory Agreements,
the Advisor may cause the Funds to pay a broker, which provides
brokerage and research services to the Advisor, a commission for
effecting a securities transaction in excess of the amount
another broker would have charged for effecting the transaction.
The Advisor believes it is important to its investment decision-
making process to have access to independent research. The
Advisory Agreements provide that such higher commissions will not
be paid by a Fund unless (a) the Advisor determines in good faith
that the amount is reasonable in relation to the services in
terms of the particular transaction or in terms of the Advisor's
overall responsibilities with respect to the accounts as to which
it exercises investment discretion; (b) such payment is made in
compliance with the provisions of Section 28(e), other applicable
state and federal laws, and the Advisory Agreement; and (c) in
the opinion of the Advisor, the total commissions paid by a Fund
will be reasonable in relation to the benefits to the Fund over
the long term. The investment management fees paid by the Funds
under the Advisory Agreements are not reduced as a result of the
Advisor's receipt of research services.
Generally, research services provided by brokers may include
information on the economy, industries, groups of securities,
individual companies, statistical information, accounting and tax
law interpretations, political developments, legal developments
affecting portfolio securities, technical market action, pricing
and appraisal services, credit analysis, risk measurement
analysis, performance analysis, and analysis of corporate
responsibility issues. Such research services are received
primarily in the form of written reports, telephone contacts, and
personal meetings with security analysts. In addition, such
research services may be provided in the form of access to
various computer-generated data, computer hardware and software,
and meetings arranged with corporate and industry spokespersons,
economists, academicians, and government representatives. In some
cases, research services are generated by third parties but are
provided to the Advisor by or through brokers. Such brokers may
pay for all or a portion of computer hardware and software costs
relating to the pricing of securities.
Where the Advisor itself receives both administrative
benefits and research and brokerage services from the services
provided by brokers, it makes a good faith allocation between the
administrative benefits and the research and brokerage services,
and will pay for any administrative benefits with cash. In making
good faith allocations of costs between administrative benefits
and research and brokerage services, a conflict of interest may
exist by reason of the Advisor's allocation of the costs of such
benefits and services between those that primarily benefit the
Advisor and those that primarily benefit the Funds and other
advisory clients.
From time to time, the Advisor may purchase new issues of
securities for a Fund in a fixed price offering. In these
situations, the seller may be a member of the selling group that
will, in addition to selling the securities to the Funds and
other advisory clients, provide the Advisor with research. The
National Association of Securities Dealers has adopted rules
expressly permitting these types of arrangements under certain
circumstances. Generally, the seller will provide research
"credits" in these situations at a rate that is higher than that
which is available for typical secondary market transactions.
These arrangements may not fall within the safe harbor of Section
28(e).
Each year, the Advisor considers the amount and nature of
research and research services provided by brokers, as well as
the extent to which such services are relied upon, and attempts
to allocate a portion of the brokerage business of the Funds and
other advisory clients on the basis of that consideration. In
addition, brokers may suggest a level of business they would like
to receive in order to continue to provide such services. The
actual brokerage business received by a broker may be more or
less than the suggested allocations, depending upon the Advisor's
evaluation of all applicable considerations.
The Advisor has informal arrangements with various brokers
whereby, in consideration for providing research services and
subject to Section 28(e), the Advisor allocates brokerage to
those firms, provided that their brokerage and research services
were satisfactory to the Advisor and their execution capabilities
were compatible with the Advisor's policy of seeking best
execution at the best security price available, as discussed
above. In no case will the Advisor make binding commitments as
to the level of brokerage commissions it will allocate to a
broker, nor will it commit to pay cash if any informal targets
are not met. The Advisor anticipates it will continue to enter
into such brokerage arrangements.
The Advisor may direct the purchase of securities on behalf
of the Funds and other advisory clients in secondary market
transactions, in public offerings directly from an underwriter,
or in privately negotiated transactions with an issuer. When the
Advisor believes the circumstances so warrant, securities
purchased in public offerings may be resold shortly after
acquisition in the immediate aftermarket for the security in
order to take advantage of price appreciation from the public
offering price or for other reasons. Short-term trading of
securities acquired in public offerings, or otherwise, may result
in higher portfolio turnover and associated brokerage expenses.
The Advisor places portfolio transactions for other advisory
accounts, including other mutual funds managed by the Advisor.
Research services furnished by firms through which the Funds
effect their securities transactions may be used by the Advisor
in servicing all of its accounts; not all of such services may be
used by the Advisor in connection with the Funds. In the opinion
of the Advisor, it is not possible to measure separately the
benefits from research services to each of the accounts
(including the Funds) managed by the Advisor. Because the volume
and nature of the trading activities of the accounts are not
uniform, the amount of commissions in excess of those charged by
another broker paid by each account for brokerage and research
services will vary. However, in the opinion of the Advisor, such
costs to the Funds will not be disproportionate to the benefits
received by the Funds on a continuing basis.
The Advisor seeks to allocate portfolio transactions
equitably whenever concurrent decisions are made to purchase or
sell securities by the Funds and another advisory account. In
some cases, this procedure could have an adverse effect on the
price or the amount of securities available to the Funds. In
making such allocations between a Fund and other advisory
accounts, the main factors considered by the Advisor are the
respective investment objectives, the relative size of portfolio
holdings of the same or comparable securities, the availability
of cash for investment, the size of investment commitments
generally held, and the opinions of the persons responsible for
recommending the investment.
Where consistent with a client's investment objectives,
investment restrictions, and risk tolerance, the Advisor may
purchase securities sold in underwritten public offerings for
client accounts, commonly referred to as "deal" securities. The
Advisor has adopted deal allocation procedures (the
"procedures"), summarized below, that reflect the Advisor's
overriding policy that deal securities must be allocated among
participating client accounts in a fair and equitable manner and
that deal securities may not be allocated in a manner that
unfairly discriminates in favor of certain clients or types of
clients.
The procedures provide that, in determining which client
accounts a portfolio manager team will seek to have purchase deal
securities, the team will consider all relevant factors
including, but not limited to, the nature, size, and expected
allocation to the Advisor of deal securities; the size of the
account(s); the accounts' investment objectives and restrictions;
the risk tolerance of the client; the client's tolerance for
possibly higher portfolio turnover; the amount of commissions
generated by the account during the past year; and the number of
other deals the client has participated in during the past year.
Where more than one of the Advisor portfolio manager team
seeks to have client accounts participate in a deal and the
amount of deal securities allocated to the Advisor by the
underwriting syndicate is less than the aggregate amount ordered
by the Advisor (a "reduced allocation"), the deal securities will
be allocated among the portfolio manager teams based on all
relevant factors. The primary factor shall be assets under
management, although other factors that may be considered in the
allocation decision include, but are not limited to, the nature,
size, and expected Advisor allocation of the deal; the amount of
brokerage commissions or other amounts generated by the
respective participating portfolio manager teams; and which
portfolio manager team is primarily responsible for the Advisor
receiving securities in the deal. Based on the relevant factors,
the Advisor has established general allocation percentages for
its portfolio manager teams, and these percentages are reviewed
on a regular basis to determine whether asset growth or other
factors make it appropriate to use different general allocation
percentages for reduced allocations.
When a portfolio manager team receives a reduced allocation
of deal securities, the portfolio manager team will allocate the
reduced allocation among client accounts in accordance with the
allocation percentages set forth in the team's initial allocation
instructions for the deal securities, except where this would
result in a de minimis allocation to any client account. On a
regular basis, the Advisor reviews the allocation of deal
securities to ensure that they have been allocated in a fair and
equitable manner that does not unfairly discriminate in favor of
certain clients or types of clients.
The following table sets forth certain information
concerning brokerage commissions paid by each Fund for the fiscal
year ended October 31, 1996, the ten-month fiscal year ended
October 31, 1995, and for the fiscal years ended December 31,
1994 and December 31, 1993.
Short-Term Bond Fund Brokerage Commissions
1993 $ 286,000
1994 $ 66,000
1995* $ 1,045,000(1)
1996 $ 174,817
Government Fund
1993 $ 63,000
1994 $ 8,000
1995* $ 153,000
1996 $ 46,170
Corporate Bond Fund
1993 $ 61,000
1994 $ 4,000
1995* $ 101,000
1996 $ 63,034
High-Yield Bond Fund
1996 $ 7,551
* For the ten-month fiscal year ended October 31, 1995.
(1) The Fund paid higher brokerage commissions for the ten-month
fiscal period ended October 31, 1995, due to trading strategies
employed in response to volatile foreign market conditions.
These strategies were designed to help the Fund achieve a high
level of current income in pursuit of its investment objective.
For the fiscal year ended October 31, 1996, the ten-month
fiscal period ending October 31, 1995, and the 1994 fiscal period
ended December 31, the Government and Corporate Bond Funds'
respective portfolio turnover rates were as follows: (1)
Government Fund: 457.6%, 409.2%, and 479.0%; and (2) Corporate
Bond Fund: 672.8%, 621.4%, and 603.0%. For the fiscal year ended
October 31, 1996, the High-Yield Fund's portfolio turnover rate
was 390.8%. The above listed portfolio turnover rates for the
respective Funds were higher than anticipated primarily because
each Fund employed a trading strategy to take advantage of yield
spread opportunities to help enhance the Fund's total return.
As of October 31, 1996, the following Funds had acquired
securities of its regular brokers or dealers (as defined in Rule
10b-1 under the 1940 Act) or their parents in the following
amounts:
Regular Broker or Dealer or Fund/Value of Securities Owned
Parent Issuer as of October 31, 1996
Lehman Brothers Holdings, Inc. Government/$10,562,000
Corporate/$7,291,000
Merrill Lynch, Pierce, Fenner & Smith Government/$726,000
Corporate/$363,000
Short-Term Bond/$2,363,000
Salomon Brothers, Inc. Corporate/$8,100,000
CUSTODIAN
As custodian of each Fund's assets, Firstar Trust Company,
P.O. Box 701, Milwaukee, Wisconsin 53201, has custody of all
securities and cash of the Funds, delivers and receives payment
for securities sold, receives and pays for securities purchased,
collects income from investments, and performs other duties, all
as directed by the officers of the Funds. The custodian and, if
applicable, the sub-custodian are in no way responsible for any
of the investment policies or decisions of the Funds.
TRANSFER AGENT AND DIVIDEND-DISBURSING AGENT
The Advisor acts as transfer agent and dividend-disbursing
agent for the Funds. The Advisor is compensated based on an
annual fee per open account of $31.50, plus out-of-pocket
expenses, such as postage and printing expenses in connection
with shareholder communications. The Advisor also receives an
annual fee per closed account of $4.20 from each Fund. The fees
received and the services provided as transfer agent and dividend
disbursing agent are in addition to those received and provided
by the Advisor under the Advisory Agreement. In addition, the
Advisor provides certain printing and mailing services for the
Funds, such as printing and mailing of shareholder account
statements, checks, and tax forms.
The following table sets forth certain information
concerning amounts paid by each Fund for transfer agency and
dividend disbursing and printing and mailing services for the
fiscal year ended October 31, 1996, the ten-month fiscal year
ended October 31, 1995, and for the fiscal years ended December
31, 1994 and December 31, 1993:
Transfer Agency and Dividend Disbursement
Services Charges Incurred
Per Printing and Amounts Net Amount
Account Out-of-Pocket Mailing Absorbed By Paid By
Fund Charges Expenses Services Advisor Fund
Short-Term Bond Fund
1993 $1,818,354 $503,093 $65,804 $ 0 $2,387,251
1994 $2,550,992 $528,202 $58,057 $ 0 $3,137,251
1995* $1,833,475 $214,821 $32,413 $ 0 $2,080,709
1996 $2,186,020 $185,316 $33,221 $ 0 $2,404,557
Government Fund
1993 $334,277 $76,557 $10,009 $ 0 $420,843
1994 $525,837 $81,183 $9,695 $ 0 $616,715
1995* $541,956 $43,541 $6,796 $ 0 $592,293
1996 $1,010,103 $62,450 $9,379 $ 0 $1,081,932
Corporate Bond Fund
1993 $374,189 $82,743 $11,692 $ 0 $468,624
1994 $389,833 $79,434 $8,512 $ 0 $477,779
1995* $365,802 $39,362 $6,936 $ 0 $412,100
1996 $712,084 $67,332 $8,885 $ 0 $788,301
High-Yield Bond Fund
1996 $82,506 $10,502 $1,161 $94,169 $ 0
__________________________
* For the ten-month fiscal year ended October 31, 1995.
From time to time, the Funds, directly or indirectly through
arrangements with the Advisor, and/or the Advisor may pay amounts
to third parties that provide transfer agent and other
administrative services relating to the Funds to persons who
beneficially own interests in the Funds, such as participants in
401(k) plans. These services may include, among other things,
sub-accounting services, transfer agent type activities,
answering inquiries relating to the Funds, transmitting, on
behalf of the Funds, proxy statements, annual reports, updated
Prospectuses, other communications regarding the Funds, and
related services as the Funds or beneficial owners may reasonably
request. In such cases, the Funds will not pay fees based on the
number of beneficial owners at a rate that is greater than the
rate the Funds are currently paying the Advisor for providing
these services to Fund shareholders.
TAXES
General
As indicated under "About the Funds - Distributions and
Taxes" in the Prospectus, each Fund intends to continue to
qualify annually for treatment as a regulated investment company
("RIC") under the Internal Revenue Code of 1986, as amended (the
"Code"). This qualification does not involve government
supervision of the Funds' management practices or policies.
In order to qualify for treatment as a RIC under the Code,
each Fund must distribute to its shareholders for each taxable
year at least 90% of its investment company taxable income
(consisting generally of net investment income, net short-term
capital gain, and net gains from certain foreign currency
transactions ) ("Distribution Requirement") and must meet several
additional requirements. For each Fund these requirements
include the following: (1) the Fund must derive at least 90% of
its gross income each taxable year from dividends, interest,
payments with respect to securities loans, and gains from the
sale or other disposition of securities or foreign currencies or
other income (including gains from options, futures, or forward
currency contracts) derived with respect to its business of
investing in securities or these currencies ("Income
Requirement"); (2) the Fund must derive less than 30% of its
gross income each taxable year from the sale or other disposition
of securities, or options or futures (other than those on foreign
currencies), or foreign currencies (or options, futures, or
forward contracts thereon) that are not directly related to the
Fund's principal business of investing in securities (or options
and futures with respect to securities) that were held for less
than three months ("30% Limitation"); (3) at the close of each
quarter of a Fund's taxable year, at least 50% of the value of
its total assets must be represented by cash and cash items, U.S.
government securities, securities of other RICs, and other
securities, with these other securities limited, in respect of
any one issuer, to an amount that does not exceed 5% of the value
of the Fund's total assets and that does not represent more than
10% of the issuer's outstanding voting securities; and (4) at the
close of each quarter of the Fund's taxable year, not more than
25% of the value of its total assets may be invested in
securities (other than U.S. government securities or the
securities of other RICs) of any one issuer. From time to time
the Advisor may find it necessary to make certain types of
investments for the purpose of ensuring that the Fund continues
to qualify for treatment as a RIC under the Code.
If Fund shares are sold at a loss after being held for six
months or less, the loss will be treated as long-term, instead of
short-term, capital loss to the extent of any capital gain
distributions received on those shares.
Each Fund will be subject to a nondeductible 4% excise tax
("Excise Tax") to the extent it fails to distribute by the end of
any calendar year substantially all of its ordinary income for
that year and capital gain net income for the one-year period
ending on October 31 of that year, plus certain other amounts.
Foreign Transactions
Interest and dividends received by a Fund may be subject to
income, withholding, or other taxes imposed by foreign countries
and U.S. possessions that would reduce the yield on its
securities. Tax conventions between certain countries and the
United States may reduce or eliminate these foreign taxes,
however, and many foreign countries do not impose taxes on
capital gains in respect of investments by foreign investors.
Each Fund maintains its accounts and calculates its income
in U.S. dollars. In general, gain or loss (1) from the
disposition of foreign currencies and forward currency contracts,
(2) from the disposition of foreign-currency-denominated debt
securities that are attributable to fluctuations in exchange
rates between the date the securities are acquired and their
disposition date, and (3) attributable to fluctuations in
exchange rates between the time a Fund accrues interest or other
receivables or expenses or other liabilities denominated in a
foreign currency and the time the Fund actually collects those
receivables or pays those liabilities, will be treated as
ordinary income or loss. A foreign-currency-denominated debt
security acquired by a Fund may bear interest at a high normal
rate that takes into account expected decreases in the value of
the principal amount of the security due to anticipated currency
devaluations; in that case, the Fund would be required to include
the interest in income as it accrues but generally would realize
a currency loss with respect to the principal only when the
principal was received (through disposition or upon maturity).
Derivative Instruments
The use of derivatives strategies, such as purchasing and
selling (writing) options and futures and entering into forward
currency contracts, involves complex rules that will determine
for income tax purposes the character and timing of recognition
of the gains and losses the Funds realize in connection
therewith. Gains from the disposition of foreign currencies
(except certain gains therefrom that may be executed by future
regulations), and income from transactions in options, futures,
and forward currency contracts derived by a Fund with respect to
its business of investing in securities or foreign currencies,
will qualify as permissible income under the Income Requirement.
However, income from the disposition of options and futures
(other than those on foreign currencies) will be subject to the
30% Limitation if they are held for less than three months.
Income from the disposition of foreign currencies, and options,
futures, and forward contracts on foreign currencies that are not
directly related to a Fund's principal business of investing in
securities (or options and futures with respect to securities)
also will be subject to the 30% Limitation if they are held for
less than three months.
If a Fund satisfies certain requirements, any increase in
value of a position that is part of a "designated hedge" will be
offset by any decrease in value (whether realized or not) of the
offsetting hedging position during the period of the hedge for
purposes of determining whether the Fund satisfies the 30%
Limitation. Thus, only the net gain (if any) from the designated
hedge will be included in gross income for purposes of that
limitation. The Funds intend that, when they engage in hedging
strategies, the hedging transactions will qualify for this
treatment, but at the present time it is not clear whether this
treatment will be available for all of the Funds' hedging
transactions. To the extent this treatment is not available or
is not elected by a Fund, it may be forced to defer the closing
out of certain options, futures, or forward currency contracts
beyond the time when it otherwise would be advantageous to do so,
in order for the Fund to continue to qualify as a RIC.
For federal income tax purposes, each Fund is required to
recognize as income for each taxable year its net unrealized
gains and losses on options, futures, or forward currency
contracts that are subject to section 1256 of the Code ("Section
1256 Contracts") and are held by the Fund as of the end of the
year, as well as gains and losses on Section 1256 Contracts
actually realized during the year. Except for Section 1256
Contracts that are part of a "mixed straddle" and with respect to
which a Fund makes a certain election, any gain or loss
recognized with respect to Section 1256 Contracts is considered
to be 60% long-term capital gain or loss and 40% short-term
capital gain or loss, without regard to the holding period of the
Section 1256 Contract. Unrealized gains on Section 1256
Contracts that have been held by a Fund for less than three
months as of the end of its taxable year, and that are recognized
for federal income tax purposes as described above, will not be
considered gains on investments held for less than three months
for purposes of the 30% Limitation.
Zero-Coupon, Step-Coupon, and Pay-in-Kind Securities
Certain Funds may acquire zero-coupon, step-coupon, or other
securities issued with original issue discount. As a holder of
those securities, a Fund must include in its income the original
issue discount that accrues on the securities during the taxable
year, even if the Fund receives no corresponding payment on the
securities during the year. Similarly, a Fund must include in
its income securities it receives as "interest" on pay-in-kind
securities. Because a Fund annually must distribute
substantially all of its investment company taxable income,
including any original issue discount and other non-cash income,
to satisfy the Distribution Requirement and avoid imposition of
the Excise Tax, it may be required in a particular year to
distribute as a dividend an amount that is greater than the total
amount of cash it actually receives. Those distributions may be
made from the proceeds on sales of portfolio securities, if
necessary. A Fund may realize capital gains or losses from those
sales, which would increase or decrease its investment company
taxable income or net capital gain, or both. In addition, any
such gains may be realized on the disposition of securities held
for less than three months. Because of the 30% Limitation, any
such gains would reduce the Fund's ability to sell other
securities, or certain options, or futures, or forward currency
contracts, held for less that three months that it might wish to
sell in the ordinary course of its portfolio management.
The foregoing federal tax discussion as well as the tax
discussion contained within the Prospectus under "About the Funds
- - Distributions and Taxes" is intended to provide you with an
overview of the impact of federal income tax provisions on each
Fund or its shareholders. These tax provisions are subject to
change by legislative or administrative action at the federal,
state, or local level, and any changes may be applied
retroactively. Any such action that limits or restricts each
Fund's current ability to pass-through earnings without taxation
at the Fund level, or otherwise materially changes a Fund's tax
treatment, could adversely affect the value of a shareholder's
investment in a Fund. Because each Fund's taxes are a complex
matter, you should consult your tax adviser for more detailed
information concerning the taxation of a Fund and the federal,
state, and local tax consequences to shareholders of an
investment in a Fund.
DETERMINATION OF NET ASSET VALUE
As set forth in the Prospectus under the caption
"Shareholder Manual - Determining Your Share Price," the net
asset value of each Fund will be determined as of the close of
trading on each day the New York Stock Exchange (the "NYSE") is
open for trading. The New York Stock Exchange is open for trading
Monday through Friday except New Year's Day, Presidents' Day,
Good Friday, Memorial Day, Independence Day, Labor Day,
Thanksgiving Day, and Christmas Day. Additionally, if any of the
aforementioned holidays falls on a Saturday, the NYSE will not be
open for trading on the preceding Friday, and when any such
holiday falls on a Sunday, the NYSE will not be open for trading
on the succeeding Monday, unless unusual business conditions
exist, such as the ending of a monthly or yearly accounting
period.
ADDITIONAL SHAREHOLDER INFORMATION
Telephone Exchange and Redemption Privileges
The Funds employ reasonable procedures to confirm that
instructions communicated by telephone are genuine. The Funds may
not be liable for losses due to unauthorized or fraudulent
instructions. Such procedures include but are not limited to
requiring a form of personal identification prior to acting on
instructions received by telephone, providing written
confirmations of such transactions to the address of record, and
tape recording telephone instructions.
Redemption-in-Kind
The Funds have elected to be governed by Rule 18f-1 under
the 1940 Act, which obligates each Fund to redeem shares in cash,
with respect to any one shareholder during any 90-day period, up
to the lesser of $250,000 or 1% of the assets of the Fund. If
the Advisor determines that existing conditions make cash
payments undesirable, redemption payments may be made in whole or
in part in securities or other financial assets, valued for this
purpose as they are valued in computing the NAV for the Fund's
shares (a "redemption-in-kind"). Shareholders receiving
securities or other financial assets in a redemption-in-kind may
realize a gain or loss for tax purposes, and will incur any costs
of sale, as well as the associated inconveniences. If you expect
to make a redemption in excess of the lesser of $250,000 or 1% of
the Fund's assets during any 90-day period and would like to
avoid any possibility of being paid with securities in-kind, you
may do so by providing Strong Funds with an unconditional
instruction to redeem at least 15 calendar days prior to the date
on which the redemption transaction is to occur, specifying the
dollar amount or number of shares to be redeemed and the date of
the transaction (please call 1-800-368-3863). This will provide
the Fund with sufficient time to raise the cash in an orderly
manner to pay the redemption and thereby minimize the effect of
the redemption on the interests of the Fund's remaining
shareholders. Redemption checks in excess of the lesser of
$250,000 or 1% of the Fund's assets during any 90-day period may
not be honored by the Fund if the Advisor determines that
existing conditions make cash payments undesirable.
Retirement Plans
Individual Retirement Account (IRA): Everyone under age 70 1/2
with earned income may contribute to a tax-deferred IRA. The
Strong Funds offer a prototype plan for you to establish your own
IRA. You are allowed to contribute up to the lesser of $2,000 or
100% of your earned income each year to your IRA (or up to $4,000
between your IRA and your non-working spouses' IRA). Under
certain circumstances, your contribution will be deductible.
Direct Rollover IRA: To avoid the mandatory 20% federal
withholding tax on distributions, you must transfer the
qualified retirement or Code section 403(b) plan distribution
directly into an IRA. The distribution must be eligible for
rollover. The amount of your Direct Rollover IRA contribution
will not be included in your taxable income for the year.
Simplified Employee Pension Plan (SEP-IRA): A SEP-IRA plan allows
an employer to make deductible contributions to separate IRA
accounts established for each eligible employee.
Salary Reduction Simplified Employee Pension Plan (SAR SEP-IRA):
A SAR SEP-IRA plan is a type of SEP-IRA plan in which an employer
may allow employees to defer part of their salaries and
contribute to an IRA account. These deferrals help lower the
employees' taxable income. Please note that you may no longer
open new SAR SEP-IRA plans (since December 31, 1996). However,
employers with SAR SEP-IRA plans that were established prior to
January 31, 1997 may still open accounts for new employees.
Simplified Incentive Match Plan for Employees (SIMPLE-IRA): A
SIMPLE-IRA plan is a retirement savings plan that allows
employees to contribute a percentage of their compensation, up to
$6,000, on a pre-tax basis, to a SIMPLE-IRA account. The
employer is required to make annual contributions to eligible
employees' accounts. All contributions grow tax-deferred.
Defined Contribution Plan: A defined contribution plan allows
self-employed individuals, partners, or a corporation to provide
retirement benefits for themselves and their employees. Plan
types include: profit-sharing plans, money purchase pension
plans, and paired plans (a combination of a profit-sharing plan
and a money purchase plan).
401(k) Plan: A 401(k) plan is a type of profit-sharing plan that
allows employees to have part of their salary contributed on a
pre-tax basis to a retirement plan which will earn tax-deferred
income. A 401(k) plan is funded by employee contributions,
employer contributions, or a combination of both.
403(b)(7) Plan: A tax-sheltered custodial account designed to
qualify under section 403(b)(7) of the Code is available for use
by employees of certain educational, non-profit, hospital, and
charitable organizations.
FUND ORGANIZATION
Each Corporation was organized on the following dates and
currently has the following authorized shares of capital stock:
Date
Incorporation Series Authorized Par
Corporation Date Created Shares Value ($)
Strong Corporate Bond 07/19/85 Indefinite .001
Fund, Inc.(1)
Strong Government 08/08/86 Indefinite .001
Securities Fund, Inc.
Strong Income Funds, 02/24/89 Indefinite .00001
Inc.(2)
- Strong High-Yield 10/27/95 Indefinite .00001
Bond Fund
Strong Short-Term Bond 03/20/87 Indefinite .001
Fund, Inc.
(1) Prior to April 17, 1995, the Fund's name was Strong Income Fund, Inc.
(2) Prior to April 17, 1995, the Fund's name was Strong U.S. Treasury
Money Fund, Inc.
The Short-Term Bond, Government, and Corporate Bond Funds
are Wisconsin corporations (each a "Corporation") that are
authorized to offer separate series of shares representing
interests in separate portfolios of securities, each with
differing investment objectives. The High-Yield Fund is a series
of common stock of Strong Income Funds, Inc., a Wisconsin
corporation (a "Corporation") that is authorized to offer
separate series of shares representing interests in separate
portfolios of securities, each with differing objectives. The
shares in any one portfolio may, in turn, be offered in separate
classes, each with differing preferences, limitations or relative
rights. However, the Articles of Incorporation for each of the
Corporations provides that if additional classes of shares are
issued by a Corporation, such new classes of shares may not
affect the preferences, limitations or relative rights of the
Corporation's outstanding shares. In addition, the Board of
Directors of each Corporation is authorized to allocate assets,
liabilities, income and expenses to each series and class.
Classes within a series may have different expense arrangements
than other classes of the same series and, accordingly, the net
asset value of shares within a series may differ. Finally, all
holders of shares of a Corporation may vote on each matter
presented to shareholders for action except with respect to any
matter which affects only one or more series or class, in which
case only the shares of the affected series or class are entitled
to vote. Fractional shares have the same rights proportionately
as do full shares. Shares of the Corporation have no preemptive,
conversion, or subscription rights. If a Corporation issues
additional series, the assets belonging to each series of shares
will be held separately by the custodian, and in effect each
series will be a separate fund.
SHAREHOLDER MEETINGS
The Wisconsin Business Corporation Law permits registered
investment companies, such as the Corporations, to operate
without an annual meeting of shareholders under specified
circumstances if an annual meeting is not required by the 1940
Act. Each Corporation has adopted the appropriate provisions in
their Bylaws and may, at their discretion, not hold an annual
meeting in any year in which the election of directors is not
required to be acted on by shareholders under the 1940 Act.
Each Corporation's Bylaws allow for a director to be removed
by its shareholders with or without cause, only at a meeting
called for the purpose of removing the director. Upon the written
request of the holders of shares entitled to not less than ten
percent (10%) of all the votes entitled to be cast at such
meeting, the Secretary of the Corporation shall promptly call a
special meeting of shareholders for the purpose of voting upon
the question of removal of any director. The Secretary of the
Corporation shall inform such shareholders of the reasonable
estimated costs of preparing and mailing the notice of the
meeting, and upon payment to the Corporation of such costs, the
Corporation shall give not less than ten nor more than sixty days
notice of the special meeting.
PERFORMANCE INFORMATION
As described in the "About the Funds - Performance
Information" section of the Funds' Prospectus, each Fund's
historical performance or return may be shown in the form of
"yield." In addition, each Funds' performance may be shown in
the form of "average annual total return," "total return," and
"cumulative total return," and the Money Fund's performance may
be shown in the form of "effective yield." From time to time,
the advisor agrees to waive or reduce its management fee and to
absorb certain operating expenses for a Fund. Without these
waivers and absorptions, the performance results for the Funds
noted herein would have been lower. All performance and returns
noted herein are historical and do not represent the future
performance of a Fund.
Yield
Each Fund's yield is computed in accordance with a
standardized method prescribed by rules of the SEC. Under that
method, the current yield quotation for a Fund is based on a one
month or 30-day period. The yield is computed by dividing the
net investment income per share earned during the 30-day or one
month period by the maximum offering price per share on the last
day of the period, according to the following formula:
YIELD = 2[( a-b + 1)6 - 1]
---
cd
Where: a = dividends and interest earned during the period.
b = expenses accrued for the period (net of
reimbursements).
c = the average daily number of shares outstanding
during the period that were entitled to receive dividends.
d = the maximum offering price per share on the last
day of the period.
For the 30-day period ended October 31, 1996, the Short-Term
Bond Fund's yield was 7.23%, the Government Fund's yield was
6.62%, the Corporate Bond Fund's yield was 7.10%, and the High-
Yield Fund's yield was 10.33%. In computing yield, the Funds
follow certain standardized accounting practice specified by SEC
rules. During this period, the Advisor waived management fees of
.625% and absorbed expenses of .185% for the High-Yield Fund.
Without this waiver and absorption, the High-Yield Fund's yield
would have been 9.52%. These practices are not necessarily
consistent with those that the Funds use to prepare annual and
interim financial statements in conformity with generally
accepted accounting principles.
Distribution Rate
The distribution rate is computed, according to a non-
standardized formula, by dividing the total amount of actual
distributions per share paid by a Fund over a twelve month period
by the Fund's net asset value on the last day of the period. The
distribution rate differs from a Fund's yield because the
distribution rate includes distributions to shareholders from
sources other than dividends and interest, such as premium income
from option writing and short-term capital gains. Therefore, a
Fund's distribution rate may be substantially different than its
yield. Both a Fund's yield and distribution rate will fluctuate.
Average Annual Total Return
Each Fund's average annual total return quotation is
computed in accordance with a standardized method prescribed by
rules of the SEC. The average annual total return for a Fund for
a specific period is found by first taking a hypothetical $10,000
investment ("initial investment") in the Fund's shares on the
first day of the period and computing the "redeemable value" of
that investment at the end of the period. The redeemable value
is then divided by the initial investment, and this quotient is
taken to the Nth root (N representing the number of years in the
period) and 1 is subtracted from the result, which is then
expressed as a percentage. The calculation assumes that all
income and capital gains dividends paid by the Fund have been
reinvested at net asset value on the reinvestment dates during
the period. Average annual total return figures for various
periods are set forth in the table below.
Total Return
Calculation of each Fund's total return is not subject to a
standardized formula. Total return performance for a specific
period is calculated by first taking an investment (assumed below
to be $10,000) ("initial investment") in the Fund's shares on the
first day of the period and computing the "ending value" of that
investment at the end of the period. The total return percentage
is then determined by subtracting the initial investment from the
ending value and dividing the remainder by the initial investment
and expressing the result as a percentage. The calculation
assumes that all income and capital gains dividends paid by the
Fund have been reinvested at net asset value on the reinvestment
dates during the period. Total return may also be shown as the
increased dollar value of the hypothetical investment over the
period. Total return figures for various periods are set forth
in the table below.
Cumulative Total Return
Calculation of each Fund's cumulative total return is not
subject to a standardized formula and represents the simple
change in value of our investment over a stated period and may be
quoted as a percentage or as a dollar amount. Total returns and
cumulative total returns may be broken down into their components
of income and capital (including capital gains and changes in
share price) in order to illustrate the relationship between
these factors and their contributions to total return.
A Fund's performance figures are based upon historical
results and do not represent future results. Each Fund's shares
are sold at net asset value per share. The Short-Term Bond,
Government, Corporate Bond, and High-Yield Fund's returns and net
asset value will fluctuate and shares are redeemable at the then
current net asset value of the Fund, which may be more or less
than original cost. Factors affecting a Fund's performance
include general market conditions, operating expenses and
investment management. Any additional fees charged by a dealer
or other financial services firm would reduce the returns
described in this section.
The figures below show performance information for various
periods ended October 31, 1996. No adjustment has been made for
taxes, if any, payable on dividends. Securities prices
fluctuated during these periods.
Short-Term Bond Fund
Total Average Annual
Return Total Return
Initial
$10,000 Ending Value Percentage Percentage
Investment October 31, 1996 Increase Increase
Life of Fund(1) $10,000 $20,034 100.34% 7.87%
Five Years $10,000 $13,968 39.68% 6.91%
One Year $10,000 $10,707 7.07% 7.07%
_______________________
(1) Commenced operations on August 31, 1987.
Government Fund
Total Average Annual
Return Total Return
Initial
$10,000 Ending Value Percentage Percentage
Investment October 31, 1996 Increase Increase
Life of Fund(1) $10,000 $23,544 135.44% 8.93%
Ten Years $10,000 $23,510 135.10% 8.92%
Five Years $10,000 $15,203 52.03% 8.74%
One Year $10,000 $10,460 4.60% 4.60%
________________________
(1) Commenced operations on October 29, 1986.
Corporate Bond Fund
Total Average Annual
Return Total Return
Initial
$10,000 Ending Value Percentage Percentage
Investment October 31, 1996 Increase Increase
Life of Fund(1) $10,000 $27,858 178.58% 9.87%
Ten Years $10,000 $21,006 110.06% 7.70%
Five Years $10,000 $16,935 69.35% 11.11%
One Year $10,000 $10,798 7.98% 7.98%
________________________
(1) Commenced operations on December 12, 1985.
High-Yield Bond Fund
Total Average Annual
Return Total Return
Initial
$10,000 Ending Value Percentage Percentage
Investment October 31, 1996 Increase Increase
Life of Fund(1) $10,000 $12,166 21.66% 21.66%
________________________
(1) Commenced operations on December 30, 1995.
The Short-Term Bond, Government, Corporate Bond, and High-
Yield Funds' total return for the three months ending January 31,
1997, were 2.33%, 1.87%, 2.74% and 6.41%, respectively.
Comparisons
(1) U.S. Treasury Bills, Notes, or Bonds
Investors may want to compare the performance of a Fund to
that of U.S. Treasury bills, notes or bonds, which are issued by
the U.S. government. Treasury obligations are issued in selected
denominations. Rates of Treasury obligations are fixed at the
time of issuance and payment of principal and interest is backed
by the full faith and credit of the United States Treasury. The
market value of such instruments will generally fluctuate
inversely with interest rates prior to maturity and will equal
par value at maturity. Generally, the values of obligations with
shorter maturities will fluctuate less than those with longer
maturities.
(2) Certificates of Deposit
Investors may want to compare a Fund's performance to that
of certificates of deposit offered by banks and other depositary
institutions. Certificates of deposit may offer fixed or
variable interest rates and principal is guaranteed and may be
insured. Withdrawal of the deposits prior to maturity normally
will be subject to a penalty. Rates offered by banks and other
depositary institutions are subject to change at any time
specified by the issuing institution.
(3) Money Market Funds
Investors may also want to compare performance of a Fund to
that of money market funds. Money market fund yields will
fluctuate and shares are not insured, but share values usually
remain stable.
(4) Lipper Analytical Services, Inc. ("Lipper") and Other
Independent Ranking Organizations
From time to time, in marketing and other fund literature, a
Fund's performance may be compared to the performance of other
mutual funds in general or to the performance of particular types
of mutual funds, with similar investment goals, as tracked by
independent organizations. Among these organizations, Lipper, a
widely used independent research firm which ranks mutual funds by
overall performance, investment objectives, and assets, may be
cited. Lipper performance figures are based on changes in net
asset value, with all income and capital gain dividends
reinvested. Such calculations do not include the effect of any
sales charges imposed by other funds. A Fund will be compared to
Lipper's appropriate fund category, that is, by fund objective
and portfolio holdings. A Fund's performance may also be
compared to the average performance of its Lipper category.
(5) Morningstar, Inc.
A Fund's performance may also be compared to the performance
of other mutual funds by Morningstar, Inc. which rates funds on
the basis of historical risk and total return. Morningstar's
ratings range from five stars (highest) to one star (lowest) and
represent Morningstar's assessment of the historical risk level
and total return of a fund as a weighted average for 3, 5, and 10
year periods. Ratings are not absolute and do not represent
future results.
(6) Independent Sources
Evaluations of Fund performance made by independent sources
may also be used in advertisements concerning a Fund, including
reprints of, or selections from, editorials or articles about a
Fund, especially those with similar objectives. Sources for Fund
performance information and articles about a Fund may include
publications such as Money, Forbes, Kiplinger's, Smart Money,
Morningstar, Inc., Financial World, Business Week, U.S. News and
World Report, The Wall Street Journal, Barron's, and a variety of
investment newsletters.
(7) Various Bank Products
Each Fund's performance also may be compared on a before or
after-tax basis to various bank products, including the average
rate of bank and thrift institution money market deposit
accounts, Super N.O.W. accounts and certificates of deposit of
various maturities as reported in the Bank Rate Monitor, National
Index of 100 leading banks, and thrift institutions as published
by the Bank Rate Monitor, Miami Beach, Florida. The rates
published by the Bank Rate Monitor National Index are averages of
the personal account rates offered on the Wednesday prior to the
date of publication by 100 large banks and thrifts in the top ten
Consolidated Standard Metropolitan Statistical Areas. The rates
provided for the bank accounts assume no compounding and are for
the lowest minimum deposit required to open an account. Higher
rates may be available for larger deposits.
With respect to money market deposit accounts and Super
N.O.W. accounts, account minimums range upward from $2,000 in
each institution and compounding methods vary. Super N.O.W.
accounts generally offer unlimited check writing while money
market deposit accounts generally restrict the number of checks
that may be written. If more than one rate is offered, the
lowest rate is used. Rates are determined by the financial
institution and are subject to change at any time specified by
the institution. Generally, the rates offered for these products
take market conditions and competitive product yields into
consideration when set. Bank products represent a taxable
alternative income producing product. Bank and thrift
institution deposit accounts may be insured. Shareholder
accounts in the Fund are not insured. Bank passbook savings
accounts compete with money market mutual fund products with
respect to certain liquidity features but may not offer all of
the features available from a money market mutual fund, such as
check writing. Bank passbook savings accounts normally offer a
fixed rate of interest while the yield of the Fund fluctuates.
Bank checking accounts normally do not pay interest but compete
with money market mutual fund products with respect to certain
liquidity features (e.g., the ability to write checks against the
account). Bank certificates of deposit may offer fixed or
variable rates for a set term. (Normally, a variety of terms are
available.) Withdrawal of these deposits prior to maturity will
normally be subject to a penalty. In contrast, shares of each
Fund are redeemable at the net asset value (normally, $1.00 per
share) next determined after a request is received, without
charge.
(8) Indices
The Funds may compare their performance to a wide variety of
indices including the following:
(a) The Consumer Price Index
(b) Merrill Lynch 91 Day Treasury Bill Index
(c) Merrill Lynch Government/Corporate 1-3 Year Index
(d) IBC/Donoghue's General Purpose Money Fund AverageTM
(e) IBC/Donoghue's Taxable Money Fund AverageTM
(f) IBC/Donoghue's Government Money Fund AverageTM
(g) Salomon Brothers 1-Month Treasury Bill Index
(h) Salomon Brothers 3-Month Treasury Bill Index
(i) Salomon Brothers 1-Year Treasury Benchmark-on-the-Run Index
(j) Salomon Brothers 1-3 Year Treasury/Government-
Sponsored/Corporate Bond Index
(k) Salomon Brothers Corporate Bond Index
(l) Salomon Brothers AAA, AA, A, BBB, and BB Corporate Bond Indexes
(m) Salomon Brothers Broad Investment-Grade Bond Index
(n) Salomon Brothers High-Yield BBB Index
(o) Lehman Brothers Aggregate Bond Index
(p) Lehman Brothers 1-3 Year Government/Corporate Bond Index
(q) Lehman Brothers Intermediate Government/Corporate Bond Index
(r) Lehman Brothers Intermediate AAA, AA, and A Corporate Bond Indexes
(s) Lehman Brothers Government/Corporate Bond Index
(t) Lehman Brothers Corporate Baa Index
(u) Lehman Brothers Intermediate Corporate Baa Index
(v) Lehman Brothers High-Yield Index
There are differences and similarities between the
investments which a Fund may purchase and the investments
measured by the indices which are noted herein. The market
prices and yields of taxable and tax-exempt bonds will fluctuate.
There are important differences among the various investments
included in the indices that should be considered in reviewing
this information.
(9) Historical Asset Class Returns
From time to time, marketing materials may portray the
historical returns of various asset classes. Such presentations
will typically compare the average annual rates of return of
inflation, U.S. Treasury bills, bonds, common stocks, and small
stocks. There are important differences between each of these
investments that should be considered in viewing any such
comparison. The market value of stocks will fluctuate with
market conditions, and small-stock prices generally will
fluctuate more than large-stock prices. Stocks are generally more
volatile than bonds. In return for this volatility, stocks have
generally performed better than bonds or cash over time. Bond
prices generally will fluctuate inversely with interest rates and
other market conditions, and the prices of bonds with longer
maturities generally will fluctuate more than those of shorter-
maturity bonds. Interest rates for bonds may be fixed at the time
of issuance, and payment of principal and interest may be
guaranteed by the issuer and, in the case of U.S. Treasury
obligations, backed by the full faith and credit of the U.S.
Treasury.
(10) Strong Family of Funds
The Strong Family of Funds offers a comprehensive range of
conservative to aggressive investment options. All of the members
of the Strong Family and their investment objectives are listed
below. The Funds are listed in ascending order of risk and
return, as determined by the Funds' Advisor.
Fund Name Investment Objective
Strong Money Market Current income, a stable share price, and
Fund daily liquidity.
Strong Heritage Current income, a stable share price, and
Money Fund daily liquidity.
Strong Municipal Federally tax-exempt current income, a
Money Market Fund stable share-price, and daily liquidity.
Strong Municipal Federally tax-exempt current income with a
Advantage Fund very low degree of share-price fluctuation.
Strong Advantage Current income with a very low degree of
Fund share-price fluctuation.
Strong Short-Term Total return by investing for a high level
Municipal Bond Fund of federally tax-exempt current income
with a low degree of share-price fluctuation.
Strong Short-Term Total return by investing for a high level
Bond Fund of current income with a low degree of
share-price fluctuation.
Strong Short-Term Total return by investing for a high level
Global Bond Fund of income with a low degree of share-price
fluctuation.
Strong Government Total return by investing for a high level
Securities Fund of current income with a moderate degree
of share-price fluctuation.
Strong Municipal Total return by investing for a high level
Bond Fund of federally tax-exempt current income
with a moderate degree of share-price
fluctuation.
Strong Corporate Total return by investing for a high level
Bond Fund of current income with a moderate degree
of share-price fluctuation.
Strong High-Yield Total return by investing for a high level
Municipal Bond Fund of federally tax-exempt current income.
Strong High-Yield Total return by investing for a high level
Bond Fund of current income and capital growth.
Strong High total return by investing for both
International Bond Fund income and capital appreciation.
Strong Asset High total return consistent with
Allocation Fund reasonable risk over the long term.
Strong Equity Total return by investing for both income
Income Fund and capital growth.
Strong American Total return by investing for both income
Utilities Fund and capital growth.
Strong Total Return High total return by investing for capital
Fund growth and income.
Strong Growth and High total return by investing for capital
Income Fund growth and income.
Strong Schafer Long-term capital appreciation principally
Value Fund through investment in common stocks and
other equity securities. Current income
is a secondary objective.
Strong Value Fund Capital growth.
Strong Opportunity Fund Capital growth.
Strong Growth Fund Capital growth.
Strong Mid Cap Fund Capital growth.
Strong Common Stock Fund* Capital growth.
Strong Small Cap Fund Capital growth.
Strong Discovery Fund Capital growth.
Strong International Capital growth.
Stock Fund
Strong Asia Pacific Fund Capital growth.
* The Fund is closed to new investors, except the Fund may
continue to offer its shares through certain 401(k) plans and
similar company-sponsored retirement plans.
The Advisor also serves as Advisor or Subadvisor to several
management investment companies, some of which fund variable
annuity separate accounts of certain insurance companies.
Each Fund may from time to time be compared to the other
funds in the Strong Family of Funds based on a risk/reward
spectrum. In general, the amount of risk associated with any
investment product is commensurate with that product's potential
level of reward. The Strong Funds risk/reward continuum or any
Fund's position on the continuum may be described or diagrammed
in marketing materials. The Strong Funds risk/reward continuum
positions the risk and reward potential of each Strong Fund
relative to the other Strong Funds, but is not intended to
position any Strong Fund relative to other mutual funds or
investment products. Marketing materials may also discuss the
relationship between risk and reward as it relates to an
individual investor's portfolio.
Financial goals vary from person to person. You may choose
one or more of the Strong Funds to help you reach your financial
goals. To help you better understand the Strong Income Funds and
determine which Fund or combination of Funds best meets your
personal investment objectives, they are described in the same
Prospectus.
(10) Tying Time Frames to Your Goals
There are many issues to consider as you make your
investment decisions, including analyzing your risk tolerance,
investing experience, and asset allocations. You should start to
organize your investments by learning to link your many financial
goals to specific time frames. Then you can begin to identify
the appropriate types of investments to help meet your goals. As
a general rule of thumb, the longer your time horizon, the more
price fluctuation you will be able to tolerate in pursuit of
higher returns. For that reason, many people with longer-term
goals select stocks or long-term bonds, and many people with
nearer-term goals match those up with for instance, short-term
bonds. The Advisor developed the following suggested holding
periods to help our investors set realistic expectations for both
the risk and reward potential of our funds. (See table below.)
Of course, time is just one element to consider when making your
investment decision.
Strong Funds Suggested Minimum Holding Periods
Under 1 Year 1 to 2 Years 4 to 7 Years 5 or More Years
Money Market Fund Advantage Fund Government Total Return Fund
Heritage Money Fund Municipal Advantage Securities Fund Opportunity Fund
Municipal Money Fund Municipal Bond Growth Fund
Market Fund Fund Common Stock Fund*
Corporate Bond Discovery Fund
2 to 4 Years Fund International Stock
International Fund
Short-Term Bond Fund Bond Fund Asia Pacific Fund
Short-Term Municipal Bond Fund High-Yield Value Fund
Short-Term Global Bond Fund Municipal Bond Small Cap Fund
Fund Growth and
Asset Allocation Income Fund
Fund Mid Cap Fund
American Schafer Value Fund
Utilities Fund
High-Yield Bond
Fund
Equity Income Fund
* This Fund is closed to new investors, except the Fund may continue to
offer its shares through certain 401(k) plans and similar company-sponsored
retirement plans.
Additional Fund Information
(1) Duration
Duration is a calculation that seeks to measure the price
sensitivity of a bond or a bond fund to changes in interest
rates. It measures bond price sensitivity to interest rate
changes by taking into account the time value of cash flows
generated over the bond's life. Future interest and principal
payments are discounted to reflect their present value and then
are multiplied by the number of years they will be received to
produce a value that is expressed in years. Since duration can
also be computed for the Funds, you can estimate the effect of
interest rates on a Fund's share price. Simply multiply the
Fund's duration by an expected change in interest rates. For
example, the price of a Fund with a duration of two years would
be expected to fall approximately two percent if market interest
rates rose by one percentage point.
(2) Portfolio Characteristics
In order to present a more complete picture of a Fund's
portfolio, marketing materials may include various actual or
estimated portfolio characteristics, including but not limited to
median market capitalizations, earnings per share, alphas, betas,
price/earnings ratios, returns on equity, dividend yields,
capitalization ranges, growth rates, price/book ratios, top
holdings, sector breakdowns, asset allocations, quality
breakdowns, and breakdowns by geographic region.
(3) Measures of Volatility and Relative Performance
Occasionally statistics may be used to specify Fund
volatility or risk. The general premise is that greater
volatility connotes greater risk undertaken in achieving
performance. Measures of volatility or risk are generally used
to compare the Fund's net asset value or performance relative to
a market index. One measure of volatility is beta. Beta is the
volatility of a fund relative to the total market as represented
by the Standard & Poor's 500 Stock Index. A beta of more than
1.00 indicates volatility greater than the market, and a beta of
less than 1.00 indicates volatility less than the market.
Another measure of volatility or risk is standard deviation.
Standard deviation is a statistical tool that measures the degree
to which a fund's performance has varied from its average
performance during a particular time period.
Standard deviation is calculated using the following formula:
Standard deviation = the square root of S (xi - xm)2
----------------
n-1
where S = "the sum of",
xi = each individual return during the time period,
xm = the average return over the time period, and
n = the number of individual returns during the time period.
Statistics may also be used to discuss a Fund's relative
performance. One such measure is alpha. Alpha measures the actual
return of a fund compared to the expected return of a fund given
its risk (as measured by beta). The expected return is based on
how the market as a whole performed, and how the particular fund
has historically performed against the market. Specifically,
alpha is the actual return less the expected return. The expected
return is computed by multiplying the advance or decline in a
market representation by the fund's beta. A positive alpha
quantifies the value that the fund manager has added, and a
negative alpha quantifies the value that the fund manager has
lost.
Other measures of volatility and relative performance may be
used as appropriate. However, all such measures will fluctuate
and do not represent future results.
GENERAL INFORMATION
Business Philosophy
The Advisor is an independent, Midwestern-based investment
advisor, owned by professionals active in its management.
Recognizing that investors are the focus of its business, the
Advisor strives for excellence both in investment management and
in the service provided to investors. This commitment affects
many aspects of the business, including professional staffing,
product development, investment management, and service delivery.
The increasing complexity of the capital markets requires
specialized skills and processes for each asset class and style.
Therefore, the Advisor believes that active management should
produce greater returns than a passively managed index. The
Advisor has brought together a group of top-flight investment
professionals with diverse product expertise, and each
concentrates on their investment specialty. The Advisor believes
that people are the firm's most important asset. For this reason,
continuity of professionals is critical to the firm's long-term
success.
Investment Environment
Discussions of economic, social, and political conditions
and their impact on the Funds may be used in advertisements and
sales materials. Such factors that may impact the Funds include,
but are not limited to, changes in interest rates, political
developments, the competitive environment, consumer behavior,
industry trends, technological advances, macroeconomic trends,
and the supply and demand of various financial instruments. In
addition, marketing materials may cite the portfolio management's
views or interpretations of such factors.
Eight Basic Principles For Successful Mutual Fund Investing
These common sense rules are followed by many successful
investors. They make sense for beginners, too. If you have a
question on these principles, or would like to discuss them with
us, please contact us at 1-800-368-3863.
1. Have a plan - even a simple plan can help you take control
of your financial future. Review your plan once a year, or if
your circumstances change.
2. Start investing as soon as possible. Make time a valuable
ally. Let it put the power of compounding to work for you, while
helping to reduce your potential investment risk.
3. Diversify your portfolio. By investing in different asset
classes - stocks, bonds, and cash - you help protect against poor
performance in one type of investment while including investments
most likely to help you achieve your important goals.
4. Invest regularly. Investing is a process, not a one-time
event. By investing regularly over the long term, you reduce the
impact of short-term market gyrations, and you attend to your
long-term plan before you're tempted to spend those assets on
short-term needs.
5. Maintain a long-term perspective. For most individuals, the
best discipline is staying invested as market conditions change.
Reactive, emotional investment decisions are all too often a
source of regret - and principal loss.
6. Consider stocks to help achieve major long-term goals. Over
time, stocks have provided the more powerful returns needed to
help the value of your investments stay well ahead of inflation.
7. Keep a comfortable amount of cash in your portfolio. To meet
current needs, including emergencies, use a money market fund or
a bank account - not your long-term investment assets.
8. Know what you're buying. Make sure you understand the
potential risks and rewards associated with each of your
investments. Ask questions... request information...make up your own
mind. And choose a fund company that helps you make informed
investment decisions.
Strong Retirement Plan Services
Strong Retirement Plan Services offers a full menu of high
quality, affordable retirement plan options, including
traditional money purchase pension and profit sharing plans,
401(k) plans, simplified employee pension plans, salary reduction
plans, Keoghs, and 403(b) plans. Retirement plan specialists are
available to help companies determine which type of retirement
plan may be appropriate for their particular situation.
Markets:
The retirement plan services provided by the Advisor focus
on four distinct markets, based on the belief that a retirement
plan should fit the customer's needs, not the other way around.
1. Small company plans. Small company plans are designed for
companies with 1-50 plan participants. The objective is to
incorporate the features and benefits typically reserved for
large companies, such as sophisticated recordkeeping systems,
outstanding service, and investment expertise, into a small
company plan without administrative hassles or undue expense.
Small company plan sponsors receive a comprehensive plan
administration manual as well as toll-free telephone support.
2. Large company plans. Large company plans are designed for
companies with between 51 and 1,000 plan participants. Each
large company plan is assigned a team of professionals consisting
of an account manager, who is typically an attorney, CPA, or
holds a graduate degree in business, a conversion specialist (if
applicable), an accounting manager, a legal/technical manager,
and an education/communications educator.
3. Women-owned businesses.
4. Non-profit and educational organizations (the 403(b)
market).
Turnkey approach:
The retirement plans offered by the Advisor are designed to
be streamlined and simple to administer. To this end, the
Advisor has invested heavily in the equipment, systems, and
people necessary to adopt or convert a plan, and to keep it
running smoothly. The Advisor provides all aspects of the plan,
including plan design, administration, recordkeeping, and
investment management. To streamline plan design, the Advisor
provides customizable IRS-approved prototype documents. The
Advisor's services also include annual government reporting and
testing as well as daily valuation of each participant's account.
This structure is intended to eliminate the confusion and
complication often associated with dealing with multiple vendors.
It is also designed to save plan sponsors time and expense.
The Advisor strives to provide one-stop retirement savings
programs that combine the advantages of proven investment
management, flexible plan design and a wide range of investment
options. The open architecture design of the plans allow for the
use of the family of mutual funds managed by the Advisor as well
as a stable asset value option. Large company plans may
supplement these options with their company stock (if publicly
traded) or funds from other well-known mutual fund families.
Education:
Participant education and communication is key to the
success of any retirement program, and therefore is one of the
most important services that the Advisor provides. The Advisor's
goal is twofold: to make sure that plan participants fully
understand their options and to educate them about the lifelong
investment process. To this end, the Advisor provides
attractive, readable print materials that are supplemented with
audio and video tapes and retirement education programs.
Service:
The Advisor's goal is to provide a world class level of
service. One aspect of that service is an experienced,
knowledgeable team that provides ongoing support for plan
sponsors, both at adoption or conversion and throughout the life
of a plan. The Advisor is committed to delivering accurate and
timely information, evidenced by straightforward, complete, and
understandable reports, participant account statements and plan
summaries.
The Advisor has designed both "high-tech" and "high-touch"
systems, providing an automated telephone system as well as
personal contact. Participants can access daily account
information, conduct transactions, or have questions answered in
the way that is most comfortable for them.
Strong Financial Advisors Group
The Strong Financial Advisors Group is dedicated to helping
financial advisors better serve their clients. Financial
advisors receive regular updates on the mutual funds managed by
the Advisor, access to portfolio managers through special
conference calls, consolidated mailings of duplicate confirmation
statements, access to the Advisor's network of regional
representatives, and other specialized services. For more
information on the Strong Financial Advisors Group, call 1-800-
368-1683.
PORTFOLIO MANAGEMENT
Each portfolio manager works with a team of analysts,
traders, and administrative personnel. From time to time,
marketing materials may discuss various members of the team,
including their education, investment experience, and other
credentials.
The Advisor believes that actively managing each Fund's
portfolio and adjusting the average portfolio maturity according
to the Advisor's interest rate outlook is the best way to achieve
the Fund's objectives. This policy is based on a fundamental
belief that economic and financial conditions create favorable
and unfavorable investment periods (or seasons) and that these
different seasons require different investment approaches.
Through its active management approach, the Advisor seeks to
avoid or reduce any negative change in the Fund's net asset value
per share during the periods of falling bond prices and provide
consistently positive annual returns throughout the seasons of
investment.
The Advisor's investment philosophy includes the following basic
beliefs:
- - Active management pursued by a team with a uniform
discipline across the fixed income spectrum can produce results
that are superior to those produced through passive management.
- - Controlling risk by making only moderate deviations from the
defined benchmark is the cornerstone of successful fixed income
investing.
- - Successful fixed income management is best pursued on a top-
down basis utilizing fundamental techniques.
The investment process includes decisions made at four levels
that are consistent with the Advisor's viewpoint of the path of
economic activity, interest rates, and the supply of and demand
for credit.
The goal is to derive equivalent amounts of excess performance
and risk control over the long run from each of the four levels
of decision-making:
1. Duration. Each Fund's portfolio duration is managed within
a range relative to its respective benchmark.
2. Yield Curve. Modest overweights and underweights along the
yield curve are made to benefit from changes in the yield curve's
shape.
3. Sector/Quality. Sector weightings are generally maintained
between zero and two times those of the benchmark.
4. Security Selection. Quantitative analysis drives issue
selection in the Treasury and mortgage marketplace. Proactive
credit research drives corporate issue selection.
Risk control is pursued at three levels:
1. Portfolio structure. In structuring the portfolio, the
Advisor carefully considers such factors as position sizes,
duration, benchmark characteristics, and the use of illiquid
securities.
2. Credit research. Proactive credit research is used to
identify issues which the Advisor believes will be candidates for
credit upgrade. This research includes visiting company
management, establishing appropriate values for credit ratings,
and monitoring yield spread relationships.
3. Portfolio monitoring. Portfolio fundamentals are re-
evaluated continuously, and buy/sell targets are established and
generally adhered to.
LEGAL COUNSEL
Godfrey & Kahn, S.C., 780 North Water Street, Milwaukee,
Wisconsin 53202, acts as outside legal counsel for the Funds.
INDEPENDENT ACCOUNTANTS
Coopers & Lybrand L.L.P., 411 East Wisconsin Avenue,
Milwaukee, Wisconsin 53202, are the independent accountants for
the Funds, providing audit services and assistance and
consultation with respect to the preparation of filings with the
SEC.
FINANCIAL STATEMENTS
The Annual Report for the Short-Term Bond, Government,
Corporate Bond, and High-Yield Funds that is attached hereto
contains the following audited financial information for the
Funds:
(a) Schedules of Investments in Securities.
(b) Statements of Operations.
(c) Statements of Assets and Liabilities.
(d) Statements of Changes in Net Assets.
(e) Notes to Financial Statements.
(f) Financial Highlights.
(g) Reports of Independent Accountants.
APPENDIX
BOND RATINGS
Standard & Poor's Debt Ratings
A Standard & Poor's corporate or municipal debt rating
is a current assessment of the creditworthiness of an
obligor with respect to a specific obligation. This
assessment may take into consideration obligors such as
guarantors, insurers, or lessees.
The debt rating is not a recommendation to purchase,
sell, or hold a security, inasmuch as it does not comment as
to market price or suitability for a particular investor.
The ratings are based on current information furnished
by the issuer or obtained by S&P from other sources it
considers reliable. S&P does not perform an audit in
connection with any rating and may, on occasion, rely on
unaudited financial information. The ratings may be
changed, suspended, or withdrawn as a result of changes in,
or unavailability of, such information, or based on other
circumstances.
The ratings are based, in varying degrees, on the
following considerations:
1.Likelihood of default capacity and willingness
of the obligor as to the timely payment of
interest and repayment of principal in
accordance with the terms of the obligation.
2.Nature of and provisions of the obligation.
3.Protection afforded by, and relative position
of, the obligation in the event of bankruptcy,
reorganization, or other arrangement under the
laws of bankruptcy and other laws affecting
creditors' rights.
Investment Grade
AAA Debt rated "AAA" has the highest rating assigned by
Standard & Poor's. Capacity to pay interest and repay
principal is extremely strong.
AA Debt rated "AA" has a very strong capacity to pay
interest and repay principal and differs from the highest
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.
Speculative grade
Debt rated "BB", "B", "CCC", "CC" and "C" is regarded
as having predominantly speculative characteristics with
respect to capacity to pay interest and repay principal.
"BB" indicates the least degree of speculation and "C" the
highest. While such debt will likely have some quality and
protective characteristics, these are outweighed by large
uncertainties or major exposures to adverse conditions.
BB Debt rated "BB" has less near-term vulnerability to
default than other speculative issues. However, it faces
major ongoing uncertainties or exposure to adverse business,
financial, or economic conditions which could lead to
inadequate capacity to meet timely interest and principal
payments. The "BB" rating category is also used for debt
subordinated to senior debt that is assigned an actual or
implied "BBB-" rating.
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" or "BB-"
rating.
CCC Debt rated "CCC" has a currently identifiable
vulnerability to default, and is dependent upon favorable
business, financial, and economic conditions to meet timely
payment of interest and repayment of principal. In the
event of adverse business, financial, or economic
conditions, it is not likely to have the capacity to pay
interest and repay principal. The "CCC" rating category is
also used for debt subordinated to senior debt that is
assigned an actual or implied "B" or "B-" rating.
CC Debt rated "CC" typically is applied to debt
subordinated to senior debt that is assigned an actual or
implied "CCC" rating.
C Debt rated "C" typically is applied to debt
subordinated to senior debt which is assigned an actual or
implied "CCC-" rating. The "C" rating may be used to cover
a situation where a bankruptcy petition has been filed, but
debt service payments are continued.
CI The rating "CI" is reserved for income bonds on
which no interest is being paid.
D Debt rated "D" is in payment default. The "D"
rating category is used when interest payments or principal
payments are not made on the date due, even if the
applicable grace period has not expired, unless S&P believes
that such payments will be made during such grade period.
The "D" rating also will be used upon the filing of a
bankruptcy petition if debt service payments are
jeopardized.
Moody's Long-Term Debt Ratings
Aaa - Bonds which are rated Aaa are judged to be of
the best quality. They carry the smallest degree of
investment risk and are generally referred to as "gilt
edged". Interest payments are protected by a large or by an
exceptionally stable margin and principal is secure. While
the various protective elements are likely to change, such
changes as can be visualized are most unlikely to impair the
fundamentally strong position of such issues.
Aa - Bonds which are rated Aa are judged to be of high
quality by all standards. Together with the Aaa group they
comprise what are generally known as high grade bonds. They
are rated lower than the best bonds because margins of
protection may not be as large as in Aaa securities or
fluctuation of protective elements may be of greater
amplitude or there may be other elements present which make
the long-term risk appear somewhat larger than in Aaa
securities.
A - Bonds which are rated A possess many favorable
investment attributes and are to be considered as upper-
medium grade obligations. Factors giving security to
principal and interest are considered adequate, but elements
may be present which suggest a susceptibility to impairment
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 rated Ba are judged to have
speculative elements; their future cannot be considered as
well-assured. Often the protection of interest and principal
payments may be very moderate, and thereby not well
safeguarded during both good and bad times over the future.
Uncertainty of position characterizes bonds in this class.
B - Bonds which are rated B generally lack
characteristics of the desirable investment. Assurance of
interest and principal payments or maintenance of other
terms of the contract over any long period of time may be
small.
Caa - Bonds which are rated Caa are of poor standing.
Such issues may be in default or there may be present
elements of danger with respect to principal or interest.
Ca - Bonds which are rated Ca represent obligations
which are speculative in a high degree. Such issues are
often in default or have other marked shortcomings.
C - Bonds which are rated C are the lowest rated class
of bonds, and issues so rated can be regarded as having
extremely poor prospects of ever attaining any real
investment standing.
Fitch Investors Service, Inc. Bond Ratings
Fitch investment grade bond and preferred stock ratings
provide a guide to investors in determining the credit risk
associated with a particular security. The ratings
represent Fitch's assessment of the issuer's ability to meet
the obligations of a specific debt or preferred issue in a
timely manner.
The rating takes into consideration special features of
the issue, its relationship to other obligations of the
issuer, the current and prospective financial condition and
operating performance of the issuer and any guarantor, as
well as the economic and political environment that might
affect the issuer's future financial strength and credit
quality.
Fitch ratings do not reflect any credit enhancement
that may be provided by insurance policies or financial
guaranties unless otherwise indicated.
Bonds and preferred stock carrying the same rating are
of similar but not necessarily identical credit quality
since the rating categories do not fully reflect small
differences in the degrees of credit risk.
Fitch ratings are not recommendations to buy, sell, or
hold any security. Ratings do not comment on the adequacy
of market price, the suitability of any security for a
particular investor, or the tax-exempt nature or taxability
of payments made in respect of any security.
Fitch ratings are based on information obtained from
issuers, other obligors, underwriters, their experts, and
other sources Fitch believes to be reliable. Fitch does not
audit or verify the truth or accuracy of such information.
Ratings may be changed, suspended, or withdrawn as a result
of changes in, or the unavailability of, information or for
other reasons.
AAA Bonds and preferred stock considered to be
investment grade and of the highest credit
quality. The obligor has an exceptionally strong
ability to pay interest and/or dividends and repay
principal, which is unlikely to be affected by
reasonably foreseeable events.
AA Bonds and preferred stock considered to be
investment grade and of very high credit quality.
The obligor's ability to pay interest and/or
dividends and repay principal is very strong,
although not quite as strong as bonds rated "AAA".
Because bonds and preferred stock rated in the
"AAA" and "AA" categories are not significantly
vulnerable to foreseeable future developments,
short-term debt of the issuers is generally rated
"F-1+".
A Bonds and preferred stock considered to be
investment grade and of high credit quality. The
obligor's ability to pay interest and/or dividends
and repay principal is considered to be strong,
but may be more vulnerable to adverse changes in
economic conditions and circumstances than debt or
preferred securities with higher ratings.
BBB Bonds and preferred stock considered to be
investment grade and of satisfactory credit
quality. The obligor's ability to pay interest or
dividends 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 securities and,
therefore, impair timely payment. The likelihood
that the ratings of these bonds or preferred will
fall below investment grade is higher than for
securities with higher ratings.
Fitch speculative grade bond or preferred stock ratings
provide a guide to investors in determining the credit risk
associated with a particular security. The ratings ("BB" to
"C") represent Fitch's assessment of the likelihood of
timely payment of principal and interest or dividends in
accordance with the terms of obligation for issues not in
default. For defaulted bonds or preferred stock, the rating
("DDD" to "D") is an assessment of the ultimate recovery
value through reorganization or liquidation.
The rating takes into consideration special features of
the issue, its relationship to other obligations of the
issuer or possible recovery value in bankruptcy, the current
and prospective financial condition and operating
performance of the issuer and any guarantor, as well as the
economic and political environment that might affect the
issuer's future financial strength.
Bonds or preferred stock that have the same rating are
of similar but not necessarily identical credit quality
since the rating categories cannot fully reflect the
differences in the degrees of credit risk.
BB Bonds or preferred stock are considered
speculative. The obligor's ability to pay
interest or dividends 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 or preferred stock are considered highly
speculative. While bonds in this class are
currently meeting debt service requirements or
paying dividends, the probability of continued
timely payment of principal and interest reflects
the obligor's limited margin of safety and the
need for reasonable business and economic activity
throughout the life of the issue.
CCC Bonds or preferred stock have certain identifiable
characteristics that, if not remedied, may lead to
default. The ability to meet obligations requires
an advantageous business and economic environment.
CC Bonds or preferred stock are minimally protected.
Default in payment of interest and/or principal
seems probable over time.
C Bonds are in imminent default in payment of
interest or principal or suspension of preferred
stock dividends is imminent.
DDD, DD,
and D Bonds are in default on interest and/or
principal payments or preferred stock dividends
are suspended. Such securities are extremely
speculative and should be valued on the basis of
their ultimate recovery value in liquidation or
reorganization of the obligor. "DDD" represents
the highest potential for recovery of these
securities, and "D" represents the lowest
potential for recovery.
Duff & Phelps, Inc. Long-Term Debt Ratings
These ratings represent a summary opinion of the
issuer's long-term fundamental quality. Rating
determination is based on qualitative and quantitative
factors which may vary according to the basic economic and
financial characteristics of each industry and each issuer.
Important considerations are vulnerability to economic
cycles as well as risks related to such factors as
competition, government action, regulation, technological
obsolescence, demand shifts, cost structure, and management
depth and expertise. The projected viability of the obligor
at the trough of the cycle is a critical determination.
Each rating also takes into account the legal form of
the security, (e.g., first mortgage bonds, subordinated
debt, preferred stock, etc.). The extent of rating
dispersion among the various classes of securities is
determined by several factors including relative weightings
of the different security classes in the capital structure,
the overall credit strength of the issuer, and the nature of
covenant protection. Review of indenture restrictions is
important to the analysis of a company's operating and
financial constraints. From time to time, Duff & Phelps
Credit Rating Co. places issuers or security classes on
Rating Watch. The Rating Watch Status results from a need
to notify investors and the issuer that there are conditions
present leading us to re-evaluate the current rating(s). A
listing on Rating Watch, however, does not mean a rating
change is inevitable. The Rating Watch Status can either be
resolved quickly or over a longer period of time, depending
on the reasons surrounding the placement on Rating Watch.
The "up" designation means a rating may be upgraded; the
"down" designation means a rating may be downgraded, and the
uncertain designation means a rating may be raised or
lowered.
The Credit Rating Committee formally reviews all
ratings once per quarter (more frequently, if necessary).
Ratings of "BBB-" and higher fall within the definition of
investment grade securities, as defined by bank and
insurance supervisory authorities. Structured finance
issues, including real estate, asset-backed and mortgage-
backed financings, use this same rating scale with minor
modification in the definitions. Thus, an investor can
compare the credit quality of investment alternatives across
industries and structural types. A "Cash Flow Rating" (as
noted for specific ratings) addresses the likelihood that
aggregate principal and interest will equal or exceed the
rated amount under appropriate stress conditions.
Rating Scale Definition
AAA Highest credit quality. The risk factors are
negligible, being only slightly more
than for risk-free U.S. Treasury debt.
AA+ High credit quality. Protection factors are
AA strong. Risk is modest, but may vary slightly
AA- from time to time because of economic conditions.
A+ Protection factors are average but adequate.
A However, risk factors are more
A- variable and greater in periods of economic stress.
BBB+ Below-average protection factors but still
BBB considered sufficient for prudent
BBB- investment. Considerable variability in risk
during economic cycles.
BB+ Below investment grade but deemed likely to
BB meet obligations when due.
BB- Present or prospective financial protection
factors fluctuate according to
industry conditions or company fortunes.
Overall quality may move up or
down frequently within this category.
B+ Below investment grade and possessing risk
B that obligations will not be met
B- when due. Financial protection factors will
fluctuate widely according to
economic cycles, industry conditions and/or
company fortunes. Potential exists for frequent
changes in the rating within this category or
into a higher or lower rating grade.
CCC Well below investment grade securities.
Considerable uncertainty exists as to
timely payment of principal, interest or
preferred dividends. Protection factors are
narrow and risk can be substantial with unfavorable
economic/industry conditions, and/or with
unfavorable company developments.
DD Defaulted debt obligations. Issuer failed to
meet scheduled principal and/or interest payments.
DP Preferred stock with dividend arrearages.
____________________________________________________________
IBCA Long-Term Debt Ratings
AAA - Obligations for which there is the lowest
expectation of investment risk. Capacity for timely
repayment of principal and interest is substantial, such
that adverse changes in business, economic or financial
conditions are unlikely to increase investment risk
substantially.
AA - Obligations for which there is a very low
expectation of investment risk. Capacity for timely
repayment of principal and interest is substantial. Adverse
changes in business, economic or financial conditions may
increase investment risk, albeit not very significantly.
A - Obligations for which there is a low expectation of
investment risk. Capacity for timely repayment of principal
and interest is strong, although adverse changes in
business, economic or financial conditions may lead to
increased investment risk.
BBB - Obligations for which there is currently a low
expectation of investment risk. Capacity for timely
repayment of principal and interest is adequate, although
adverse changes in business, economic or financial
conditions are more likely to lead to increased investment
risk than for obligations in other categories.
BB - Obligations for which there is a possibility of
investment risk developing. Capacity for timely repayment
of principal and interest exists, but is susceptible over
time to adverse changes in business, economic or financial
conditions.
B - Obligations for which investment risk exists.
Timely repayment of principal and interest is not
sufficiently protected against adverse changes in business,
economic or financial conditions.
CCC - Obligations for which there is a current
perceived possibility of default. Timely repayment of
principal and interest is dependent on favorable business,
economic or financial conditions.
CC - Obligations which are highly speculative or which
have a high risk of default.
C - Obligations which are currently in default.
Notes: "+" or "-" may be appended to a rating below
AAA to denote relative status within major rating
categories. Ratings of BB and below are assigned where it
is considered that speculative characteristics are present.
Thomson BankWatch Long-Term Debt Ratings
Long-Term Debt Ratings assigned by Thomson BankWatch
also weigh heavily government ownership and support. The
quality of both the company's management and franchise are
of even greater importance in the Long-Term Debt Rating
decisions. Long-Term Debt Ratings look out over a cycle and
are not adjusted frequently for what we believe are short-
term performance aberrations.
Long-Term Debt Ratings can be restricted to local
currency debt - ratings will be identified by the
designation LC. In addition, Long-Term Debt Ratings may
include a plus (+) or minus (-) to indicate where within the
category the issue is placed. BankWatch Long-Term Debt
Ratings are based on the following scale:
Investment Grade
AAA (LC-AAA) - Indicates that the ability to repay
principal and interest on a timely basis is extremely high.
AA (LC-AA) - Indicates a very strong ability to repay
principal and interest on a timely basis, with limited
incremental risk compared to issues rated in the highest
category.
A (LC-A) - Indicates the ability to repay principal and
interest is strong. Issues rated A could be more vulnerable
to adverse developments (both internal and external) than
obligations with higher ratings.
BBB (LC-BBB) - The lowest investment-grade category;
indicates an acceptable capacity to repay principal and
interest. BBB issues are more vulnerable to adverse
developments (both internal and external) than obligations
with higher ratings.
Non-Investment Grade - may be speculative in the likelihood
of timely repayment of principal and interest
BB (LC-BB) - While not investment grade, the BB rating
suggests that the likelihood of default is considerably less
than for lower-rated issues. However, there are significant
uncertainties that could affect the ability to adequately
service debt obligations.
B (LC-B) - Issues rated B show higher degree of
uncertainty and therefore greater likelihood of default than
higher-rated issues. Adverse developments could negatively
affect the payment of interest and principal on a timely
basis.
CCC (LC-CCC) - Issues rated CCC clearly have a high
likelihood of default, with little capacity to address
further adverse changes in financial circumstances.
CC (LC-CC) - CC is applied to issues that are
subordinate to other obligations rated CCC and are afforded
less protection in the event of bankruptcy or
reorganization.
D (LC-D) - Default.
SHORT-TERM RATINGS
Standard & Poor's Commercial Paper Ratings
A Standard & Poor's commercial paper rating is a
current assessment of the likelihood of timely payment of
debt considered short-term in the relevant market.
Ratings are graded into several categories, ranging
from "A-1" for the highest quality obligations to "D" for
the lowest. These categories are as follows:
A-1 This highest category indicates that the degree of
safety regarding timely payment is strong. Those issues
determined to possess extremely strong safety
characteristics are denoted with a plus sign (+)
designation.
A-2 Capacity for timely payment on issues with this
designation is satisfactory. However, the relative degree
of safety is not as high as for issues designated "A-1".
A-3 Issues carrying this designation have adequate
capacity for timely payment. They are, however, more
vulnerable to the adverse effects of changes in
circumstances than obligations carrying the higher
designations.
B Issues rated "B" are regarded as having only
speculative capacity for timely payment.
C This rating is assigned to short-term debt
obligations with doubtful capacity for payment.
D Debt rated "D" is in payment default. The "D" rating
category is used when interest payments or principal
payments are not made on the date due, even if the
applicable grace period has not expired, unless S&P believes
that such payments will be made during such grace period.
Standard & Poor's Note Ratings
An S&P note rating reflects the liquidity factors and
market-access risks unique to notes. Notes maturing in
three years or less will likely receive a note rating.
Notes maturing beyond three years will most likely receive a
long-term debt rating.
The following criteria will be used in making the
assessment:
- Amortization schedule - the larger the final maturity
relative to other maturities, the more likely the issue is
to be treated as a note.
- Source of payment - the more the issue depends on the
market for its refinancing, the more likely it is to be
treated as a note.
Note rating symbols and definitions are as follows:
SP-1 Strong capacity to pay principal and interest.
Issues determined to possess very strong characteristics are
given a plus (+) designation.
SP-2 Satisfactory capacity to pay principal and
interest, with some vulnerability to adverse financial and
economic changes over the term of the notes.
SP-3 Speculative capacity to pay principal and
interest.
Moody's Short-Term Ratings
Moody's short-term debt ratings are opinions of the
ability of issuers to repay punctually senior debt
obligations. These obligations have an original maturity
not exceeding one year, unless explicitly noted.
Moody's employs the following three designations, all
judged to be investment grade, to indicate the relative
repayment ability of rated issuers:
Issuers rated Prime-1 (or supporting institutions) have
a superior ability for repayment of senior short-term debt
obligations. Prime-1 repayment ability will often be
evidenced by many of the following characteristics: (i)
leading market positions in well-established industries,
(ii) high rates of return on funds employed, (iii)
conservative capitalization structure with moderate reliance
on debt and ample asset protection, (iv) broad margins in
earnings coverage of fixed financial charges and high
internal cash generation, and (v) well established access to
a range of financial markets and assured sources of
alternate liquidity.
Issuers rated Prime-2 (or supporting institutions) have
a strong ability for repayment of senior short-term debt
obligations. This will normally be evidenced by many of the
characteristics cited above, but to a lesser degree.
Earnings trends and coverage ratios, while sound, may be
more subject to variation. Capitalization characteristics,
while still appropriate, may be more affected by external
conditions. Ample alternate liquidity is maintained.
Issuers rated Prime-3 (or supporting institutions) have
an acceptable ability for repayment of senior short-term
obligations. The effect of industry characteristics and
market compositions may be more pronounced. Variability in
earnings and profitability may result in changes in the
level of debt protection measurements and may require
relatively high financial leverage. Adequate alternate
liquidity is maintained.
Issuers rated Not Prime do not fall within any of the
Prime rating categories.
Fitch Investors Service, Inc. Short-Term Ratings
Fitch's short-term ratings apply to debt obligations
that are payable on demand or have original maturities of
generally up to three years, including commercial paper,
certificates of deposit, medium-term notes, and municipal
and investment notes.
The short-term rating places greater emphasis than a
long-term rating on the existence of liquidity necessary to
meet the issuer's obligations in a timely manner.
F-1+ Exceptionally Strong Credit Quality. Issues
assigned this rating are regarded as having the
strongest degree of assurance for timely payment.
F-1 Very Strong Credit Quality. Issues assigned this
rating reflect an assurance of timely payment only
slightly less in degree than issues rated "F-1+".
F-2 Good Credit Quality. Issues assigned this rating
have a satisfactory degree of assurance for timely
payment but the margin of safety is not as great
as for issues assigned "F-1+" and "F-1" ratings.
F-3 Fair Credit Quality. Issues assigned this rating
have characteristics suggesting that the degree of
assurance for timely payment is adequate; however,
near-term adverse changes could cause these
securities to be rated below investment grade.
F-S Weak Credit Quality. Issues assigned this rating
have characteristics suggesting a minimal degree
of assurance for timely payment and are vulnerable
to near-term adverse changes in financial and
economic conditions.
D Default. Issues assigned this rating are in
actual or imminent payment default.
LOC The symbol LOC indicates that the rating is based
on a letter of credit issued by a commercial bank.
Duff & Phelps, Inc. Short-Term Debt Ratings
Duff & Phelps' short-term ratings are consistent with
the rating criteria used by money market participants. The
ratings apply to all obligations with maturities of under
one year, including commercial paper, the uninsured portion
of certificates of deposit, unsecured bank loans, master
notes, bankers acceptances, irrevocable letters of credit,
and current maturities of long-term debt. Asset-backed
commercial paper is also rated according to this scale.
Emphasis is placed on liquidity which is defined as not
only cash from operations, but also access to alternative
sources of funds including trade credit, bank lines, and the
capital markets. An important consideration is the level of
an obligor's reliance on short-term funds on an ongoing
basis.
The distinguishing feature of Duff & Phelps' short-term
ratings is the refinement of the traditional "1" category.
The majority of short-term debt issuers carry the highest
rating, yet quality differences exist within that tier. As
a consequence, Duff & Phelps has incorporated gradations of
"1+" (one plus) and "1-" (one minus) to assist investors in
recognizing those differences.
From time to time, Duff & Phelps places issuers or
security classes on Rating Watch. The Rating Watch status
results from a need to notify investors and the issuer that
there are conditions present leading us to re-evaluate the
current rating(s). A listing on Rating Watch, however, does
not mean a rating change is inevitable.
The Rating Watch status can either be resolved quickly
or over a longer period of time, depending on the reasons
surrounding the placement on Rating Watch. The "up"
designation means a rating may be upgraded; the "down"
designation means a rating may be downgraded, and the
"uncertain" designation means a rating may be raised or
lowered.
Rating Scale: Definition
High Grade
D-1+ Highest certainty of timely payment. Short-
Term liquidity, including internal operating
factors and/or access to alternative sources
of funds, is outstanding, and safety is just
below risk-free U.S. Treasury short-term
obligations.
D-1 Very high certainty of timely payment.
Liquidity factors are excellent and supported
by good fundamental protection factors. Risk
factors are minor.
D-1- High certainty of timely payment. Liquidity
factors are strong and supported by good
fundamental protection factors. Risk factors
are very small.
Good Grade
D-2 Good certainty of timely payment. Liquidity
factors and company fundamentals are sound.
Although ongoing funding needs may enlarge
total financing requirements, access to
capital markets is good. Risk factors are
small.
Satisfactory Grade
D-3 Satisfactory liquidity and other protection
factors qualify issues as to investment
grade. Risk factors are larger and subject
to more variation. Nevertheless, timely
payment is expected.
Non-Investment Grade
D-4 Speculative investment characteristics.
Liquidity is not sufficient to insure against
disruption in debt service. Operating
factors and market access may be subject to a
high degree of variation.
Default
D-5 Issuer failed to meet scheduled principal
and/or interest payments.
Thomson BankWatch (TBW) Short-Term Ratings
The TBW Short-Term Ratings apply, unless otherwise
noted, to specific debt instruments of the rated entities
with a maturity of one year or less. TBW Short-Term Ratings
are intended to assess the likelihood of an untimely or
incomplete payments of principal or interest.
TBW-1 The highest category; indicates a very high
likelihood that principal and interest will be paid on a
timely basis.
TBW-2 The second highest category; while the degree of
safety regarding timely repayment of principal and interest
is strong, the relative degree of safety is not as high as
for issues rated "TBW-1".
TBW-3 The lowest investment-grade category; indicates
that while the obligation is more susceptible to adverse
developments (both internal and external) than those with
higher ratings, the capacity to service principal and
interest in a timely fashion is considered adequate.
TBW-4 The lowest rating category; this rating is
regarded as non-investment grade and therefore speculative.
IBCA Short-Term Ratings
IBCA Short-Term Ratings assess the borrowing
characteristics of banks and corporations, and the capacity
for timely repayment of debt obligations. The Short-Term
Ratings relate to debt which has a maturity of less than one
year.
A1 Obligations supported by the highest capacity for
timely repayment. Where issues possess a
particularly strong credit feature, a rating of A1+ is
assigned.
A2 Obligations supported by a good capacity for
timely repayment.
A3 Obligations supported by a satisfactory capacity
for timely repayment.
B Obligations for which there is an uncertainty as
to the capacity to ensure timely repayment.
C Obligations for which there is a high risk of
default or which are currently in default.
