<PAGE>
===============================================================================
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM N-1A
REGISTRATION STATEMENT (N0. 33-1569) UNDER
THE SECURITIES ACT OF 1933
PRE-EFFECTIVE AMENDMENT NO. X
POST-EFFECTIVE AMENDMENT NO. 12
AND
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY
ACT OF 1940
AMENDMENT NO. 15
VANGUARD CALIFORNIA
TAX-FREE FUND
(EXACT NAME OF REGISTRANT AS SPECIFIED IN CHARTER)
100 VANGUARD BOULEVARD,
MALVERN, PA 19355-0741
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICE)
REGISTRANT'S TELEPHONE NUMBER (610) 669-1000
RAYMOND J. KLAPINSKY, ESQUIRE
P.O. BOX 876
VALLEY FORGE, PA 19482
It is hereby requested that this filing become effective on March 29,
1996, pursuant to paragraph (b) of Rule 485 of the Securities Act of 1933.
Approximate Date of Proposed Public Offering: As soon as practicable after
this Registration Statement becomes effective*.
Registrant elects to register an indefinite number of shares pursuant to
Regulation 24f-2 under the Investment Company Act of 1940. Registrant filed
its Rule 24f-2 Notice for the year ended November 30, 1995 on January 25,
1996.
===============================================================================
<PAGE>
VANGUARD CALIFORNIA TAX-FREE FUND
CROSS-REFERENCE SHEET
<TABLE>
<CAPTION>
Form N-1A
Item Number Location in Prospectus
<S> <C> <C>
Item 1. Cover Page ........................... Cover Page
Item 2. Synopsis ............................ Not Applicable
Item 3. Condensed Financial Information ..... Financial Highlights
Item 4. General Description of Registrant .... Investment Objective; Investment
Limitations; Investment Policies;
General Information
Item 5. Management of the Fund .............. Management of the Fund;
Investment Adviser
Item 6. Capital Stock and Other Securities .. Opening an Account and Purchasing Shares;
Selling Your Shares; The Share Price of
Each Portfolio; Dividends,
Capital Gains and Taxes; General
Information
Item 7. Purchase of Securities Being Offered .. Cover Page; Opening an Account and
Purchasing Shares
Item 8. Redemption or Repurchase ............. Selling Your Shares
Item 9. Pending Legal Proceedings ............ Not Applicable
Form N-1A Location in Statement
Item Number of Additional Information
Item 10. Cover Page ........................... Cover Page
Item 11. Table of Contents ..................... Cover Page
Item 12. General Information and History ...... Management of the Fund
Item 13. Investment Objective and Policies .... Investment Limitations
Item 14. Purchase of Securities Being Offered .. Management of the Fund; Investment
Management
Item 15. Control Persons and Principal Holders of
Securities ........................... Management of the Fund
Item 16. Investment Advisory and Other Services.. Management of the Fund; Investment
Manager
Item 17. Brokerage Allocation ................... Not Applicable
Item 18. Capital Stock and Other Securities .... Financial Statements
Item 19. Purchase, Redemption and Pricing of
Securities Being Offered ............. Purchase of Shares; Redemption of
Shares
Item 20. Tax Status ........................... Appendix
Item 21. Underwriters .......................... Not Applicable
Item 22. Calculations of Yield Quotations of
Money Market Fund ..................... Calculation of Yield
Item 23. Financial Statements .................. Financial Statements
</TABLE>
<PAGE>
===============================================================================
Vanguard
CALIFORNIA
TAX-FREE FUND A Member of The Vanguard Group
===============================================================================
PROSPECTUS-March 29, 1996
- -------------------------------------------------------------------------------
NEW ACCOUNT INFORMATION: Investor Information Department-1-800-662-7447 (SHIP)
- -------------------------------------------------------------------------------
SHAREHOLDER ACCOUNT SERVICES: Client Services Department-1-800-662-2739 (CREW)
- -------------------------------------------------------------------------------
INVESTMENT
OBJECTIVE AND
POLICIES Vanguard California Tax-Free Fund (the "Fund") is an
open-end non-diversified investment company that seeks to
provide income that is exempt from federal and California
State personal income taxes. The Fund will invest
primarily in securities issued by California state and
local governments and public financing authorities, but
may also invest in securities of issuers other than
California and its political subdivisions. Although the
Fund invests in high-quality instruments, the shares of
the Fund are not insured or guaranteed by the U.S.
Government. The Fund consists of a Money Market Portfolio,
an Insured Intermediate-Term Portfolio and an Insured
Long-Term Portfolio, each of which has distinct investment
objectives and policies. The Portfolios are available only
to California residents. The Money Market Portfolio seeks
to maintain, but does not guarantee, a constant net asset
value of $1.00 per share.
- -------------------------------------------------------------------------------
OPENING AN
ACCOUNT Please complete and return the Account Registration Form.
If you need assistance in completing this Form, please
call the Investor Information Department, Monday through
Friday, from 8:00 a.m. to 9:00 p.m. and Saturday, from
9:00 a.m. to 4:00 p.m. (Eastern time). The minimum initial
investment is $3,000 for each Portfolio or $1,000 for
Uniform Gifts/Transfers to Minors Act accounts. The Fund
is offered on a no-load basis (i.e., there are no sales
commissions or 12b-1 fees). However, the Fund incurs
expenses for investment advisory, management,
administrative, and distribution services.
- -------------------------------------------------------------------------------
ABOUT THIS
PROSPECTUS This Prospectus is designed to set forth concisely the
information that you should know about the Fund before you
invest. It should be retained for future reference. A
"Statement of Additional Information" containing
additional information about the Fund has been filed with
the Securities and Exchange Commission. This Statement is
dated March 29, 1996, and has been incorporated by
reference into this Prospectus. It may be obtained,
without charge, by writing to the Fund or by calling the
Investor Information Department.
- -------------------------------------------------------------------------------
<PAGE>
TABLE OF CONTENTS
Page
Highlights ................................. 2
Fund Expenses .............................. 5
Financial Highlights ....................... 6
Yield and Total Return ..................... 8
FUND INFORMATION
Investment Objective ....................... 9
Investment Policies ........................ 9
Investment Risks ........................... 12
Who Should Invest .......................... 15
How to Compare Tax-Free and Taxable Yields . 16
Implementation of Policies ................. 17
Investment Limitations ..................... 21
Management of the Fund ..................... 22
Investment Adviser ......................... 23
Dividends, Capital Gains and Taxes ......... 23
The Share Price of Each
Portfolio ................................ 25
General Information ........................ 27
SHAREHOLDER GUIDE
Opening an Account and
Purchasing Shares ........................ 28
When Your Account Will Be Credited ......... 31
Selling Your Shares ........................ 32
Exchanging Your Shares ..................... 35
Important Information About Telephone
Transactions ............................. 36
Transferring Registration .................. 37
Other Vanguard Services .................... 37
- -------------------------------------------------------------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION, NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE COMMISSION PASSED UPON THE ACCURACY OR
ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL
OFFENSE.
- -------------------------------------------------------------------------------
<PAGE>
HIGHLIGHTS
OBJECTIVES AND
POLICIES Vanguard California Tax-Free Fund (the "Fund") is a
no-load, open-end non-diversified investment company
whose objective is to provide investors with income that
is exempt from federal and California personal income
taxes. The Fund consists of three separate Portfolios,
each of which invests in California municipal securities
within prescribed maturity and quality standards. There is
no assurance, however, that the Fund will achieve its
stated objective. Page 9
- -------------------------------------------------------------------------------
THREE SEPARATE
PORTFOLIOS Investors may choose from three separate Portfolios of the
Fund:
Money Market Portfolio--invests in high-quality California
municipal securities with a dollar-weighted average
maturity of 90 days or less and seeks to maintain a stable
$1.00 share price. An investment in the Money Market
Portfolio is neither insured nor guaranteed by the U.S.
Government, and there is no assurance that the Portfolio
will be able to maintain a stable net asset value of $1.00
per share.
Insured Intermediate-Term Portfolio--invests in insured
California municipal securities with a dollar-weighted
average maturity of 7 to 12 years.
Insured Long-Term Portfolio--invests in insured California
municipal securities with a dollar-weighted average
maturity of 15 to 25 years. Page 9
- -------------------------------------------------------------------------------
RISK
CHARACTERISTICS The three Portfolios of the Fund differ significantly in
terms of interest rate risk. Interest rate risk is the
potential for fluctuations in the principal value of a
bond investment caused by changes in market interest
rates. It depends chiefly on the average maturity of a
Portfolio's securities.
The Money Market Portfolio, which is expected to maintain
a stable $1.00 share price, provides minimal exposure to
interest rate risk. In contrast, share prices of the
Insured Intermediate-Term and Insured Long-Term Portfolios
will generally fluctuate as interest rates change. In
relative terms, share price fluctuations are expected to
be medium for the Insured Intermediate-Term Portfolio and
high for the Insured Long-Term Portfolio. Page 12
- -------------------------------------------------------------------------------
THE VANGUARD
GROUP The Fund is a member of The Vanguard Group of Investment
Companies, a group of more than 30 investment companies
with more than 90 distinct investment portfolios and total
assets in excess of $190 billion. The Vanguard Group, Inc.
("Vanguard"), a subsidiary jointly owned by the Vanguard
Funds, provides all corporate management, administrative,
distribution and shareholder accounting services on an
at-cost basis to the Funds in the Group. Page 22
- -------------------------------------------------------------------------------
INVESTMENT
ADVISER The Fund receives investment advisory services on an
at-cost basis from an experienced investment management
staff employed directly by Vanguard. As a result, the Fund
receives its investment advisory services at a
substantially lower cost than would be possible if the
Fund paid an investment advisory fee to an external
investment adviser. Page 23
- -------------------------------------------------------------------------------
2
<PAGE>
DIVIDEND POLICY Each Portfolio declares a dividend based on its ordinary
income each business day. Dividends are paid monthly and
may be received in cash or reinvested in additional
shares. Page 23
- -------------------------------------------------------------------------------
TAXES Shareholders pay no federal or California personal income
taxes on tax-exempt dividends paid by the Fund's
Portfolios. Capital gains distributions from the Fund are
subject to federal income tax, as well as state and local
taxes if applicable. However, part or all of any gain
realized by the Fund on the disposition of securities
purchased at a market discounted price above a certain
nominal or de minimus amount will be subject to federal
income tax as ordinary income (see page 16). Although the
Fund seeks to avoid taxable income, shareholders would be
responsible for any taxes due if taxable income were
realized. Also, while not presently the case, it is
possible that a portion of the tax-exempt dividends paid
by the Fund may be a tax preference item for purposes of
the alternative minimum tax. Page 23
- -------------------------------------------------------------------------------
PURCHASING
SHARES If you are a California resident, you may purchase shares
by mail, wire or exchange from another Vanguard Fund. The
minimum initial investment is $3,000 per Portfolio; the
minimum for subsequent investments is $100. There are no
sales commissions or 12b-1 fees. Page 28
- -------------------------------------------------------------------------------
SELLING SHARES You may redeem shares of each Portfolio by mail,
telephone, wire or check. There is no charge for
redemptions, except for wire withdrawals under $5,000,
which are subject to a $5 charge. (Your bank may also
impose a fee upon receipt of a wire.) Each Portfolio's
share price (except the Money Market Portfolio's) is
expected to fluctuate, and may at redemption be more or
less than at the time of initial purchase, resulting in a
gain or loss. Page 32
- -------------------------------------------------------------------------------
SERVICES TO
SHAREHOLDERS The Fund offers free checkwriting services (minimum $250
per check) for easy access to your Fund account. Page 32
The Fund also offers special services, including Direct
Deposit, for deposit of payroll checks into your Fund
account; Fund Express, for electronic transfers between
the Fund and your bank account; Dividend Express, for
electronic transfer of your Fund dividends to your bank
account; and Tele-Account, for 24-hour telephone access to
your Fund account balance and certain transactions. Page 37
- -------------------------------------------------------------------------------
SPECIAL
CONSIDERATIONS (1) The value of a Portfolio's municipal securities is
expected to fluctuate inversely with interest rates. In
general, if interest rates rise, municipal bond prices
fall; if interest rates fall, bond prices rise. In
addition, for a given change in interest rates, bonds of
longer maturities fluctuate more in value than bonds of
shorter maturities. Thus, you should expect that each
Portfolio's share price (except the Money Market
Portfolio's) will vary as interest rates change, and that
a Portfolio with a longer maturity will fluctuate more
than a Portfolio with a shorter maturity. Page 12
3
<PAGE>
(2) From time to time Congress has considered proposals to
restrict or eliminate the tax-exempt status of municipal
securities. If such proposals were enacted in the future,
each Portfolio would reconsider its investment objectives
and policies. Page 9
(3) Each Portfolio (except the Money Market Portfolio) may
invest a portion of its assets in futures contracts and
options. Page 20
(4) The Money Market and Insured Long-term Portfolios may
invest up to 20% of their assets in short-term
non-California municipal securities or in taxable
short-term securities. The Intermediate Portfolio may
invest up to 35% of its assets in such securities. Page 9
(5) Each Portfolio may purchase municipal obligations on a
when-issued basis. Securities purchased on a when-issued
basis may decline or appreciate in market value prior to
their actual delivery to a Portfolio. Page 19
(6) Each Portfolio may lend its investment securities.
Page 19
(7) Each Portfolio may invest in municipal lease
obligations. Page 20
- -------------------------------------------------------------------------------
4
<PAGE>
FUND EXPENSES The following table illustrates all expenses and fees that
you would incur as a shareholder of the Fund. The expenses
and fees set forth in the table are for the 1995 fiscal
year.
Insured
Money Intermediate- Insured
Market Term Long-Term
Shareholder Transaction Expenses Portfolio Portfolio Portfolio
- -------------------------------------------------------------------------------
Sales Load Imposed on Purchases ........ None None None
Sales Load Imposed on Reinvested
Dividends ............................. None None None
Redemption Fees* ....................... None None None
Exchange Fees .......................... None None None
Insured
Money Intermediate- Insured
Market Term Long-Term
Annual Fund Operating Expenses Portfolio Portfolio Portfolio
- -------------------------------------------------------------------------------
Management & Administrative Expenses ... 0.15% 0.16% 0.16%
Investment Advisory Expenses ........... 0.01 0.01 0.01
12b-1 Fees ............................. None None None
Other Expenses
Distribution Costs .................... 0.03 0.02 0.02
Miscellaneous Expenses ................ 0.01 0.02 0.01
Fund Insurance ........................ None 0.00 0.00
-------- --------- -------
Total Other Expenses ................... 0.04% 0.04% 0.03%
-------- --------- -------
Total Operating Expenses ............. 0.20% 0.21% 0.20%
======== ========= =======
*Wire redemptions under $5,000 are subject to a $5
processing fee.
The purpose of this table is to assist you in
understanding the various costs and expenses that you
would bear directly or indirectly as an investor in the
Fund. The following example illustrates the expenses that
you would incur on a $1,000 investment over various
periods, assuming (1) a 5% annual rate of return and (2)
redemption at the end of each period. As noted in the
table above, the Fund charges no redemption fees of any
kind.
1 Year 3 Years 5 Years 10 Years
-------- --------- --------- ----------
Money Market Portfolio ............ $2 $6 $11 $26
Insured Intermediate-Term Portfolio $2 $7 $12 $27
Insured Long-Term Portfolio ....... $2 $6 $11 $26
This example should not be considered a representation of
past or future expenses or performance. Actual expenses
may be higher or lower than those shown.
- -------------------------------------------------------------------------------
5
<PAGE>
- -------------------------------------------------------------------------------
FINANCIAL
HIGHLIGHTS The following financial highlights for a share outstanding
throughout each period, insofar as they relate to each of
the five years in the period ended November 30, 1995, have
been audited by Price Waterhouse LLP, independent
accountants, whose report thereon was unqualified. This
information should be read in conjunction with the
financial statements and notes thereto, which, together
with the remaining portions of the Fund's 1995 Annual
Report to Shareholders, are incorporated by reference in
the Statement of Additional Information and this
Prospectus, and which appear, along with the report of
Price Waterhouse LLP, in the Fund's 1995 Annual Report to
Shareholders. For a more complete discussion of the Fund's
performance, please see the Fund's 1995 Annual Report to
Shareholders which may be obtained without charge by
writing to the Fund or by calling our Investor Information
Department at 1-800-662-7447.
<TABLE>
<CAPTION>
-----------------------------------------------
MONEY MARKET PORTFOLIO
-----------------------------------------------
Year Ended November 30,
-----------------------------------------------
1995 1994 1993 1992
- ----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net Asset Value, Beginning of
Period ................................. $ 1.00 $ 1.00 $ 1.00 $ 1.00
------ ------ ------ ------
Investment Operations
Net Investment Income .................. .036 .026 .024 .029
Net Realized and Unrealized Gain
(Loss) on Investments ................ -- -- -- --
------ ------ ------ ------
Total from Investment
Operations ......................... .036 .026 .024 .029
- ----------------------------------------------------------------------------------------------
Distributions
Dividends from Net Investment
Income ............................... (.036) (.026) (.024) (.029)
Distributions from Realized
Capital Gains ........................ -- -- -- --
------ ------ ------ ------
Total Distributions .................. (.036) (.026) (.024) (.029)
- ----------------------------------------------------------------------------------------------
Net Asset Value, End of Period ............ $ 1.00 $ 1.00 $ 1.00 $ 1.00
==============================================================================================
Total Return .............................. 3.69% 2.59% 2.40% 2.97%
==============================================================================================
Ratios/Supplemental Data
Net Assets, End of Period (Millions) $1,202 $1,159 $1,006 $ 794
Ratio of Expenses to Average Net
Assets ................................. .20%+ .19% .19% .24%
Ratio of Net Investment Income to
Average Net Assets ..................... 3.61% 2.57% 2.37% 2.92%
Portfolio Turnover Rate ................... N/A N/A N/A N/A
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
-----------------------------------------------------
MONEY MARKET PORTFOLIO
-----------------------------------------------------
Year Ended November 30, June 1**
--------------------------------------- to
Nov. 30,
1991 1990 1989 1988 1987
- -----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of
Period ........................... $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00
------ ------ ------ ------ ------
Investment Operations
Net Investment Income ............ .043 .054 .060 .049 .020
Net Realized and Unrealized Gain
(Loss) on Investments ......... -- -- -- -- --
------ ------ ------ ------ ------
Total from Investment
Operations .................. .043 .054 .060 .049 .020
- -----------------------------------------------------------------------------------------------
Distributions
Dividends from Net Investment
Income ........................ (.043) (.054) (.060) (.049) (0.20)
Distributions from Realized
Capital Gains ................. -- -- -- -- --
------ ------ ------ ------ ------
Total Distributions ............ (.043) (.054) (.060) (.049) (.020)
- -----------------------------------------------------------------------------------------------
Net Asset Value, End of Period ..... $1.00 $1.00 $1.00 $1.00 $1.00
===============================================================================================
Total Return ....................... 4.44% 5.59% 6.19% 5.06% 2.23%
===============================================================================================
Ratios/Supplemental Data
Net Assets, End of Period (Millions) $759 $723 $540 $290 $71
Ratio of Expenses to Average Net
Assets ........................... .24% .25% .22% .26% .33%*
Ratio of Net Investment Income to
Average Net Assets ............... 4.32% 5.43% 5.99% 5.02% 4.04%*
Portfolio Turnover Rate ............ N/A N/A N/A N/A N/A
*Annualized.
**Commencement of operations.
+Effective in fiscal 1995, does not include reductions from directed
brokerage and custodian fee offset arrangements.
</TABLE>
6
<PAGE>
<TABLE>
<CAPTION>
-----------------------------------------------
INSURED LONG-TERM PORTFOLIO
-----------------------------------------------
Year Ended November 30,
-----------------------------------------------
1995 1994 1993 1992
- -------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net Asset Value, Beginning of Period $9.92 $11.30 $10.89 $10.43
----- ------ ------ ------
Investment Operations
Net Investment Income ............ .602 .604 .604 .633
Net Realized and Unrealized Gain
(Loss) on Investments ......... 1.350 (1.228) .609 .464
----- ------ ------ ------
Total from Investment
Operations .............. 1.952 (.624) 1.213 1.097
- -------------------------------------------------------------------------------------
Distributions
Dividends from Net Investment
Income ........................ (.602) (.604) (.604) (.633)
Distributions from Realized
Capital Gains ................. -- (.152) (.199) (.004)
----- ------ ------ ------
Total Distributions ........... (.602) (.756) (.803) (.637)
- -------------------------------------------------------------------------------------
Net Asset Value, End of Period ..... $11.27 $9.92 $11.30 $10.89
=====================================================================================
Total Return ....................... 20.11% (5.88)% 11.53% 10.81%
=====================================================================================
Ratios/Supplemental Data
Net Assets, End of Period (Millions) $975 $834 $1,074 $828
Ratio of Expenses to Average Net
Assets ........................... .20%(1) .19% .19% .24%
Ratio of Net Investment Income to
Average Net Assets ............... 5.59% 5.60% 5.38% 5.92%
Portfolio Turnover Rate ............ 23% 28% 27% 54%
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
------------------------------------------------------------------
INSURED LONG-TERM PORTFOLIO
------------------------------------------------------------------
Year Ended November 30, April 7**
----------------------------------------------------- to
Nov. 30,
1991 1990 1989 1988 1987 1987
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Period $10.22 $10.19 $9.71 $9.26 $10.47 $10.00
-------- -------- -------- ------- --------- --------
Investment Operations
Net Investment Income ............ .644 .660 .671 .656 .668 .412
Net Realized and Unrealized Gain
(Loss) on Investments ......... .210 .030 .480 .450 (1.210) .481
-------- -------- -------- ------- --------- --------
Total from Investment
Operations .............. .854 .690 1.151 1.106 (.542) .893
----------------------------------------------------------------------------------------------------------
Distributions
Dividends from Net Investment
Income ........................ (.644) (.660) (.671) (.656) (.668) (.412)
Distributions from Realized
Capital Gains ................. -- -- -- -- -- (.011)
-------- -------- -------- ------- --------- --------
Total Distributions ........... (.644) (.660) (.671) (.656) (.668) (.423)
- ------------------------------------------------------------------------------------------------------------
Net Asset Value, End of Period ..... $10.43 $10.22 $10.19 $9.71 $9.26 $10.47
============================================================================================================
Total Return ....................... 8.61% 7.06% 12.16% 12.22% (5.25)% 9.47%
============================================================================================================
Ratios/Supplemental Data
Net Assets, End of Period (Millions) $629 $385 $260 $126 $89 $76
Ratio of Expenses to Average Net
Assets ........................... .25%+ .26%+ .24%+ .30%+ .31%+ .33%+*
Ratio of Net Investment Income to
Average Net Assets ............... 6.24% 6.57% 6.67% 6.83% 6.86% 6.65%*
Portfolio Turnover Rate ............ 19% 6% 3% 4% 37% 12%
</TABLE>
*Annualized.
+Insurance Expenses Represent .01%, .01%, .02%, .02%, .03%, and .03%
respectively and/or less than 0.01% in 1992, 1993, 1994, and 1995.
**Commencement of operations.
(1)Effective in fiscal 1995, does not include reductions from directed
brokerage and custodian fee offset arrangements.
7
<PAGE>
<TABLE>
<CAPTION>
-----------------------------------
INSURED INTERMEDIATE-TERM PORTFOLIO
-----------------------------------
Year Ended March 4**
November 30, to November 30,
1995 1994
- -------------------------------------------------------------------------------------------
<S> <C> <C>
Net Asset Value, Beginning of Period ................. $9.64 $10.00
----------- ----------
Investment Operations
Net Investment Income .............................. .511 .346
Net Realized and Unrealized Gain (Loss) on
Investments ..................................... .800 (.360)
----------- ----------
Total from Investment Operations ........... 1.311 (.014)
- -------------------------------------------------------------------------------------------
Distributions
Dividends from Net Investment Income ............... (.511) (.346)
Distributions from Realized Capital Gains .......... -- --
----------- ----------
Total Distributions ............................. (.511) (.346)
- -------------------------------------------------------------------------------------------
Net Asset Value, End of Period ....................... $10.44 $9.64
===========================================================================================
Total Return ......................................... 13.88% (0.19)%
===========================================================================================
Ratios/Supplemental Data
Net Assets, End of Period (Millions) ................. $206 $100
Ratio of Expenses to Average Net Assets .............. .21%+ .19%*
Ratio of Net Investment Income to Average Net Assets . 5.05% 4.97%*
Portfolio Turnover Rate .............................. 11% 6%
</TABLE>
*Annualized.
**Commencement of operations.
+Effective in fiscal 1995, does not include reductions from directed
brokerage and custodian fee offset arrangements.
- -------------------------------------------------------------------------------
<PAGE>
YIELD AND
TOTAL RETURN From time to time a Portfolio of the Fund may advertise
its yield and total return. Both yield and total return
figures are based on historical earnings and are not
intended to indicate future performance. The "total
return" of a Portfolio refers to the average annual
compounded rates of return over one-, five- and ten-year
periods or over the life of a Portfolio (as stated in the
advertisement) that would equate an initial amount
invested at the beginning of a stated period to the ending
redeemable value of the investment, assuming the
reinvestment of all dividend and capital gains
distributions.
In accordance with industry guidelines set forth by the
U.S. Securities and Exchange Commission, the "30-day
yield" of the Insured Intermediate-Term and Insured
Long-Term Portfolios is calculated by dividing the net
investment income per share earned during a 30-day period
by the net asset value per share on the last day of the
period. Net investment income includes interest and
dividend income earned on a Portfolio's securities; it is
net of all expenses and all recurring and nonrecurring
charges that have been applied to all shareholder
accounts. The yield calculation assumes that the net
investment income earned over 30 days is compounded
monthly for six months and then annualized.
The "seven-day" or "current" yield of the Money Market
Portfolio reflects the income earned by a hypothetical
account in the Portfolio during a seven-day
8
<PAGE>
period, expressed as an annual percentage rate. The
"effective yield" of the Money Market Portfolio assumes
that the income over the seven-day period is reinvested
weekly, resulting in a slightly higher stated yield
through compounding.
Methods used to calculate advertised yields are
standardized for money market and bond funds. However,
these methods differ from the accounting methods used by
the Portfolios to maintain their books and records, and so
advertised yields may not fully reflect the income paid to
an investor's account or the yield reported in the Fund's
Annual Report to Shareholders.
- -------------------------------------------------------------------------------
INVESTMENT The Fund consists of the California Money Market
OBJECTIVES Portfolio, the California Insured Intermediate-Term
Portfolio and the California Insured Long-Term Portfolio,
The Fund seeks to each of which has a distinct investment objective.
provide income
that is exempt o The objective of the California Money Market Portfolio
from federal and is to provide investors with income that is exempt from
California income both federal and California State personal income
taxes taxes. The Portfolio also seeks to maintain, but does
not guarantee, a constant net asset value of $1.00 per
share. Although the Portfolio invests in high quality
instruments, the shares of the Portfolio are not
insured or guaranteed by the U.S. Government.
o The objective of the California Insured
Intermediate-Term and Insured Long-Term Portfolios is
to provide investors with a high level of income that
is exempt from federal and California personal income
taxes.
The three Portfolios of the Fund are available only to
investors who reside in California. There is no assurance
that the Portfolios will achieve their stated objectives.
The investment objective of each Portfolio is fundamental
and so may not be changed without the approval of a
majority of the Fund's shareholders.
- -------------------------------------------------------------------------------
INVESTMENT
POLICIES Each Portfolio of the Fund will invest at least 80% of its
net assets in California municipal securities, exclusive
of California AMT bonds (see "Implementation of
Policies"). California municipal securities are debt
obligations issued by California state and local
governments and public financing authorities that provide
interest income that is exempt from both federal and
California personal income taxes. The California municipal
securities described above, may include securities in
which the tax-exempt interest rate is determined by an
index, swap or some other formula. Although each Portfolio
invests primarily in California municipal obligations, the
three Portfolios differ in terms of credit quality and
maturity standards.
The Money Market Under normal circumstances, the California Money Market
Portfolio will Portfolio will invest at least 80% of its net assets in
invest in the following high-quality, short-term California
short-term municipal securities:
California
municipal o Municipal notes and variable rate
securities demand instruments, including derivative securities, rated
MIG-1 or VMIG-1, or P-1 by Moody's Investors Service, Inc.
("Moody's") or SP-1+, SP-1, A-1+, or A-1 by Standard &
Poor's Corporation ("Standard & Poor's");
9
<PAGE>
o Tax-exempt commercial paper rated P-1 by Moody's or
A-1+ or A-1 by Standard & Poor's;
o Municipal bonds, including derivative securities, with
an effective maturity of 13 months or less rated a
minimum of Aa by Moody's or AA by Standard & Poor's;
and
o Unrated municipal notes considered by the Board of
Trustees to be comparable in credit quality to
securities rated MIG-1 by Moody's or SP-1+ or SP-1 by
Standard & Poor's.
In addition, up to 10% of the Money Market Portfolio's net
assets may be invested in "restricted" money market
securities, which are not freely marketable or which are
subject to restrictions on disposition under the
Securities Act of 1933.
In seeking to provide a stable share price of $1.00, the
California Money Market Portfolio is expected to maintain
a dollar-weighted average maturity of 90 days or less, and
will purchase securities with an effective maturity of 13
months or less which are eligible for purchase under Rule
2a-7 of the Investment Company Act of 1940 (the "1940
Act").
Normally, the California Money Market Portfolio will seek
to invest substantially all of its assets in the
short-term California municipal obligations listed above.
However, under certain circumstances, such as a temporary
decline in the issuance of California obligations, the
Portfolio may invest up to 20% of its net assets in
short-term municipal securities issued outside of
California (the income from which may be subject to
California income taxes) and certain taxable fixed-income
securities (the income from which may be subject to
federal and California income taxes).
Subject to the same 20% limit, the Portfolio is also
authorized to invest in short-term California AMT bonds.
The income from California AMT bonds is exempt from
regular federal and California income taxes, but may be a
tax preference item for purposes of the federal
alternative minimum tax (see "Implementation of
Policies").
Any non-California securities or California AMT bonds
purchased by the Portfolio will be subject to the same
ratings requirements as described above.
Under unusual circumstances, such as a national financial
emergency, the Portfolio reserves the right to invest more
than 20% of its net assets in securities other than
California municipal obligations. In most instances,
however, the California Money Market Portfolio will seek
to avoid such holdings in an effort to provide income that
is fully exempt from federal and California personal
income taxes.
Two Portfolios Under normal circumstances, the California Insured
invest in insured Intermediate-Term Portfolio will invest at least 65% of
California its assets in insured California municipal securities;
municipal while the California Insured Long-Term Portfolio will
securities invest at least 80% of its assets in insured California
municipal securities.
10
<PAGE>
Insured municipal bonds are those for which scheduled
payments of interest and principal are guaranteed by a
private (non-governmental) insurance company. The
insurance feature does not guarantee the market value of
the municipal bonds or the value of the shares of the
California Insured Intermediate-Term Portfolio or the
California Insured Long-Term Portfolio. The insurance
refers to the face or par value of the securities in a
Portfolio. See "Implementation of Policies" for a
description of the insurance feature of the Portfolios.
Any uninsured securities purchased by the California
Insured Intermediate-Term Portfolio or the California
Insured Long-Term Portfolio will be rated a minimum of
"investment grade" by a nationally recognized statistical
rating organization, or if unrated, will be deemed to be
of comparable quality by the investment adviser.
The California Insured Intermediate-Term Portfolio is
expected to maintain a dollar-weighted average maturity
between 7 and 12 years.
The California Insured Long-Term Portfolio is expected to
maintain a dollar-weighted average maturity between 15 and
25 years.
Bonds with longer maturities usually offer higher yields,
but are also subject to greater market fluctuations as
interest rates change. See the section entitled
"Investment Risks" for further information.
Normally, the Insured Intermediate-Term and Insured
Long-Term Portfolios seek to invest most of their assets
in insured California municipal securities. However, under
certain circumstances, such as a temporary decline in the
issuance of California obligations, the Portfolios may
invest in other types of securities. The Insured
Intermediate-Term Portfolio may invest up to 35% of its
assets in any combination of the securities listed below;
while the Insured Long-Term Portfolio may invest up to 20%
of its assets in any combination of the securities listed
below:
o Uninsured, intermediate-term or long-term California
municipal securities, respectively, rated a minimum of
Aa by Moody's or AA by Standard & Poor's;
o Uninsured, short-term municipal securities, issued in
California or in other states, with the same quality
standards that apply for the California Money Market
Portfolio; and
o Certain taxable securities, subject to the same quality
standards that apply to the California Money Market
Portfolio, including U.S. Government securities.
In such cases, a portion of a Portfolio's income may be
subject to California income taxes, federal income taxes,
or both.
Subject to a 20% of net assets limit, the Portfolios are
also authorized to invest in California AMT bonds. The
income from California AMT bonds is exempt from federal
and California income taxes, but may be a tax preference
item for purposes of the federal alternative minimum tax
(see "Implementation of Policies").
11
<PAGE>
Under unusual circumstances, such as a national financial
emergency, the Portfolios reserve the right to invest more
than 20% of their assets in securities other than
California municipal obligations. In most instances,
however, the California Insured Intermediate-Term and
Insured Long-Term Portfolios will seek to avoid such
holdings in an effort to provide income that is fully
exempt from federal and California personal income taxes.
In the event that a security held by the California
Insured Intermediate-Term Portfolio or the California
Insured Long-Term Portfolio is downgraded, the Portfolio
may continue to hold such security until the investment
adviser determines that it should be sold.
Each Portfolio Although the Fund is organized as a non-diversified
will diversify investment company, each Portfolio of the Fund intends to
its holdings diversify its holdings of California municipal securities
by complying with Subchapter M of the Internal Revenue
Code. In part, Subchapter M requires that, at the close of
each quarter of the taxable year, those issuers which
represent more than 5% of each Portfolio's assets be
limited in aggregate to 50% of the Portfolio, and that no
one issue exceed 25% of the Portfolio's total assets. As
of November 30, 1995, the California Money Market
Portfolio held securities of 49 issuers, with the largest
holding representing 9.95% of the Portfolio's assets; the
California Insured Long-Term Portfolio held securities of
96 issuers, with the largest holding representing 4.8% of
the Portfolio's assets. The California Insured
Intermediate-Term Portfolio held securities of 57 issuers,
with the largest holding representing 4.3% of the
Portfolio's assets.
Under California law, in order to be eligible to pay
dividends to California residents which will be exempt
from California personal income taxes, a mutual fund must,
at the close of each quarter, have at least 50% of the
value of its total assets invested in obligations the
interest on which is exempt from personal income taxation
under California law.
The Fund is responsible for voting the shares of all
securities its holds.
The Fund's policy of investing at least 80% of its assets
in California's municipal securities (excluding AMT bonds)
under normal circumstances is fundamental and may not be
changed without shareholder approval. The other investment
policies described above are not fundamental and so may be
changed by the Board of Trustees without shareholder
approval.
- -------------------------------------------------------------------------------
INVESTMENT As mutual funds investing in municipal securities, the
RISKS three Portfolios of the Fund are subject to interest rate,
credit, call, income and manager risk.
The Fund is Interest rate risk is the potential for fluctuations in
subject to bond prices due to changing interest rates. In general,
interest rate, bond prices vary inversely with interest rates. If
credit, call, interest rates rise, bond prices generally decline; if
income and interest rates fall, bond prices generally rise. In
manager risk addition, for a given change in interest rates,
longer-maturity bonds exhibit greater price fluctuations
than shorter-maturity bonds. To compensate investors for
this risk, longer-maturity bonds generally offer higher
yields than shorter-maturity bonds, other factors,
including credit quality, being equal. Interest rate
12
<PAGE>
risk may be increased or decreased when a portfolio
initiates or purchases derivative California municipal
securities. Such derivative securities rely on
sophisticated interest rate calculation mechanisms. For
certain types of derivative bonds, the magnitude of
increases and decreases in their price may be
proportionately larger or smaller than, or inverse to, the
price changes that broad market interest rate fluctuations
would produce in long-term bonds.
Credit risk is the possibility that a bond issuer will
fail to make timely payments of interest or principal to a
Portfolio. The credit risk of a Portfolio depends on the
credit quality of its underlying securities. In general,
the lower the credit quality of a Portfolio's municipal
securities, the higher a Portfolio's yield, all other
factors such as maturity being equal.
Call risk is the possibility that, during periods of
falling interest rates, a municipal security with a high
stated interest rate will be prepaid (or "called") prior
to its expected maturity date. As a result, a Portfolio
will be required to invest the unanticipated proceeds at
lower interest rates and the Portfolio's income may
decline. Call provisions are most common for intermediate-
and long-term municipal bonds.
Income risk is the potential for a decline in a
Portfolio's income due to falling market interest rates.
Because a Portfolio's income is based on interest rates,
which can fluctuate substantially over short periods,
income risk is expected to vary from Portfolio to
Portfolio.
The Fund is subject Finally, the investment adviser manages the Fund's
to manager risk Portfolios according to the traditional methods of
"active" investment management, which involve the buying
and selling of securities based upon economic, financial
and market analysis and investment judgment. Manager risk
refers to the possibility that the Fund's investment
adviser may fail to execute a Portfolio's investment
strategy effectively. As a result, a Portfolio may fail to
achieve its stated objective.
Except for the In terms of interest rate risk, you should anticipate that
Money Market the share prices of the Portfolios will fluctuate
Portfolio, share inversely with interest rates. The one exception is the
prices will Money Market Portfolio, which seeks to maintain a stable
fluctuate share price of $1.00.
The following chart illustrates the relative interest rate
risk of the California Insured Intermediate-Term and
Insured Long-Term Portfolios. The chart shows the market
value of a $1,000 investment in a single bond with the
same yield and maturity characteristics as the Insured
Intermediate-Term and Insured Long-Term Portfolios on
December 29, 1995, assuming a 1% point and 2% point
increase or decrease in interest rates.
13
<PAGE>
Hypothetical Value of $1,000 Investment
<TABLE>
<CAPTION>
After Change in Interest Rates of:
-------------------------------------------
30-Day Average 1% Point 1% Point 2% Point 2% Point
Portfolio Yield Maturity Increase Decrease Increase Decrease
- --------- ------ -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Intermediate-Term
Bond ........... 4.50% 6.5 Years $946 $1,058 $895 $1,119
Long-Term Bond .. 4.96% 11.6 Years $912 $1,087 $838 $1,190
</TABLE>
This chart is intended to provide you with general
guidelines for evaluating the effect of interest rate
changes on the California Insured Intermediate-Term and
Insured Long-Term Portfolios and determining the degree of
interest rate risk you may be willing to assume.
Credit risk is The California Money Market Portfolio invests primarily in
expected to high-quality, short-term California municipal securities;
be low while the California Insured Intermediate-Term and
Insured Long-Term Portfolios invest primarily in bonds
insured by top-rated insurance companies against the
possible default of an issuer as to the timely payment of
interest and principal. As a result, the average credit
quality of each Portfolio is expected to be very high and
credit risk is expected to be minimal.
Ordinarily, an investment company concentrating its
investments in one state, such as the Fund, would be
exposed to greater credit risks than an investment company
investing in a nationally diversified portfolio of
municipal securities. These risks include possible tax law
changes, a deterioration in economic conditions, differing
levels of supply and demand for California municipal
obligations, and localized natural disasters.
To minimize the effects of concentrating its investments
in California obligations, each Portfolio of the Fund
intends to diversify its holdings by complying with
Subchapter M of the Internal Revenue Code. (See
"Investment Policies" for a description of the
requirements of Subchapter M.) In addition, the
high-quality instruments held by the Money Market
Portfolio and the use of municipal bond insurance in the
Insured Intermediate-Term and Long-Term Portfolios should
minimize the credit risk associated with the Fund.
As of November 30, 1995, the top ten portfolio issuers,
based on market value, represented 47.6% of the Money
Market Portfolio's net assets, 27.8% of the Insured
Long-Term Portfolio's net assets and 30.1% of the Insured
Intermediate-Term Portfolio's net assets.
14
<PAGE>
The following chart summarizes credit, interest rate,
income and call risks for the Fund's Portfolios.
<TABLE>
<CAPTION>
=============================================================================================
Credit Interest Income Prepayment/
Portfolio Risk Rate Risk Risk Call Risk
- ---------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Money Market Low Low High Very Low
Insured Intermediate-Term Very Low Medium Medium Low
Insured Long-Term Very Low High Low Medium
=============================================================================================
</TABLE>
- -------------------------------------------------------------------------------
WHO SHOULD The Fund is intended for California residents seeking
INVEST income that is exempt from federal and California personal
income taxes. As a rule, tax-free income is attractive to
California investors in high federal and California tax brackets. You
residents can determine whether tax-exempt or taxable income is more
sseeking attractive in your own case by comparing a Portfolio's
tax-exempt tax-exempt yield with the yield from a comparable taxable
income mutual fund investment. See "How to Compare Tax-Free and
Taxable Yields."
Assuming that tax-exempt income is attractive in your own
tax bracket, you should base your selection of a Portfolio
(or Portfolios) on its expected price volatility and
yield, and your own investment objectives, risk
preferences and time horizon.
The California Money Market Portfolio is intended for
investors who are seeking a stable share price and minimal
credit risk. The yield on the Portfolio is expected to
fluctuate from day-to-day and to be lower on average than
the yield from the California Insured Intermediate-Term
and Insured Long-Term Portfolios. The California Money
Market Portfolio is suitable as a short-term investment
vehicle, emphasizing maximum protection of principal.
The California Insured Intermediate-Term Portfolio is
intended for investors who are willing to accept moderate
share price fluctuations in exchange for potentially
higher and more durable yields.
The California Insured Long-Term Portfolio is intended for
investors who are seeking the highest, most durable
streams of income and who can tolerate sometimes sharp
fluctuations in share price in pursuit of their income
objectives. The yield of the Portfolio is expected to be
higher, and the level of income provided more stable, than
that of the California Money Market and Insured
Intermediate-Term Portfolios. However, because of the
potential volatility of the Portfolio's shares price, the
California Insured Long-Term Portfolio is appropriate only
for those investors who can hold their investment over the
long term.
The Fund is intended to be a long-term investment vehicle
and is not designed to provide investors with a means of
speculating on short-term market movements. Investors who
engage in excessive account activity generate additional
costs which are borne by all of the Fund's shareholders.
In order to minimize such costs the Fund has adopted the
following policies. The Fund reserves the right to reject
any purchase request (including exchange purchases from
15
<PAGE>
other Vanguard portfo lios) that is reasonably deemed to
be disruptive to efficient portfolio management, either
because of the timing of the investment or previous
excessive trading by the investor. Additionally, the Fund
has adopted exchange privilege limitations as described in
the section "Exchange Privilege Limitations." Finally, the
Fund reserves the right to suspend the offering of its
shares.
- -------------------------------------------------------------------------------
HOW TO COMPARE Before choosing a specific tax-exempt investment, such as
TAX-FREE AND a Portfolio of the Fund, you should determine if you would
TAXABLE YIELDS be better off with taxable or tax-exempt income in your
tax bracket. To compare taxable and tax-exempt income, you
should first determine your combined federal, state and
local tax bracket. Then you should calculate the "taxable
equivalent yield" for the Portfolio you are considering,
and compare it with the yield of a taxable investment with
similar credit and maturity characteristics.
1. Determine your combined tax bracket. Your combined tax
bracket depends on whether you itemize state and local
taxes as a deduction on your federal return. If you do not
itemize, then your combined tax bracket is the sum of your
federal, state and local tax brackets.
If you do itemize, then your combined tax bracket is
calculated as follows. First, calculate your effective
state and local tax bracket using the following formula:
( Federal ) Effective
( 100% - Tax ) X State & State &
( Bracket ) Local Bracket Local Bracket
For example, if you are in a 9.3% state and local tax
bracket and a 28% federal tax bracket, your effective
state and local tax bracket would be 6.7%:
(100% -- 28%) X 9.3% = 6.7%
Second, add your effective state and local tax bracket to
your federal tax bracket to determine your combined tax
bracket:
Federal Effective Combined
Tax + State & = Tax
Bracket Local Bracket Bracket
28% + 6.7% = 34.7%
2. Calculate your taxable equivalent yield. The taxable
equivalent yield for a Portfolio is based upon the
Portfolio's current tax-exempt yield and your combined tax
bracket. The formula is:
Portfolio's Tax-Exempt Yield
--------------------------------- = Your Taxable
100% -- Your Combined Tax Bracket Equivalent Yield
For example, if you are in a combined tax bracket of
34.7%, and a Portfolio's tax- free yield is 6%, the
Portfolio's taxable equivalent yield would be 9.2%:
6%
------------- = 9.2%
100% -- 34.7%
16
<PAGE>
In this example, you would choose the tax-exempt
investment if the 9.2% taxable equivalent yield were
greater than the taxable yield from a comparable
investment (e.g., a taxable bond fund of comparable
maturity and credit quality).
- -------------------------------------------------------------------------------
IMPLEMENTATION The Fund's adviser uses a variety of investment vehicles
OF POLICIES to achieve the objective of the Fund.
The Fund invests Each Portfolio of the Fund invests principally in
in municipal tax-exempt California municipal securities, which are debt
bonds, notes and obligations issued by state and local governments and
securities derived public financing authorities that provide interest income
from municipal that is exempt from federal and California personal income
bonds and notes taxes. Municipal securities include both municipal bonds
(those securities with maturities of five years or more)
municipal notes (those securities with maturities of less
than five years) and derivative securities (for example,
those securities for which a maturity may have been
shortened by a demand feature).
Municipal bonds are issued for a wide variety of reasons:
to construct public facilities, such as airports,
highways, bridges, schools, hospitals, housing, mass
transportation, streets, water and sewer works; to obtain
funds for operating expenses; to refund outstanding
municipal obligations; and to loan funds to various public
institutions and facilities. Certain industrial
development bonds are also considered municipal bonds if
their interest is exempt from federal income tax.
Industrial development bonds are issued by, or on behalf
of, public authorities to obtain funds for various
privately-operated manufacturing facilities, housing,
sports arenas, convention centers, airports, mass
transportation systems, and water, gas or sewage works.
General obligation municipal bonds are secured by the
issuer's pledge of full faith, credit and taxing power.
Revenue or special tax bonds are payable from the revenues
derived from a particular facility or, in some cases, from
a special excise or other tax, but not from general tax
revenue. Industrial development bonds are ordinarily
dependent on the credit quality of a private authority.
Municipal notes are issued to meet the short-term funding
requirements of local, regional and state 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. Demand notes permit
an investor (such as the Fund) to demand from the issuer
payment of principal plus accrued interest upon a
specified number of days' notice.
The Fund may Although neither does so at present, each Portfolio of the
invest in AMT Fund is authorized to invest up to 20% of its assets in
bonds so-called "AMT" bonds. AMT bonds are tax- exempt "private
activity" bonds issued after August 7, 1986, whose
proceeds are directed at least in part to a private,
for-profit organization. While the income from AMT bonds
is exempt from regular federal income tax, it is a tax
17
<PAGE>
preference item for purposes of the alternative minimum
tax. The alternative minimum tax is a special separate tax
that applies to a limited number of taxpayers who have
certain adjustments to income or tax preference items.
The Fund may The Fund may invest in "Market Discount" bonds when, in
invest in Market the opinion of the Fund's adviser, the investment will be
Discount bonds advantageous to the Fund's shareholders. A Market Discount
bond is a bond purchased at a discount from its original
issue price after April 30, 1993 and with a maturity in
excess of one year from its issue date. In certain
circumstances, disposition of a Market Discount bond will
result in taxable ordinary income to the extent of any
gain realized.
Although the objective of the Fund is to provide income
free of federal income tax, certain market conditions may
make Market Discount bonds desirable investments. The Fund
will purchase Market Discount bonds only if the Fund's
adviser expects that the purchase of these investments on
an after-tax basis will enhance the Fund's total return.
Three types of To provide an added level of credit protection, the
insurance may be California Insured Intermediate-Term and Insured Long-Term
used in the Portfolios use three types of insurance: new issue, mutual
Insured fund and secondary market insurance. A new issue policy is
Intermediate-Term purchased by a bond issuer who wishes to increase the
and Insured credit rating of a security. By paying a premium and
Long-Term meeting the insurer's underwriting standards, the bond
Portfolios issuer is able to obtain a high credit rating for the
security (usually Aaa from Moody's or AAA from Standard &
Poor's). New issue insurance policies are non-cancellable
and continue in force as long as the bonds are
outstanding.
A mutual fund insurance policy may be used to guarantee
specific bonds only while owned by a mutual fund. The
Insured Intermediate-Term and Insured Long- Term
Portfolios of the Fund have obtained mutual fund insurance
policies from Financial Guaranty Insurance Company
("Financial Guaranty"), a AAA-rated insurance company.
Based upon the expected composition of each Portfolio, the
annual premiums for the policies are likely to range from
0.20% to 0.40% of the principal value of the bonds insured
under the policy, thereby reducing the Portfolios' current
yield.
A secondary market insurance policy is purchased by an
investor (such as the Insured Intermediate-Term or Insured
Long-Term Portfolio) subsequent to the bond's original
issuance and generally insures a particular bond for the
remainder of its term. A Portfolio may purchase bonds
which have already been insured under a secondary market
insurance policy by a prior investor, or the Portfolio may
itself purchase such a policy from Financial Guaranty for
bonds that are currently uninsured.
An insured municipal bond in either of the Portfolios will
typically be covered by only one of the three policies.
For instance, if a bond is already covered by a new issue
insurance policy or a secondary market insurance policy,
then that security will not be insured under a Portfolio's
mutual fund insurance policy. All of the insurance
policies used by the Portfolios will be obtained only from
insurance companies rated Aaa by Moody's or AAA by
18
<PAGE>
Standard & Poor's. The purchase of insurance from such
companies will have the effect of making the insured bonds
equivalent in quality to AAA-rated bonds.
The Insured Each Portfolio of the Fund observes strict maturity
Intermediate-Term guidelines as set forth in detail under "Investment
and Insured Long- Policies." These maturity standards are specified in terms
Term Portfolios of a Portfolio's average dollar-weighted maturity. From
may report an time to time, however, the Fund may also report an
effective average effective average dollar-weighted maturity for the Insured
dollar-weighted Intermediate-Term or Insured Long-Term Portfolio, which
maturity reflects, among other items, the likelihood that a
municipal bond or note held by the Portfolio may be
redeemed or "called" prior to its stated maturity date.
For example, if the Insured Long-Term Portfolio consists
entirely of 20-year bonds, some of which may be "called"
prior to their stated maturity in 20 years, the
Portfolio's average weighted maturity will be 20 years,
while its effective average maturity will be shorter.
A Portfolio's effective average weighted maturity will be
influenced by bond market conditions, and so may vary from
day to day, even if no change has been made to the
Portfolio's underlying investment securities. For example,
if interest rates decline, a greater proportion of a
Portfolio's securities may be subject to call (redemption)
prior to their stated maturity. As a result, reflecting
this increased call risk, the effective average maturity
of a Portfolio will shorten, independent of actual
purchases or sales of portfolio securities.
Temporary Except as described on page 10, each Portfolio will not
Investments invest in securities other than municipal bonds, except
that each Portfolio may make temporary investments for
temporary defensive purposes (and subject to the quality
standards described on page 11) in (a) notes issued by or
on behalf of municipal or corporate issuers, obligations
of the U.S. Government and its agencies, commercial paper
and bank certificates of deposit; (b) investment companies
investing in such securities which have investment
objectives consistent with those of the Portfolio to the
extent permitted by the Investment Company Act of 1940;
and (c) any such securities or municipal bonds subject to
repurchase agreements.
The Fund may Each Portfolio may purchase tax-exempt securities on a
purchase "when-issued" basis. In buying "when-issued" securities, a
when-issued Portfolio commits to buy securities at a certain price
securities even though the securities may not be delivered for up to
45 days. The Portfolio pays for the securities and begins
earning interest when the securities are actually
delivered. As a consequence, it is possible that the
market price of the securities at the time of delivery may
be higher or lower than the purchase price.
The Fund may Each Portfolio may lend its investment securities for
lend its either short-term or long-term purposes to qualified
securities institutional investors for the purpose of realizing
additional net investment income. Loans of securities by a
Portfolio will be collateralized by cash, letters of
credit, or securities issued or guaranteed by the U.S.
Government or its agencies. The collateral will equal at
least 100% of the current market value of the loaned
securities. Income derived from the lending of securities
is not tax-exempt, and a portion of the tax-exempt
19
<PAGE>
interest earned when a municipal security is on loan must
be characterized as taxable income.
Therefore, each Portfolio will limit such activity in
accordance with its investment objective.
The Fund may Each Portfolio may purchase municipal lease obligations,
invest in which are securities issued by state and local governments
municipal lease to acquire land, equipment and facilities. These
obligations obligations typically are not backed by the issuing
municipality's full authority to assess taxes to meet its
debt obligations. If the issuing authority fails to make
the appropriations necessary to cover lease payments, then
the lease may terminate, with the possibility of default
on the lease obligation and loss to investors.
Derivative Derivatives are instruments whose values are linked to or
Investing derived from an underlying security or index. The most
common and conventional types of derivative securities are
futures and options.
The Insured The California Insured Intermediate-Term and Insured
Intermediate-Term Long-Term Portfolios may invest in conventional derivative
and Insured securities including futures contracts and options, but
Long-Term only to a limited extent. The Portfolios may enter into
Portfolios may futures contracts provided that not more than 5% of its
invest in assets are required as a futures deposit; in addition, a
derivative Portfolio may enter into futures contracts and options
securities transactions to the extent that obligations under such
contracts or transactions represent not more than 20% of
the Portfolio's assets.
Futures contracts and options may be used for several
common fund management strategies: to maintain cash
reserves while simulating full investment, to facilitate
trading, to reduce transaction costs, or to seek higher
investment returns when a specific futures contract is
priced more attractively than other futures contracts or
the underlying security or index. The Portfolios may not
use futures contracts or options transactions to leverage
its assets.
For example, in order to remain fully invested in bonds
while maintaining liquidity to meet potential shareholder
redemptions, the California Insured Intermediate-Term and
Long-Term Portfolios may invest a portion of its assets in
a bond futures contract. Because futures contracts only
require a small initial margin deposit, the Portfolios
would then be able to maintain a cash reserve to meet
potential redemptions, while at the same time remaining
fully invested. Also, because the transaction costs of
futures and options may be lower than the cost of
investing in bonds directly, it is expected that the use
of futures contracts and options may reduce the
Portfolios' total transaction costs.
The Portfolios may use futures contracts for bona fide
"hedging" purposes. In executing a hedge, a manager sells,
for example, municipal bond futures contracts to protect
against a decline in the bond market. If the market drops,
the value of the futures position will rise, thereby
offsetting the decline in value of the portfolio's bond
holdings.
The Portfolios may invest in partnerships and grantor
trust derivative products. However, prior to the purchase
of such security, a determination must be made by the
Portfolio that the inherent risk of the partnership or
grantor trust derivative product is minimal.
20
<PAGE>
Futures contracts The primary risks associated with the use of futures
and options pose contracts and options are: (i) imperfect correlation
risks between the change in market value of the bonds held by a
Portfolio and the prices of futures contracts and options;
and (ii) possible lack of a liquid secondary market for a
futures contract and the resulting inability to close a
futures position prior to its maturity date. The risk of
imperfect correlation will be minimized by investing in
those contracts whose price fluctuations are expected to
resemble those of the Portfolio's underlying securities.
The risk that a Portfolio will be unable to close out a
futures position will be minimized by entering into such
transactions on a national exchange with an active and
liquid secondary market.
The risk of loss in trading futures contracts in some
strategies can be substantial, due both to the low margin
deposits required and the extremely high degree of
leverage involved in futures pricing. As a result, a
relatively small price movement in a futures contract may
result in immediate and substantial loss (or gain) to the
investor. When investing in futures contracts, a Portfolio
will segregate cash or cash equivalents in the amount of
the underlying obligation.
Partnerships and The primary risks associated with partnerships and grantor
grantor trusts trust derivative products are (i) the possibility of a tax
pose certain ruling which affects the status of the state or federal
risks opinions which are necessary to support the issuance of
the derivative; (ii) the possibility that the tender
option on a security could be withdrawn upon the
occurrence of certain events and (iii) the possible lack
of a liquid secondary market for the securities. The
Portfolios will attempt to minimize the risks of
partnership and grantor trust derivative products by
carefully selecting which securities to purchase and by
constantly monitoring securities held by the Portfolios.
- -------------------------------------------------------------------------------
INVESTMENT The Fund has adopted certain limitations designed to
LIMITATIONS reduce its exposure to specific situations. These
limitations include the following:
The Fund has (a) California Insured Intermediate-Term Portfolio
adopted certain will invest a minimum of 65% of its net assets in
fundamental insured municipal bonds, the interest on which is
limitations exempt from federal and California personal income
taxes, except that it may make temporary investments
as described in "Implementation of Policies."
(b) The California Insured Long-Term Portfolio will invest
a minimum of 80% of its net assets in insured
municipal bonds, the interest on which is exempt from
federal and California personal income taxes, except
that it may make temporary investments as described in
(c) The California Money Market Portfolio "Implementation
of Policies." will invest a minimum of 80% of its net
assets in short-term municipal securities, the
interest on which is exempt from federal and
California personal income taxes, except that it may
make temporary investments as described in
"Implementation of Policies."
(d) At the close of each quarter of the taxable year,
those issuers which represent more than 5% of a
Portfolio's assets will be limited in aggregate to 50%
of the assets of that Portfolio (except U.S.
Government and cash items, as defined in the Internal
Revenue Code (the "Code")).
21
<PAGE>
(e) Each Portfolio will limit the aggregate value of
holdings of a single issuer (except U.S. Government
and cash items as defined in the Code) to a maximum of
25% of the Portfolio's total assets. For the purposes
of this limitation, identification of the issuer will
be based on a determination of the source of assets
and revenues committed to meeting interest and
principal payments on each security.
(f) A Portfolio will not borrow money except for temporary
or emergency purposes, and then not in excess of 10%
of the Portfolio's total assets. The Portfolio will
repay all borrowings before making additional
investments, and the interest paid on such borrowings
will reduce income.
(g) A Portfolio will not pledge, mortgage, or hypothecate
more than 10% of its total assets.
These investment limitations are considered at the time
investment securities are purchased. The limitations
described here and in the Statement of Additional
Information may be changed only with the approval of a
majority of the Fund's shareholders.
- -------------------------------------------------------------------------------
MANAGEMENT The Fund is a member of The Vanguard Group of Investment
OF THE FUND Companies, a family of more than 30 investment companies
with more than 90 distinct investment portfolios and total
Vanguard assets in excess of $190 billion. Through their
administers and jointly-owned subsidiary, The Vanguard Group, Inc.
distributes the ("Vanguard"), the Fund and the other funds in the Group
Fund obtain at cost virtually all of their corporate
management, administrative, shareholder accounting and
distribution services. Vanguard also provides investment
advisory services on an at-cost basis to certain Vanguard
funds. As a result of Vanguard's unique corporate
structure, the Vanguard funds have costs substantially
lower than those of most competing mutual funds. In 1995,
the average expense ratio (annual costs including advisory
fees divided by total net assets) for the Vanguard funds
amounted to approximately .31% compared to an average of
1.11% for the mutual fund industry (data provided by
Lipper Analytical Services).
The Officers of the Fund manage its day-to-day operations
and are responsible to the Fund's Board of Trustees
(Directors). The Trustees (Directors) set broad policies
for each Fund and choose its Officers. A list of the
Trustees and Officers of the Fund and a statement of their
present positions and principal occupations during the
past five years can be found in the Statement of
Additional Information.
Vanguard employs a supporting staff of management and
administrative personnel needed to provide the requisite
services to the funds and also furnishes the funds with
necessary office space, furnishings and equipment. Each
fund pays its share of Vanguard's total expenses, which
are allocated among the funds under methods approved by
the Board of Trustees of each fund. In addition, each fund
bears its own direct expenses, such as legal, auditing and
custodian fees.
22
<PAGE>
Vanguard also provides distribution and marketing services
to the Vanguard funds. The funds are available on a
no-load basis (i.e., there are no sales commissions or
12b-1 fees). However, each fund bears its share of the
Group's distribution costs.
- -------------------------------------------------------------------------------
INVESTMENT The three Portfolios of the Fund receive all investment
ADVISER advisory services on an at-cost basis from Vanguard's
Fixed Income Group. The Group also provides investment
Vanguard manages advisory services to more than 40 other Vanguard money
the Fund's market and bond portfolios, both taxable and tax-exempt.
investments Total assets under management by Vanguard's Fixed Income
Group were approximately $66 billion as of December 31,
1995. The Fixed Income Group is supervised by the Officers
of the Fund. Ian A. MacKinnon, Senior Vice President of
Vanguard, has been in charge of the Group since its
inception in 1981. Mr. MacKinnon is responsible for
setting the broad investment strategies employed by the
Fund, and for overseeing the portfolio managers who
implement these strategies on a day-to-day basis.
o Reid Smith, a Principal of Vanguard, serves as portfolio
manager of the California Insured Intermediate-Term and
Insured Long-Term Portfolios. Mr. Smith has managed the
Insured Intermediate-Term Portfolio since its inception in
1994, and began managing the Insured Long-Term Portfolio
in 1992. (Previously, the Insured Long-Term Portfolio was
managed by David Hamlin of the Fixed Income Group.) For 3
years prior to joining Vanguard, Mr. Smith was associated
with another mutual fund advisory firm as a fixed-income
portfolio manager.
The Fixed Income Group manages the investment and
reinvestment of the assets of the Fund's Portfolios and
continuously reviews, supervises and administers each
Portfolio's investment program, subject to the maturity
and quality standards specified in this Prospectus and
supplemental guidelines approved by the Fund's Board of
Trustees. The Fixed Income Group's selection of
investments for the Portfolios is based on: (a) continuing
credit analysis of those instruments held in the
Portfolios and those being considered for inclusion
therein; (b) possible disparities in yield relationships
between different fixed-income securities and money market
instruments; and (c) actual or anticipated movements in
the general level of interest rates.
Vanguard's Fixed Income Group places all orders for
purchases and sales of portfolio securities. Purchases of
portfolio securities are made either directly from the
issuer or from municipal securities dealers. The Fixed
Income Group may sell portfolio securities prior to their
maturity if circumstances and considerations warrant and
if it believes such dispositions advisable. The Fund's
policy of investing in short-term instruments in the
California Money Market Portfolio will likely result in
significant portfolio turnover. The Fixed Income Group
seeks to obtain the best available net price and most
favorable execution for all portfolio transactions.
- -------------------------------------------------------------------------------
DIVIDENDS, CAPITAL Dividends consisting of virtually all of the ordinary
GAINS AND TAXES income of each Portfolio are declared daily and are
payable to shareholders of record at the close of the
The Fund pays previous business day. Such dividends are paid on the
month-end first business day of each month. Capital gains
dividends distributions, if any, will be made annually.
23
<PAGE>
Dividend and capital gains distributions may be
automatically reinvested or received in cash. See
"Choosing a Distribution Option" for a description of
these distribution methods.
In addition, in order to satisfy certain distribution
requirements of the Tax Reform Act of 1986, each Portfolio
may declare special year-end dividend and capital gains
distributions during December. Such distributions, if
received by shareholders by January 31, are deemed to have
been paid by the Portfolio and received by shareholders by
December 31 of the prior year.
Dividends will be Each Portfolio of the Fund intends to continue to qualify
exempt from federal for taxation as a "regulated investment company" under the
and California Internal Revenue Code so that each Portfolio will not be
income taxes subject to federal income tax to the extent that its
income is distributed to shareholders. In addition, each
Portfolio intends to invest a sufficient portion of its
assets in municipal bonds and notes so that it will
qualify to pay "exempt-interest dividends" to
shareholders. Such exempt-interest dividends are excluded
from a shareholder's gross income for federal tax
purposes. The Revenue Reconciliation Act enacted during
1993 provides that market discount on tax- exempt bonds
purchased after April 30, 1993 must be taxed as ordinary
income. Accordingly, to the extent that the Fund purchases
such discounted securities, taxable income may result.
Furthermore, each Portfolio expects to invest
substantially all of its assets in California municipal
securities. As a result, each Portfolio will be eligible
to pay dividends to California residents that will be
exempt from California personal income taxes.
Net long-term capital gains realized by a Portfolio from
the sale of securities will be distributed as taxable
capital gains distributions for federal income tax
purposes. Any short-term capital gains or any taxable
interest income will be distributed as a taxable ordinary
dividend distribution for federal income tax purposes. In
general, such taxable income distributions from a
Portfolio are expected to be negligible in comparison with
tax-exempt dividends. However, under unusual
circumstances, a Portfolio may invest in securities other
than California municipal obligations. In such cases, a
portion of the Portfolio's income may be subject to
California income taxes, federal income taxes, or both.
At present, none of the Portfolios invests in AMT bonds.
However, were a Portfolio to invest in such bonds, all or
a portion of the Portfolio's dividends, while exempt from
the regular federal income tax, would be a tax preference
item for purposes of the federal alternative minimum tax.
A capital gain or A sale of shares in the Insured Intermediate-Term or
loss may be Insured Long-Term Portfolio is a taxable event and may
realized upon result in a capital gain or loss. A capital gain or loss
exchange or may be realized from an ordinary redemption of shares, a
redemption checkwriting redemption, or an exchange of shares between
two mutual funds (or two portfolios of a mutual fund). In
addition, if you held shares in the Insured
Intermediate-Term or Insured Long-Term Portfolio for six
months or less, any capital loss realized upon redemption
is disallowed to the extent of the tax-exempt dividend
income you received.
24
<PAGE>
Capital gains distributions from a Portfolio and any
capital gains or losses realized from the sale or exchange
of shares will generally be subject to state and local
taxes.
The Fund is required to withhold 31% of any taxable
dividends, capital gains distributions, and redemptions
paid to shareholders who have not complied with IRS
taxpayer identification regulations. You may avoid this
withholding requirement by indicating your proper Social
Security or Employer Identification Number on your Account
Registration Form and by certifying that you are not
subject to backup withholding.
Up to 85% of an individual's Social Security benefits may
be subject to federal income tax. Along with other
factors, total tax-exempt income, including any tax-exempt
dividend income from Portfolios of the Fund, is used to
calculate the taxable portion of Social Security benefits.
The Fund is organized as a Pennsylvania business trust
and, in the opinion of counsel, is not liable for any
income or franchise tax in the Commonwealth of
Pennsylvania. The Fund will be subject to Pennsylvania
county personal property tax in the county which is the
site of its principal office.
The tax discussion set forth above is included for general
information only. Prospective investors should consult
their own tax advisers concerning the tax consequences of
an investment in the Fund.
- -------------------------------------------------------------------------------
THE SHARE PRICE
OF EACH PORTFOLIO The share price or "net asset value" per share of each
Portfolio is determined daily by dividing the total value
of the investments and other assets of each Portfolio,
less any liabilities, by the total outstanding shares of
such Portfolio.
California Money Market Portfolio. For the purpose of
calculating the California Money Market Portfolio's net
asset value per share, securities are valued by the
"amortized cost" method of valuation, which does not take
into account unrealized gains or losses. This involves
valuing an instrument at its cost and thereafter assuming
a constant amortization to maturity of any discount or
premium, regardless of the impact of fluctuating interest
rates on the market value of the instrument. While this
method provides certainty in valuation, it may result in
periods during which value, as determined by amortized
cost, is higher or lower than the price the Portfolio
would receive if it sold the instrument.
The use of amortized cost and the maintenance of the
California Money Market Portfolio's per share net asset
value at $1.00 is based on its election to operate under
the provisions of Rule 2a-7 under the Investment Company
Act of 1940. As a condition of operating under that rule,
the California Money Market Portfolio must maintain a
dollar-weighted average portfolio maturity of 90 days or
less, purchase only instruments having remaining
maturities of 13 months or less, and invest only in
securities that are determined by the Trustees to present
minimal credit risks and that are of high quality as
determined by any major rating service, or in the case of
any instrument not so rated, considered by the Trustees to
be of comparable quality.
25
<PAGE>
The Trustees have established procedures designed to
stabilize the net asset value per share as computed for
the purposes of sales and redemptions at $1.00. These
procedures include periodic review, as the Trustees deem
appropriate and at such intervals as are reasonable in
light of current market conditions, of the relationship
between the amortized cost value per share and a net asset
value per share based upon available indications of market
value. In such a review, investments for which market
quotations are readily available are valued at the most
recent bid price or quoted yield equivalent for such
securities or for securities of comparable maturity,
quality and type as obtained from one or more of the major
market makers for the securities to be valued. Other
investments and assets are valued at fair value, as
determined in good faith by the Trustees.
In the event of a deviation of over 1/2 of 1% between a
Portfolio's net asset value based upon available market
quotations or market equivalents and $1.00 per share based
on amortized cost, the Trustees will promptly consider
what action, if any, should be taken. The Trustees will
also take such action as they deem appropriate to
eliminate or to reduce, to the extent reasonably
practicable, any material dilution or other unfair results
to investors or existing shareholders which might arise
from differences between the two. Such action may include
redeeming shares in kind, selling instruments prior to
maturity to realize capital gains or losses or to shorten
average maturity, withholding dividends, paying
distributions from capital or capital gains, or utilizing
a net asset value per share based upon available market
quotations.
California Insured Intermediate-Term and Insured Long-Term
Portfolios. The net asset value per share of the
California Insured Intermediate-Term and Insured Long-Term
Portfolios is determined as of the close of regular
trading on the New York Stock Exchange (generally 4:00
p.m. Eastern time) on each day that the Exchange is open
for business. When approved by the Board of Trustees,
bonds and other fixed-income securities may be valued on
the basis of prices provided by a pricing service when
such prices are believed to reflect the fair market value
of such securities. (The prices provided by pricing
services are generally determined without regard to bid or
last sale prices. Because of the large number of
outstanding municipal bonds, the majority of issues do not
trade each day; therefore, last sale prices are not
normally available. In valuing such securities, the
pricing services generally take into account institutional
size trading in similar groups of securities and any
developments related to specific securities.) The methods
used by the pricing service and the valuations so
established are reviewed by the Officers of the Fund under
the general supervision of the Trustees. There are a
number of pricing services available and the Trustees, on
the basis of ongoing evaluation of these services, may use
other pricing services or discontinue the use of any
pricing service.
Securities not priced in this manner are priced at the
most recent quoted bid price provided by investment
dealers. Short-term instruments maturing within 60 days
26
<PAGE>
of the valuation date may be valued at cost, plus or minus
any amortized discount or premium. Other assets and
securities for which no quotations are readily available
will be valued in good faith at their fair value using
methods determined by the Trustees.
The price per share of the Insured Intermediate-Term and
Insured Long-Term Portfolios can be found daily in the
mutual fund section of most major newspapers under the
heading of Vanguard.
- -------------------------------------------------------------------------------
GENERAL
INFORMATION Vanguard California Tax-Free Fund is a Pennsylvania
business trust. The Declaration of Trust permits the
Trustees to issue an unlimited number of shares of
beneficial interest, without par value, from an unlimited
number of classes of shares. Currently the Fund is
offering three classes of shares (known as "Portfolios").
Shares of each Portfolio when issued are fully paid and
non-assessable; participate equally in dividends,
distributions and net assets; are entitled to one vote per
share; have pro rata liquidation rights; and do not have
pre-emptive rights. Also, shares of the Fund have
non-cumulative voting rights, meaning that the holders of
more than 50% of the shares voting for the election of the
Trustees can elect all of the Trustees if they so choose.
Annual meetings of shareholders will not be held except as
required by the Investment Company Act of 1940 and other
applicable law. An annual meeting will be held on the
removal of a Trustee or Trustees of the Fund if requested
in writing by the holders of not less than 10% of the
outstanding shares of the Fund.
All securities and cash are held by CoreStates Bank, N.A.,
Philadelphia, PA. The Vanguard Group, Inc., Valley Forge,
PA, serves as the Fund's Transfer and Dividend Disbursing
Agent. Price Waterhouse LLP serves as independent
accountants for the Fund and audits its financial
statements annually. The Fund is not involved in any
litigation.
- -------------------------------------------------------------------------------
27
<PAGE>
SHAREHOLDER GUIDE
OPENING AN
ACCOUNT AND
PURCHASING
SHARES To open a new account, either by mail or by wire, simply
complete and return an Account Registration Form and any
required legal documentation. Please indicate the
Portfolio you have chosen and the amount you wish to
invest. Your purchase must be equal to or greater than the
$3,000 minimum initial investment requirement in any
Portfolio ($1,000 for Uniform Gifts/Transfers to Minors
Act accounts). In addition, you must be a California
resident to invest in the Fund. If you need assistance
with the Account Registration Form or have any questions,
please call our Investor Information Department at
1-800-662-7447. Note: For other types of account
registrations (e.g. corporations, associations, other
organizations, trusts or powers of attorney), please call
us to determine which additional forms you may need.
Each Portfolio's shares generally are purchased at the
next-determined net asset value after your investment has
been received in the form of Federal Funds. See "When Your
Account Will Be Credited". The Fund is offered on a
no-load basis (i.e., there are no sales commissions or
12b-1 fees).
Purchase
Restrictions 1) Because of the risks associated with bond investments, the
Fund is intended to be a long-term investment vehicle and
is not designed to provide investors with a means of
speculating on short-term market movements. Consequently
the Fund reserves the right to reject any specific
purchase (and exchange purchase) request. The Fund also
reserves the right to suspend the offering of shares for a
period of time.
2) Vanguard will not accept third-party checks to purchase
shares of the Fund. Please be sure your purchase check is
made payable to the Vanguard Group.
Additional
Investments Subsequent investments may be made by mail ($100 minimum
per Portfolio), wire ($1,000 minimum per Portfolio),
exchange from another Vanguard Fund account ($100 minimum
per Portfolio), or Vanguard Fund Express.
-----------------------------------------------------------
<TABLE>
<CAPTION>
<S> <C> <C>
Purchasing By Mail NEW ACCOUNT ADDITIONAL INVESTMENTS TO
Complete and sign Please include the amount of EXISTING ACCOUNTS
the enclosed your initial investment and Additional investments should
Account the name of the Portfolios you include the Invest-by-Mail
Registration have selected on the remittance form attached to
Form registration form, make your your Fund confirmation
check payable to The Vanguard statements. Please make your
Group- (Portfolio Number). See check payable to The Vanguard
page 29 for the appropriate Group- (Portfolio Number). See
Portfolio number, and mail to: page 29 for the appropriate
Vanguard Financial Center Portfolio number. Write your
P.O. Box 2600 account number on your check
Valley Forge, PA 19482 and, using the return envelope
provided, mail to the address
indicated on the
Invest-by-Mail Form.
</TABLE>
28
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C>
For express Vanguard Financial Center All written requests should be
or registered 455 Devon Park mailed to one of the addresses
mail, send to: Wayne, PA 19087 indicated for new accounts.
Do not send registered or
express mail to the post office
box address.
</TABLE>
VANGUARD CALIFORNIA TAX-FREE PORTFOLIOS:
California Money Market Portfolio-62
California Insured Intermediate-Term Portfolio-100
California Insured Long-Term Portfolio-75
------------------------------------------------------------
Purchasing By Wire CORESTATES BANK, N.A.
Money should be ABA 031000011
wired to: CORESTATES NO. 0141 1274
ATTN VANGUARD
Before Wiring VANGUARD CALIFORNIA TAX-FREE FUND
Please contact NAME OF PORTFOLIO
Client Services ACCOUNT NUMBER
(1-800-662-2739) ACCOUNT REGISTRATION
To assure proper receipt, please be sure your bank includes
the Portfolio name, the account number Vanguard has
assigned to you and the eight-digit CoreStates number. If
you are opening a new account, please complete the Account
Registration Form and mail it to the "New Account" address
after completing your wire arrangement. Note: Federal Funds
wire purchase orders will be accepted only when the Fund
and Custodian Bank are open for business.
------------------------------------------------------------
Purchasing By You may open an account or purchase additional shares of
Exchange (from a the Fund by making an exchange from an existing Vanguard
Vanguard account) Fund account. Accounts opened by exchange will have the
same registration as the existing account. Please note: the
Fund reserves the right to reject any exchange purchase
request. For more information, please call our Client
Services Department at 1-800-662-2739.
------------------------------------------------------------
Purchasing By The Fund Express Special Purchase option lets you move
Fund Express money from your bank account to your Vanguard account on an
"as needed" basis. Or if you choose the Automatic
Special Purchase Investment option, money will be moved automatically from
and Automatic your bank account to your Vanguard account on the schedule
Investment (monthly, bimonthly [every other month], quarterly or
yearly) you select. To establish these Fund Express
options, please provide the appropriate information on the
Account Registration Form. We will send you a confirmation
of your Fund Express service; please wait three weeks
before using the service.
- -------------------------------------------------------------------------------
CHOOSING A You must select one of three distribution options:
DISTRIBUTION
OPTION 1. Automatic Reinvestment Option--Both dividends and
capital gains distributions will be reinvested in
additional Fund shares. This option will be selected for
you automatically unless you specify one of the other
options.
29
<PAGE>
2. Cash Dividend Option--Your dividends will be paid in
cash and your capital gains will be reinvested in
additional Fund shares.
3. All Cash Option--Both dividend and capital gains
distributions will be paid in cash.
You may change your option by calling our Client Services
Department (1-800-662-2739).
In addition, an option to invest your cash dividends and/or
capital gains distributions in another Vanguard Fund
account is available. Please call our Client Services
Department (1-800-662-2739) for information. You may also
elect Vanguard Dividend Express which allows you to
transfer your cash dividends and/or capital gains
distributions automatically to your bank account. Please
see "Other Vanguard Services" for more information.
- -------------------------------------------------------------------------------
TAX CAUTION Under Federal tax laws, the Fund is required to distribute
net capital gains and investment income to Fund
Investors should shareholders. These distributions are made to all
ask about the shareholders who own Fund shares as of the distribution's
timing of capital record date, regardless of how long the shares have been
gains and owned. Purchasing shares just prior to the record date
dividend could have a significant impact on your tax liability for
distributions the year. For example, if you purchase shares immediately
before investing prior to the record date of a sizable capital gain, you
will be assessed taxes on the amount of the capital gain
distribution later paid even though you owned the Fund
shares for just a short period of time. (Taxes are due on
the distributions even if the capital gain is reinvested in
additional Fund shares.) While the total value of your
investment will be the same after the capital gain
distribution--the amount of the capital gain distribution
will offset the drop in the net asset value of the
shares--you should be aware of the tax implications the
timing of your purchase may have.
Prospective investors should, therefore, inquire about
potential distributions before investing. The Fund's annual
capital gains distribution normally occurs in December,
while income dividends are generally paid on the first
business day of each month. For additional information on
distributions and taxes, see the section titled "Dividends,
Capital Gains, and Taxes."
- -------------------------------------------------------------------------------
IMPORTANT The easiest way to establish optional Vanguard services on
ACCOUNT your account is to select the options you desire when you
INFORMATION complete your Account Registration Form. If you wish to add
shareholder options later, you may need to provide Vanguard
Establishing with additional information and a signature guarantee.
Optional Please call our Client Services Department (1-800-662-2739)
Services for further assistance
Signature
Guarantees For our mutual protection, we may require a signature
guarantee on certain written transaction requests. A
signature guarantee verifies the authenticity of your
signature, and may be obtained from banks, brokers and any
other guarantor institutions that Vanguard deems
acceptable. A signature guarantee cannot be provided by a
notary public.
30
<PAGE>
Certificates With the exception of the Money Market Portfolio, share
certificates will be issued upon request. If a certificate
is lost, you may incur an expense to replace it.
Broker-Dealer
Purchases If you purchase shares in Vanguard Funds through a
registered broker-dealer or investment adviser, the
broker-dealer or adviser may charge a service fee.
Cancelling
Trades The Fund will not cancel any trade (e.g., a purchase,
exchange or redemption) believed to be authentic, received
in writing or by telephone, once the trade request has been
received.
Electronic
Prospectus
Delivery If you would prefer to receive a prospectus for the Fund or
any of the Vanguard Funds in an electronic format, please
call 1-800-231-7870 for additional information. If you
elect to do so, you may also receive a paper copy of the
prospectus, by calling 1-800-662-7447.
- -------------------------------------------------------------------------------
WHEN YOUR The trade date is the date on which your account is
ACCOUNT WILL credited. It is generally the day on which the Fund
BE CREDITED receives your investment in the form of Federal Funds
(monies credited to the Fund's Custodian Bank by a Federal
Reserve Bank). Your trade date varies according to your
method of payment for your shares.
Purchases of Fund shares by check (except the Money Market
Portfolio) will receive a trade date the day the funds are
received in good order by Vanguard. Thus if your purchase
by check is received by the close of regular trading on the
New York Stock Exchange (generally 4:00 p.m. Eastern time),
your trade date is the business day your check is received
in good order. If your purchase is received after the close
of the exchange your trade date is the business day
following receipt of your check.
For purchases by check for the Money Market Portfolio the
Fund is ordinarily credited with Federal Funds within one
business day. Thus, if your purchase by check is received
by the close of the New York Stock Exchange (generally 4:00
p.m. Eastern time), your trade date is the business day
following receipt of your check. If your purchase is
received after the close of the Exchange, your trade date
is the second business day following receipt of your check.
For purchases by Federal Funds wire or exchange, the Fund
is credited immediately with Federal Funds. Thus, if your
purchase by Federal Funds wire or exchange is received by
the close of the Exchange your trade date is the day of
receipt. If your purchase is received after the close of
the Exchange, your trade date is the business day following
receipt of your wire or exchange.
Your shares are purchased at the net asset value determined
on your trade date. You will begin to earn dividends on the
calendar day following the trade date. (For a Friday trade
date, you will begin earning dividends on Saturday.) For a
purchase of the Money Market Portfolio by Federal Funds
wire, you may qualify for a dividend on the date of
purchase if you have notified the Fund of your intention to
make the purchase by 10:45 a.m. (Eastern time) on the
business day of the wire.
31
<PAGE>
In order to prevent lengthy processing delays caused by the
clearing of foreign checks, Vanguard will only accept a
foreign check which has been drawn in U.S. dollars and has
been issued by a foreign bank with a U.S. correspondent
bank. The name of the U.S. correspondent bank must be
printed on the face of the foreign check.
Each Portfolio reserves the right to suspend the offering
of shares for a period of time. Each Portfolio also
reserves the right to reject any specific purchase request.
- ------------------------------------------------------------------------------
SELLING YOUR
SHARES You may withdraw any portion of the funds in your account
by redeeming shares at any time. You generally may initiate
a request by writing or by telephoning. Your redemption
proceeds are normally mailed, credited or wired--depending
upon the method of withdrawal you have previously
chosen--within two business days after the receipt of the
request in Good Order.
Selling By
Writing A Check You may withdraw funds from your account by writing a check
payable in the amount of $250 or more. When a check is
presented for payment to the Fund's agent, CoreStates Bank,
the Fund will redeem sufficient shares in your account at
the net asset value next determined to cover the amount of
the check. In order to establish the checkwriting option on
your account, all registered shareholders must sign a
signature card. After your completed signature card is
received by the Fund, an initial supply of checks will be
mailed within 10 business days. There is no charge for
checks or for their clearance. Corporations, trusts and
other organizations should call our Client Services
Department (1-800-662-2739) before submitting signature
cards, as additional documents may be required to establish
the checkwriting service. Before establishing the
checkwriting option, you should be aware that:
1. Writing a check (a redemption of shares) is a taxable
event.
2. The Fund does not allow an account to be closed through
the checkwriting option.
3. Vanguard cannot guarantee a stop payment on any check.
If you wish to reverse a stop payment order, you must do
so in writing.
4. Shares held in certificate form cannot be redeemed using
the checkwriting option.
5. The Fund reserves the right to terminate or alter this
service at any time.
------------------------------------------------------------
Selling By Mail Requests should be mailed to Vanguard Financial Center,
Vanguard California Tax-Free Fund, P.O. Box 1120, Valley
Forge, PA 19482. (For express or registered mail, send your
request to Vanguard Financial Center, Vanguard California
Tax-Free Fund, 455 Devon Park Drive, Wayne, PA 19087.)
The redemption price of shares will be the Portfolio's net
asset value next determined after Vanguard has received all
required documents in Good Order.
------------------------------------------------------------
32
<PAGE>
Definition of
Good Order Good Order means that the request includes the following:
1. The account number and Portfolio name.
2. The amount of the transaction (specified in dollars or
shares).
3. Signatures of all owners exactly as they are registered
on the account.
4. Any required signature guarantees.
5. Other supporting legal documentation that might be
required in the case of estates, corporations, trusts,
and certain other accounts.
6. Any certificates that you hold for the account
If you have questions about this definition as it pertains
to your request, please call our Client Services Department
at 1-800-662-2739.
------------------------------------------------------------
Selling By
Telephone To sell shares by telephone, you or your pre-authorized
representative may call our Client Services Department at
1-800-662-2739. For telephone redemptions, you may have the
proceeds sent to you by mail or by wire. In addition to the
details below, please see "Important Information About
Telephone Transactions."
By Mail: Telephone mail redemption is automatically
established on your account unless you indicate otherwise
on your Account Registration Form. You may redeem any
amount by calling Vanguard. The proceeds will be paid to
the registered shareholders and mailed to the address of
record. Please note: As a protection against fraud, your
telephone mail redemption privilege will be suspended for
10 calendar days following any expedited address change to
your account. An expedited address change is one that is
made by telephone, by Vanguard Online or, in writing,
without the signature of all account owners.
By Wire: Telephone wire redemption must be specifically
elected for your account. The best time to elect telephone
wire redemption is at the time you complete your Account
Registration Form. If you do not presently have telephone
wire redemption and wish to establish it, please contact
our Client Services Department.
With the wire redemption option, you may withdraw a minimum
of $1,000 and have the amount wired directly to your bank
account. Wire redemptions less than $5,000 are subject to a
$5 charge deducted by Vanguard. There is no Vanguard charge
for wire redemptions of $5,000 or more. However, your bank
may assess a separate fee to accept incoming wires.
A request to change the bank associated with your wire
redemption option must be received in writing, signed by
each registered shareholder, and accompanied by a voided
check or preprinted deposit slips. A signature guarantee is
required if your bank registration is not identical to your
Vanguard Fund account registration.
------------------------------------------------------------
Selling By Fund
Express
Automatic If you select the Fund Express Automatic Withdrawal option,
Withdrawal & money will be automatically moved from your Vanguard Fund
Special account to your bank account according to the schedule you
Redemption have selected. The Special Redemption option lets you move
money from your Vanguard account to your bank account on an
33
<PAGE>
"as needed" basis. To establish these Fund Express options,
please provide the appropriate information on the Account
Registration Form. We will send you a confirmation of your
Fund Express service; please wait three weeks before using
the service.
------------------------------------------------------------
Selling By
Exchange You may sell shares of a Portfolio by making an exchange to
another Vanguard Fund account. Please see "Exchanging Your
Shares" for details.
------------------------------------------------------------
Important
Redemption
Information Shares purchased by check or Fund Express may be redeemed
at any time. However, your redemption proceeds will not be
paid until payment for the purchase is collected, which may
take up to ten calendar days.
------------------------------------------------------------
Delivery of
Redemption
Proceeds Redemption requests received by telephone prior to the
close of the New York Stock Exchange (generally 4:00 p.m.
Eastern time) are processed on the day of receipt and the
redemption proceeds are normally sent on the following
business day.
Redemption requests received by telephone after the close
of the Exchange are processed on the business day following
receipt and the proceeds are normally sent on the second
business day following receipt.
All unpaid dividends credited to your account up to the
date of redemption will be included in the redemption
check. Redemption proceeds must be sent to you within seven
days of receipt of your request in Good Order, except as
described above in "Important Redemption Information."
If you experience difficulty in making a telephone
redemption during periods of drastic economic or market
changes, your redemption request may be made by regular or
express mail. It will be implemented at the net asset value
next determined after your request has been received by
Vanguard in Good Order. The Fund reserves the right to
revise or terminate the telephone redemption privilege at
any time.
The Fund may suspend the redemption right or postpone
payment at times when the New York Stock Exchange is closed
or under any emergency circumstances as determined by the
United States Securities and Exchange Commission.
------------------------------------------------------------
Vanguard's
Average Cost
Statement If you make a redemption from a qualifying account,
Vanguard will send you an Average Cost Statement which
provides you with the tax basis of the shares you redeemed.
Please see "Statement and Reports" for additional
information.
Low Balance Fee
and Minimum
Account Balance
Requirement Due to the relatively high cost of maintaining smaller
accounts, the Fund will automatically deduct a $10 annual
fee from accounts with balances falling below $2,500
($1,000 for Uniform Gifts/Transfers to Minors Act
accounts). This fee deduction will occur mid-year,
beginning in 1996. The fee generally will be waived for
investors whose aggregate Vanguard assets exceed $50,000.
In addition, the Fund reserves the right to liquidate any
non-retirement account that is below the minimum initial
investment amount of $3,000. If at any time your total
investment does not have a value of at least $3,000, you
34
<PAGE>
may be notified that your account is below the Fund's
minimum account balance requirement. You would then be
allowed 60 days to make an additional investment before the
account is liquidated. Proceeds would be promptly paid to
the registered shareholder.
Vanguard will not liquidate your account if it has fallen
below $3,000 solely as a result of declining market (i.e.,
a decline in a Portfolio's net asset value).
- -------------------------------------------------------------------------------
EXCHANGING
YOUR SHARES Should your investment goals change, you may exchange your
shares of Vanguard California Tax-Free Fund for those of
other available Vanguard Funds.
In addition to the details below, please see "Important
Information About Telephone Transactions."
Exchanging By
Telephone When exchanging shares by telephone, please have ready the
Portfolio name, account number, Social Security Number or
Call Client Employer Identification Number listed on the account, and
Services the exact name and address in which the account is
(1-800-662-2739) registered. Only the registered shareholder may complete
such an exchange. Requests for telephone exchanges received
prior to the close of trading on the New York Stock
Exchange (generally 4:00 p.m. Eastern time) are processed
at the close of business that same day. Requests received
after the close of the Exchange are processed the next
business day. Telephone exchanges are not accepted into or
from Vanguard Balanced Index, Vanguard Index Trust,
Vanguard In ternational Equity Index Fund and Vanguard
Quantitative Portfolios. If you experience difficulty in
making a telephone exchange, your exchange request may be
made by regular or express mail, and it will be implemented
at the closing net asset value on the date received by
Vanguard provided the request is received in Good Order.
-----------------------------------------------------------
Exchanging By
Mail Please be sure to include the name and account number of
your current Fund, and the name of the Fund you wish to
exchange into, the amount you wish to exchange, and the
signatures of all registered account holders. Send your
request to Vanguard Financial Center, Vanguard California
Tax-Free Fund, P.O. Box 1120, Valley Forge, PA 19482. (For
express or registered mail, send your request to Vanguard
Financial Center, Vanguard California Tax-Free Fund, 455
Devon Park Drive, Wayne PA 19087.)
------------------------------------------------------------
Important
Exchange
Information Before you make an exchange, you should consider the
following:
o Please read the Fund's prospectus before making an
exchange. For a copy and for answers to any questions you
may have, call our Investor Information Department
1-800-662-7447).
o An exchange is treated as a redemption and a purchase.
Therefore, you could realize a taxable gain or loss on
the transaction.
o Exchanges are accepted only if the registrations and the
Taxpayer Identification numbers of the two accounts are
identical.
35
<PAGE>
o The shares to be exchanged must be on deposit and not
held in certificate form.
o New accounts are not currently accepted in
Vanguard/Windsor Fund or Vanguard/PRIMECAP Fund.
o The redemption price of shares redeemed by exchange is
the net asset value next determined after Vanguard has
received documentation in Good Order.
o When opening a new account by exchange, the required you
must meet the minimum investment requirement of the new
Fund.
Every effort will be made to maintain the exchange
privilege. However, the Fund reserves the right to revise
or terminate its provisions, limit the amount of or reject
any exchange, as deemed necessary, at any time.
The Fund's exchange privilege is only available in
California, the only state in which the Fund's shares are
registered for sale.
- ------------------------------------------------------------------------------
EXCHANGE
PRIVILEGE
LIMITATIONS The Fund's exchange privilege is not intended to afford
shareholders a way to speculate on short-term movements in
the market. Accordingly, in order to prevent excessive use
of the exchange privilege that may potentially disrupt the
management of the Fund and increase transaction costs, the
Fund has established a policy of limiting excessive
exchange activity.
Exchange activity generally will not be deemed excessive if
limited to two substantive exchange redemptions (at least
30 days apart) from a Portfolio during any twelve-month
period. These limitations do not apply to exchanges from
Vanguard's money market portfolios. Notwithstanding these
limitations, the Fund reserves the right to reject any
purchase request (including exchange purchases from other
Vanguard portfolios) that is reasonably deemed to be
disruptive to efficient portfolio management.
- -------------------------------------------------------------------------------
IMPORTANT
INFORMATION
ABOUT TELEPHONE
TRANSACTIONS The ability to initiate redemptions (except wire
redemptions) and exchanges by telephone is automatically
established on your account unless you request in writing
that telephone transactions on your account not be
permitted. The ability to initiate wire redemptions by
telephone will be established on your account only if you
specifically elect this option in writing.
To protect your account from losses resulting from
unauthorized or fraudulent telephone instructions, Vanguard
adheres to the following security procedures:
1. Security Check. To request a transaction by telephone,
the caller must know (i) the name of the Portfolio; (ii)
the 10-digit account number; (iii) the exact name and
address used in the registration; and (iv) the Social
Security or Employer Identification number listed on the
account.
2. Payment Policy. The proceeds of any telephone redemption
made by mail will be made payable to the registered
shareowner and mailed to the address of record, only. In
the case of a telephone redemption by wire, the wire
transfer will be made only in accordance with the
shareowner's prior written instructions.
36
<PAGE>
Neither the Fund nor Vanguard will be responsible for the
authenticity of transaction instructions received by
telephone, provided that reasonable security procedures
have been followed. Vanguard believes that the security
procedures described above are reasonable, and that if such
procedures are followed, you will bear the risk of any
losses resulting from unauthorized or fraudulent telephone
transactions on your account. If Vanguard fails to follow
reasonable security procedures, it may be liable for any
losses resulting from unauthorized or fraudulent telephone
transactions on your account.
- ------------------------------------------------------------------------------
TRANSFERRING
REGISTRATION You may transfer the registration of any of your Fund
shares to another person by completing a transfer form and
sending it to: Vanguard Financial Center, P.O. Box 1110,
Valley Forge, PA 19482, Attention: Transfer Department. The
request must be in Good Order. Before mailing your request,
please call our Client Services Department (1-800-662-2739)
for full instructions.
- ------------------------------------------------------------------------------
STATEMENTS AND
REPORTS Vanguard will send you a confirmation statement each time
you initiate a transaction in your account except for
checkwriting redemptions from Vanguard money market
accounts. You will also receive a comprehensive account
statement at the end of each calendar quarter. The
fourth-quarter statement will be a year-end statement,
listing all transaction activity for the entire calendar
year.
Vanguard's Average Cost Statement provides you with the
average cost of shares redeemed from your account, using
the average cost single category method. This service is
available for most taxable accounts opened since January 1,
1986. In general, investors who redeemed shares from a
qualifying Vanguard account may expect to receive their
Average Cost Statement along with their Portfolio Summary
Statement. Please call our Client Services Department
(1-800-662-2739) for information.
Financial reports on the Fund will be mailed to you
semiannually, according to the Fund's fiscal year-end.
- -------------------------------------------------------------------------------
OTHER VANGUARD
SERVICES For more information about any of these services, please
call our Investor Information Department at 1-800-662-7447.
Vanguard Direct
Deposit Service With Vanguard's Direct Deposit Service, most U.S.
Government checks (including Social Security and military
pension checks) and private payroll checks may be
automatically deposited into your Vanguard Fund account.
Separate brochures and forms are available for direct
deposit of U.S. Government and private payroll checks.
Vanguard Automatic
Exchange Service Vanguard's Automatic Exchange Service allows you to move
money automatically am ong your Vanguard Fund accounts. For
instance, the service can be used to "dollar cost average"
from a money market portfolio into a stock or bond fund or
to contribute to an IRA or other retirement plan. Please
contact our Client Services Department at 1-800-662-2739.
37
<PAGE>
Vanguard Fund
Express Vanguard's Fund Express allows you to transfer money
between your Fund account and your account at a bank,
savings and loan association, or a credit union that is a
member of the Automated Clearing House (ACH) system. You
may elect this service on the Account Registration Form or
call our Investor Information Department (1-800-662-7447)
for a Fund Express application.
Special rules govern how your Fund Express purchases or
redemptions are credited to your account. In addition, some
services of Fund Express cannot be used with specific
Vanguard Funds. For more information, please refer to the
Vanguard Fund Express brochure.
Vanguard Dividend
Express Vanguard's Dividend Express allows you to transfer your
dividends and/or capital gains distributions automatically
from your Fund account, one business day after the Fund's
payable date, to your account at a bank, savings and loan
association, or a credit union that is a member of the
Automated Clearing House (ACH) system. You may elect this
service on the Account Registration Form or call our
Investor Information Department (1-800-662-7447) for a
Vanguard Dividend Express application.
Vanguard
Tele-Account Vanguard's Tele-Account is a convenient, automated service
that provides share price, price change and yield
quotations on Vanguard Funds through any TouchTone(TR)
telephone. This service also lets you obtain information
about your account balance, your last transaction, and your
most recent dividend or capital gains payment. To contact
Vanguard's Tele-Account service, dial 1-800-ON-BOARD
(1-800-662-6273). A brochure offering detailed operating
instructions is available from our Investor Information
Department (1-800-662-7447).
- -------------------------------------------------------------------------------
38
<PAGE>
[This Page Intentionally Left Blank]
<PAGE>
[This Page Intentionally Left Blank]
<PAGE>
- ------
The Vanguard Group
of Investment
Companies
Vanguard Financial Center
P.O. Box 2600
Valley Forge, PA 19482
Investor Information
Department:
1-800-662-7447 (SHIP)
Client Services
Department:
1-800-662-2739 (CREW)
Tele-Account for
24-Hour Access:
1-800-662-6273 (ON-BOARD)
Telecommunication
Service for the
Hearing-Impaired:
1-800-662-2738
Transfer Agent:
The Vanguard Group, Inc.
Vanguard Financial Center
Valley Forge, PA 19482
PO75
P R O S P E C T U S
MARCH 29, 1996
<PAGE>
PART B
VANGUARD CALIFORNIA TAX-FREE FUND
STATEMENT OF ADDITIONAL INFORMATION
MARCH 29, 1996
This Statement is not a prospectus but should be read in conjunction with
the Fund's current Prospectus dated March 29, 1996. To obtain this
Prospectus, please call:
Vanguard's Investor Information Department
1-800-662-7447
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
--------
<S> <C>
Investment Limitations ....................................... B-1
Investment Policies ........................................... B-3
Risk Factors ................................................. B-6
Yield and Total Return ....................................... B-7
Calculation of Yield ......................................... B-7
Comparative Indexes .......................................... B-8
Investment Management ........................................ B-10
Purchase of Shares ........................................... B-10
Redemption of Shares ......................................... B-10
Valuation of Shares .......................................... B-11
Management of the Fund ....................................... B-12
Description of Shares and Voting Rights ...................... B-15
Financial Statements ......................................... B-16
Appendix A--Description of Municipal Bonds and their Ratings . B-16
Appendix B--Municipal Lease Obligations ...................... B-19
</TABLE>
INVESTMENT LIMITATIONS
The following limitations cannot be changed without the consent of the
holders of a majority of the Fund's outstanding shares (as defined in the
Investment Company Act of 1940 (the "1940 Act")), including a majority of the
shares of each Portfolio.
1. Each Portfolio will limit the aggregate value of all holdings
(except U.S. Government and cash items. as defined under Subchapter M of
the Internal Revenue Code (the "Code"), each of which exceeds 5% of the
Portfolio's total assets, to an aggregate amount of 50% of such assets;
2. Each Portfolio will limit the aggregate value of holdings of a
single issuer (except U.S. government and cash items, as defined in the
Code) to a maximum of 25% of the Portfolio's total assets. For the
purposes of this limitation, identification of the issuer will be based on
a determination of the source of assets and revenues committed to meeting
interest and principal payments of each security;
3. Each Portfolio will not borrow money except for temporary or
emergency purposes and then only in an amount not exceeding 10% of the
value of the total assets of that Portfolio. The Portfolio will repay all
borrowing before making additional investments. Interest paid on such
borrowings will reduce income;
4. Each Portfolio will not pledge, mortgage or hypothecate its assets
to any extent greater than 10% of the value of the total assets of the
Portfolio;
5. Each Portfolio will not issue senior securities as defined in the
1940 Act;
B-1
<PAGE>
6. Each Portfolio will not engage in the business of underwriting
securities issued by other persons, except to the extent that the
Portfolio may technically be deemed an underwriter under the Securities
Act of 1933, as amended, in disposing of portfolio securities;
7. Each Portfolio will not purchase or otherwise acquire any security,
if as a result, more than 15% (10% with respect to the Money Market
Portfolio) of its net assets would be invested in securities that are
illiquid (included in this limitation is the Fund's investment in The
Vanguard Group, Inc.);
8. Each Portfolio will not purchase or sell real estate, but this shall
not prevent investments in Municipal Bonds secured by real estate or
interests therein;
9. Each Portfolio will not make loans to other persons, except by the
purchase of bonds, debentures or similar obligations which are publicly
distributed and as provided under "Lending of Securities";
10. Each Portfolio will not purchase on margin or sell short, except as
specified below in Investment Limitation No. 12;
11. Each Portfolio will not purchase or retain securities of an issuer
if those Trustees of the Fund, each of whom owns more than 1/2 of 1% of
such securities, together own more than 5% of the securities of such
issuer;
12. Each Portfolio will not purchase or sell commodities or commodities
contracts, except that the California Insured Intermediate-Term and
Long-Term Portfolios may invest in bond futures contracts, bond options
and options on bond futures contracts to the extent that not more than 5%
of a Portfolio's assets are required as deposit on futures contracts and
not more than 20% of the Portfolio's assets are invested in futures
contracts and/or options transactions at any time;
13. Each Portfolio will not invest its assets in securities of other
investment companies except as they may be part of a merger,
consolidation, reorganization or acquisition of assets or otherwise, to
the extent permitted by Section 12 of the 1940 Act;
14. Each Portfolio will not invest in securities other than municipal
bonds except that each Portfolio may make temporary investments in (a)
notes issued by or on behalf of municipal or corporate issuers,
obligations of the U.S. Government and its agencies, commercial paper, and
bank certificates of deposit; (b) investment companies investing in such
securities which have investment objectives consistent with those of the
Portfolio to the extent permitted by the 1940 Act; and (c) any such
securities or municipal bonds subject to repurchase agreements;
15. Each Portfolio will not invest in put, call, straddle or spread
options (except as described above in investment limitation No. 12) or
interests in oil, gas or other mineral exploration or development
programs;
16. Each Portfolio will not purchase an industrial revenue bond if as a
result of such purchase (i) more than 5% of the Portfolio's total assets,
determined at market value at the time of the proposed investment, would
be invested in industrial revenue bonds where the payment of principal and
interest is the responsibility of a company with less than three (3)
years' operating history, or (ii) more than 20% of the Portfolio's total
assets, determined at market value at the time of the proposed investment,
would be invested in industrial development bonds. These restrictions do
not apply to municipal obligations where the payment of principal and
interest is the responsibility of a government or the political
subdivision of a government.
The above-mentioned investment limitations are considered at the time
investment securities are purchased. Notwithstanding these limitations, each
Portfolio may own all or any portion of the securities of, or make loans to,
or contribute to the costs or other financial requirements of, any company
which will be (1) wholly owned by the Fund and one or more other investment
B-2
<PAGE>
companies and (2) primarily engaged in the business of providing, at cost,
management, administrative, distribution and/or related services to the Fund
and such other investment companies. Additionally, the Fund may invest in
when-issued securities without limitation. Please see the prospectus for a
description of securities.
INVESTMENT POLICIES
Lending of Securities. Each Portfolio may lend its investment securities
to qualified institutions who need to borrow securities in order to complete
certain transactions, such as covering short sales, avoiding failures to
deliver securities or completing arbitrage operations. By lending its
investment securities, the Portfolio attempts to increase its income through
the receipt of interest on the loan. Any gain or loss in the market price of
the securities loaned that might occur during the term of the loan would be
for the account of the Portfolio. The Portfolio may lend its investment
securities to qualified brokers, dealers, banks or other financial
institutions, so long as the terms and the structure of such loans are not
inconsistent with the 1940 Act, or the Rules and Regulations or
interpretations of the Securities and Exchange Commission (the "Commission")
thereunder, which currently require that (a) the borrower pledge and maintain
with the Portfolio collateral having a value at all times not less than 100%
of the value of the securities loaned, (b) the borrower add to such
collateral whenever the price of the securities loaned rises (i.e., the
borrower "marks to the market" on a daily basis), (c) the loan be made
subject to termination by the Portfolio at any time and (d) the Portfolio
receive reasonable interest on the loan (which may include the Portfolio
investing any cash collateral in interest bearing short- term investments),
any distribution on the loaned securities and any increase in their market
value. A Portfolio will not lend its investment securities, if as a result,
the aggregate of such loans exceeds 10% of the value of its total assets.
Loan arrangements made by the Portfolio will comply with all other applicable
regulatory requirements, including the rules of the New York Stock Exchange,
which rules presently require the borrower, after notice, to redeliver the
securities within the normal settlement time of three business days. All
relevant facts and circumstances, including the creditworthiness of the
broker, dealer or institution, will be considered in making decisions with
respect to the lending of securities, subject to review by the Fund's Board
of Trustees. Income derived from lending of securities is not tax- exempt,
and, thus, a Portfolio will limit such activity in accordance with its
investment objective.
FUTURES CONTRACTS AND OPTIONS
The Insured Intermediate-Term and Insured Long-Term Portfolios may enter
into futures contracts, options, and options on futures contracts for several
reasons: to maintain cash reserves while simulating full investment, to
facilitate trading, to reduce transactions costs, or to seek higher
investment returns when a futures contract is priced more attractively than
the underlying municipal security or index. Futures contracts provide for the
future sale by one party and purchase by another party of a specified amount
of a specific security at a specified future time and at a specified price.
Futures contracts which are standardized as to maturity date and underlying
financial instrument are traded on national futures exchanges. Futures
exchanges and trading are regulated under the Commodity Exchange Act by the
Commodity Futures Trading Commission ("CFTC"), a U.S. Government Agency.
Although futures contracts by their terms call for actual delivery or
acceptance of the underlying securities, in most cases the contracts are
closed out before the settlement date without the making or taking of
delivery. Closing out an open futures position is done by taking an opposite
position ("buying" a contract which has previously been "sold," or "selling"
a contract previously purchased) in an identical contract to terminate the
position. Brokerage commissions are incurred when a futures contract is
bought or sold.
Futures traders are required to make a good faith margin deposit in cash
or government securities with a broker or custodian to initiate and maintain
open positions in futures contracts. A margin deposit is intended to assure
completion of the contract (delivery or acceptance of the underlying
security) if it is not terminated prior to the specified delivery date.
Minimal initial margin requirements are established by the futures exchange
and may be changed. Brokers may establish deposit requirements which are
higher than the exchange minimums. Futures contracts are customarily
purchased and sold at prices which may range upward from less than 5% of the
value of the contract being traded.
After a futures contract position is opened, the value of the contract is
marked to market daily. If the futures contract price changes, to the extent
B-3
<PAGE>
that the margin on deposit does not satisfy margin requirements, payment of
additional "variation" margin will be required. Conversely, changes in the
contract value may reduce the required margin, resulting in a repayment of
excess margin to the contract holder. Variation margin payments are made to
and from the futures broker for as long as the contract remains open. The Fund
expects to earn interest income on its margin deposits.
Traders in futures contracts may be broadly classified as either "hedgers"
or "speculators." Hedgers use the futures markets primarily to offset
unfavorable changes in the value of securities otherwise held for investment
purposes or expected to be acquired by them. Speculators are less inclined to
own the securities underlying the futures contracts which they trade, and use
futures contracts with the expectation of realizing profits from fluctuations
in the interest rates of underlying securities. The Fund intends to use
futures contracts only for bona fide hedging purposes.
Regulations of the CFTC applicable to the Fund require that all of its
futures transactions constitute bona fide hedging transactions. The Portfolio
will only sell futures contracts to protect securities it owns against price
declines or purchase contracts to protect against an increase in the price of
securities it intends to purchase. As evidence of this hedging interest, the
Portfolio expects that approximately 75% of its futures contract purchases
will be "completed," that is, equivalent amounts of related securities will
have been purchased or are being purchased by the Portfolio upon sale of open
futures contracts.
Although techniques other than the sale and purchase of futures contracts
could be used to control the Portfolio's exposure to market fluctuations, the
use of futures contracts may be a more effective means of hedging this
exposure. While the Portfolio will incur commission expenses in both opening
and closing out futures positions, these costs are lower than transaction
costs incurred in the purchase and sale of the underlying securities.
RESTRICTIONS ON THE USE OF FUTURES CONTRACTS
A Portfolio will not enter into futures contract transactions to the
extent that, immediately thereafter, the sum of its initial margin deposits
on open contracts exceeds 5% of the market value of the Fund's total assets.
In addition, a Portfolio will not enter into futures contracts to the extent
that its outstanding obligations to purchase securities under these contracts
would exceed 20% of the Portfolio's total assets. Assets committed to futures
contracts or options will be held in a segregated account at the Fund's
custodian bank.
RISK FACTORS IN FUTURES TRANSACTIONS
Positions in futures contracts may be closed out only on an Exchange which
provides a secondary market for such futures. However, there can be no
assurance that a liquid secondary market will exist for any particular
futures contract at any specific time. Thus, it may not be possible to close
a futures position. In the event of adverse price movements, a Portfolio
would continue to be required to make daily cash payments to maintain its
required margin. In such situations, if the Portfolio has insufficient cash,
it may have to sell portfolio securities to meet daily margin requirements at
a time when it may be disadvantageous to do so. In addition, the Portfolios
may be required to make delivery of the instruments underlying futures
contracts it holds. The inability to close options and futures positions also
could have an adverse impact on the ability to effectively hedge it.
The Portfolios will minimize the risk that they will be unable to close
out a futures contract by only entering into futures which are traded on
national futures exchanges and for which there appears to be a liquid
secondary market. The principal interest rate futures exchanges in the United
States are the Board of Trade of the City of Chicago and the Chicago
Mercantile Exchange.
The risk of loss in trading futures contracts in some strategies can be
substantial, due both to the low margin deposits required, and the extremely
high degree of leverage involved in futures pricing. As a result, a
relatively small price movement in a futures contract may result in immediate
and substantial loss (as well as gain) to the investor. For example, if at
the time of purchase, 10% of the value of the futures contract is deposited
as margin, a subsequent 10% decrease in the value of the futures contract
would result in a total loss of the margin deposit, before any deduction for
B-4
<PAGE>
the transaction costs, if the account were then closed out. A 15% decrease
would result in a loss equal to 150% of the original margin deposit if the
contract were closed out. Thus, a purchase or sale of a futures contract may
result in losses in excess of the amount invested in the contract. However,
because the futures strategies of the Portfolio are engaged in only for
hedging purposes, the Adviser does not believe that the Portfolio is subject
to the risks of loss frequently associated with futures transactions. The
Portfolio would presumably have sustained comparable losses if, instead of the
futures contract, it had invested in the underlying financial instrument and
sold it after the decline.
Utilization of futures transactions by the Portfolios does involve the
risk of imperfect or no correlation where the securities underlying futures
contracts have different maturities or other characteristics than the
portfolio securities being hedged. It is also possible that the Portfolios
could both lose money on futures contracts and also experience a decline in
value of its portfolio securities. There is also the risk of loss by a
Portfolio of margin deposits in the event of bankruptcy of a broker with whom
the Portfolio has an open position in a futures contract or related option.
Most futures exchanges limit the amount of fluctuation permitted in
futures contract prices during a single trading day. The daily limit
establishes the maximum amount that the price of a futures contract may vary
either up or down from the previous day's settlement price at the end of a
trading session. Once the daily limit has been reached in a particular type
of contract, no trades may be made on that day at a price beyond that limit.
The daily limit governs only price movement during a particular trading day
and therefore does not limit potential losses, because the limit may prevent
the liquidation of unfavorable positions. Futures contract prices have
occasionally moved to the daily limit for several consecutive trading days
with little or no trading, thereby preventing prompt liquidation of future
positions and subjecting some futures traders to substantial losses.
FEDERAL TAX TREATMENT OF FUTURES CONTRACTS
The Insured Intermediate-Term and Insured Long-Term Portfolios are
required for federal income tax purposes to recognize as income for each
taxable year their net unrealized gains and losses on certain futures
contracts held as of the end of the year as well as those actually realized
during the year. In most cases, any gain or loss recognized with respect to a
futures contract 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 contract. Furthermore, sales of futures contracts which are intended to
hedge against a change in the value of securities held by the Portfolios may
affect the holding period of such securities and, consequently, the nature of
the gain or loss on such securities upon disposition. A Portfolio may be
required to defer the recognition of losses on futures contracts to the
extent of any unrecognized gains on related positions held by the Portfolio.
In order for each Portfolio to continue to qualify for Federal income tax
treatment as a regulated investment company, at least 90% of its gross income
for a taxable year must be derived from qualifying income; i.e., dividends,
interest, income derived from loans of securities, gains from the sale of
securities or of foreign currencies or other income derived with respect to
the Portfolio's business of investing in securities. In addition, gains
realized on the sale or other disposition of securities held for less than
three months must be limited to less than 30% of the Portfolio's annual gross
income. It is anticipated that any net gain realized from the closing out of
futures contracts will be considered gain from the sale of securities and
therefore be qualifying income for purposes of the 90% requirement. In order
to avoid realizing excessive gains on securities held less than three months,
the Portfolios may be required to defer the closing out of futures contracts
beyond the time when it would otherwise be advantageous to do so. It is
anticipated that unrealized gains on futures contracts, which have been open
for less than three months as of the end of each Portfolio's fiscal year and
which are recognized for tax purposes, will not be considered gains on sales
of securities held less than three months for the purpose of the 30% test.
The Portfolios will distribute to shareholders annually any net capital
gains which have been recognized for federal income tax purposes (including
unrealized gains at each end of the Portfolio's fiscal year) on futures
transactions. Such distributions will be combined with distributions of
capital gains realized on the Portfolio's other investments and shareholders
will be advised on the nature of the transactions.
B-5
<PAGE>
RISK FACTORS
VANGUARD CALIFORNIA TAX-FREE FUND
The Vanguard California Tax-Free Fund invests primarily in the obligations
of California state government and various local governments, including
counties, cities, special districts, agencies and authorities. In general,
the credit quality and credit risk of any issuer's debt depend on the state
and local economy, the health of the issuer's finances, the amount of the
issuer's debt, the quality of management, and the strength of legal
provisions in debt documents that protect debt holders. Credit risk is
usually lower wherever the economy is strong, growing and diversified;
financial operations are sound; and the debt burden is reasonable.
The credit risk associated with direct obligations of the State of
California and State agencies, including general obligation and revenue
bonds, lease debt, and notes, is now average. For most of the last two
decades, the State's general obligation bonds had enjoyed the highest rating
by either Moody's Investors Service or Standard & Poor's. California's high
credit quality reflected the growth of its strong and diversified economy, a
low debt position, wealth levels higher than the national average, and a
generally sound and stable financial position. However, California's credit
quality has declined since the onset of the national recession in 1990.
California's economy, largest among the states, is also one of the largest
in the world. The State's population, nearly 30 million in 1990, has doubled
since 1960 and constitutes about 12% of the U.S. total. Rapid growth is
continuing, with rates more than twice that of the national average during
the 1980s. Personal income growth lagged U.S. growth in the 1980s, but per
capita income was still 10% above the national average in 1990. A growing,
young population, a strong higher education system, and excellent ports
continue to bolster California's economic prospects. Employment and income
are not concentrated in any one sector. In fact, California's economy closely
mirrors that of the U.S. One caveat to this observation concerns the defense
industry. For many years, California has led the Nation in receipt of total
direct U.S. military expenditures. However, as the State's economy expanded,
the concentration in defense has lessened. Nonetheless, as U.S. policy has
resulted in lower defense spending, parts of California, especially the Los
Angeles Region, have been adversely affected, and these trends might
continue.
The State economy and State financial operations are exposed to the risk
of cyclical national recessions. In recession, credit quality can drop if
debt issuers do not maintain a balance between revenues and expenditures.
This occurred in the early 1980s when Moody's and Standard & Poor's
downgraded the State. Subsequently, State finances were restored to sound
levels, and credit ratings were upgraded. California was especially hard hit
by the recent national recession and experienced three credit-rating
downgrades by each of the two major rating agencies. The effects of recession
were not strongly felt in California until 1991 and the state has recently
begun to emerge from the depths of recession. Led by declines in
defense-related activities and construction (especially commercial real
estate), the State lost over 800,000 jobs between 1990-1993, or about 6% of
non-agricultural employment. The recession resulted in a failure by State
government to realize revenue and spending targets. The State budget was
chronically imbalanced in 1991 and 1992. State aid was reduced, spreading
fiscal stress to local governments, including schools. Severe fiscal stress
continues in State government and many local governments, and additional
credit-rating downgrades are possible.
Despite the overall strength of California credit quality, there are a
number of additional risks. The adoption of revenue and expenditure
limitations (articles XIIIA and XIIIB of the California Constitution) by
voters in the late 1970s placed many local governments under a degree of
fiscal stress which continues. Court decisions and the adoption of subsequent
propositions softened many of the effects of these limitations. However, it
should be noted that California voters have demonstrated a willingness to
utilize the statutory initiative process to curtail the financial operations
of state and local government, as well as to increase public debt. This
willingness is a continuing risk to debt holders.
Another risk resulting from Proposition 13 concerns the security
provisions for debt repayment. Since 1978, general obligation debt issuance
has required voter approval by a two-thirds majority. As a result, most
tax-backed debt now issued by California local governments is not general
obligation debt, does not have "full faith and credit" backing, and has
higher credit risk and more limited bondholder rights.
B-6
<PAGE>
Some risks in California apply more to local issuers than to state
government. In areas of very rapid population growth, the costs of building
public infrastructure are very high, large amounts of municipal bonds are
being sold, and debt burden is increasing. In some parts of southern
California, there is also a fear that population growth may possibly limit
future economic growth due to transportation and air pollution problems.
Finally, California is subject to unique natural hazard risks. Earthquakes
and wildfires can cause localized economic harm which could limit the ability
of governments to repay debt. Drought is also a concern insofar as it affects
agricultural production, power generation, and the supply of drinking water.
Drought not only places stress on the economy generally; it can limit the
ability of certain public utilities to repay debt.
YIELD AND TOTAL RETURN
The yield of the California Insured Long-Term Portfolio and the California
Insured Intermediate-Term Portfolio for the 30-day period ended November 30,
1995 was 5.15% and 4.61%, respectively.
The average annual total return of the California Insured Long-Term
Portfolio for the one- and five- year periods ended November 30, 1995, and
the period since (inception April 7, 1986) to November 30, 1995, was +20.11%,
+8.70 and +8.11%, respectively. The total return of the California Insured
Intermediate-Term Portfolio for the one-year period and the period since
inception (March 4, 1994) to November 30, 1995 was +13.88% and +7.63%,
respectively. The average annual total return of the California Money Market
Portfolio for the one-year and five-year periods ended November 30, 1995, and
the period from inception (June 1, 1987) to November 30, 1995, was +3.69%,
+3.22% and +4.14%, respectively. Total return is computed by finding the
average compounded rates of return over the one-year period set forth above
that would equate an initial amount invested at the beginning of the period
to the ending redeemable value of the investment.
CALCULATION OF YIELD
The current yield of the California Money Market Portfolio is calculated
daily on a base period return of a hypothetical account having a beginning
balance of one share for a particular period of time (generally 7 days). The
return is determined by dividing the net change (exclusive of any capital
changes) in such account by its average net asset value for the period, and
then multiplying it by 365/7 to get the annualized current yield. The
calculation of net change reflects the value of additional shares purchased
with the dividends by the Portfolio, including dividends on both the original
share and on such additional shares. An effective yield, which reflects the
effects of compounding and represents an annualization of the current yield
with all dividends reinvested, may also be calculated for the Portfolio by
adding 1 to the net change, raising the sum to the 365/7 power, and
subtracting 1 from the result.
Set forth below is an example, for purposes of illustration only, of the
current and effective yield calculations for the California Money Market
Portfolio for the 7-day base period ended November 30, 1995.
B-7
<PAGE>
<TABLE>
<CAPTION>
Money Market Portfolio
----------------------
11/30/95
--------
<S> <C>
Value of account at beginning of period ................................ $1.00000
Value of same account at end of period* ................................ $1.00069
--------
Net Change in account value ............................................ $ .00069
Annualized Current Net Yield (Net Change X 365/7)/average net asset
value ................................................................. 3.61%
Effective Yield [(Net Change) + 1] 365/7 - 1 ......................... 3.68%
Average Weighted Maturity of Investments ............................... 65 Days
</TABLE>
- ------
* Exclusive of any capital changes.
The net asset value of the California Money Market Portfolio is $1.00 and
it is not expected to fluctuate. The Money Market Portfolio seeks to
maintain, but does not guarantee, a constant net asset value of $1.00 per
share. Although the Money Market Portfolio invests in high-quality
instruments, the shares of the Portfolio are not insured or guaranteed by the
U.S. Government. The yield of the Portfolio will fluctuate. The annualization
of a week's dividend is not a representation by the Portfolio as to what an
investment in the Portfolio will actually yield in the future. Actual yields
will depend on such variables as investment quality, average maturity, the
type of instruments the Portfolio invests in, changes in interest rates on
instruments, changes in the expenses of the Fund and other factors. Yields
are one basis investors may use to analyze the Portfolios of the Fund, and
other investment vehicles, however, yields of other investment vehicles may
not be comparable because of the factors set forth in the preceding sentence,
differences in the time periods compared, and differences in the methods used
in valuing portfolio instruments, computing net asset value and calculating
yield.
COMPARATIVE INDEXES
Vanguard may use reprinted material discussing The Vanguard Group, Inc. or
any of the member funds of The Vanguard Group of Investment Companies.
Each of the investment company members of The Vanguard Group, including
Vanguard Variable Insurance Fund, may from time to time, use one or more of
the following unmanaged indexes for comparative performance purposes.
Standard and Poor's 500 Composite Stock Price Index--is a well diversified
list of 500 companies representing the U.S. Stock Market.
Wilshire 5000 Equity Index--consists of more than 6,000 common equity
securities, covering all stocks in the U.S. for which daily pricing is
available.
Wilshire 4500 Equity Index--consists of all stocks in the Wilshire 5000
except for the 500 stocks in the Standard and Poor's 500 Index.
Russell 3000 Stock Index--a diversified portfolio of approximately 3,000
common stocks accounting for over 90% of the market value of publicly traded
stocks in the U.S.
Russell 2000 Stock Index--a subset of approximately 2,000 of the smallest
stocks contained in the Russell 3000; a widely-used benchmark for small
capitalization common stocks.
Morgan Stanley Capital International EAFE Index--is an arithmetic, market
value-weighted average of the performance of over 900 securities listed on
the stock exchanges of countries in Europe, Australia and the Far East.
Goldman Sachs 100 Convertible Bond Index--currently includes 71 bonds and 29
preferreds. The original list of names was generated by screening for
convertible issues of $100 million or greater in market capitalization. The
index is priced monthly.
Salomon Brothers GNMA Index--includes pools of mortgages originated by
private lenders and guaranteed by the mortgage pools of the Government
National Mortgage Association.
Salomon Brothers High-Grade Corporate Bond Index--consists of publicly
issued, non-convertible corporate bonds rated Aa or Aaa. It is a
value-weighted, total return index, including approximately 800 issues with
maturities of 12 years or greater.
B-8
<PAGE>
Salomon Brothers Broad Investment-Grade Bond--is a market-weighted index that
contains over 4,800 individually priced investment-grade corporate bonds
rated BBB or better, U.S. Treasury/agency issues and mortgage pass-through
securities.
Lehman Long-Term Treasury Bond--is composed of all bonds covered by the
Shearson Lehman Hutton Treasury Bond Index with maturities of 10 years or
greater.
Merrill Lynch Corporate & Government Bond--consists of over 4,500 U.S.
Treasury, Agency and investment grade corporate bonds.
Lehman Corporate (Baa) Bond Index--all publicly offered fixed-rate,
nonconvertible domestic corporate bonds rated Baa by Moody's, with a maturity
longer than 1 year and with more than $25 million outstanding. This index
includes over 1,000 issues.
Lehman Brothers Long-Term Corporate Bond Index--is a subset of the Lehman
Corporate Bond Index covering all corporate, publicly issued, fixed-rate,
nonconvertible U.S. debt issues rated at least Baa, with at least $50 million
principal outstanding and maturity greater than 10 years.
Bond Buyer Municipal Index (20 Year) Bond--is a yield index on current coupon
high-grade general obligation municipal bonds.
Standard & Poor's Preferred Index--is a yield index based upon the average
yield of four high- grade, non-callable preferred stock issues.
NASDAQ Industrial Index--is composed of more than 3,000 industrial issues. It
is a value-weighted index calculated on price change only and does not
include income.
Composite Index--70% Standard & Poor's 500 Index and 30% NASDAQ Industrial
Index.
Composite Index--35% Standard & Poor's 500 Index and 65% Lehman Brothers
Long-Term Corporate Bond Index.
Composite Index--65% Standard & Poor's 500 Index and 35% Salomon Brothers
High-Grade Bond Index.
Lehman Brothers Aggregate Bond Index--is a market-weighted index that
contains individually priced U.S. Treasury, agency, corporate, and mortgage
pass-through securities corporate rated BBB- or better. The Index has a
market value of over $4 trillion.
Lehman Brothers Mutual Fund Short (1-5) Government/Corporate Index--is a
market-weighted index that contains individually priced U.S. Treasury,
agency, and corporate investment grade bonds rated BBB- or better with
maturities between 1 and 5 years. The index has a market value of over $1.3
trillion.
Lehman Brothers Mutual Fund Intermediate (5-10) Government/Corporate
Index--is a market-weighted index that contains individually priced U.S.
Treasury, agency, and corporate securities rated BBB- or better with
maturities between 5 and 10 years. The index has a market value of over $600
billion.
Lehman Brothers Mutual Fund Long (10+) Government/Corporate Index--is a
market-weighted index that contains individually priced U.S. Treasury,
agency, and corporate securities rated BBB- or better with maturities greater
than 10 years. The index has a market value of over $900 billion.
Lipper Small Company Growth Fund Average--the average performance of small
company growth funds as defined by Lipper Analytical Services, Inc. Lipper
defines a small company growth fund as a fund that by prospectus or portfolio
practice, limits its investments to companies on the basis of the size of the
company. From time to time, Vanguard may advertise using the average
performance and/or the average expense ratio of the small company growth
funds. (This fund category was first established in 1982. For years prior to
1982, the results of the Lipper Small Company Growth category were estimated
using the returns of the Funds that constituted the Group at its inception.)
Lipper Balanced Fund Average--an industry benchmark of average balanced funds
with similar investment objectives and policies, as measured by Lipper
Analytical Services, Inc.
B-9
<PAGE>
Lipper Non-Government Money Market Fund Average--an industry benchmark of
average non- government money market funds with similar investment objectives
and policies, as measured by Lipper Analytical Services, Inc.
Lipper Government Money Market Fund Average--an industry benchmark of average
government money market funds with similar investment objectives and
policies, as measured by Lipper Analytical Services, Inc.
Lipper General Equity Fund Average--an industry benchmark of average general
equity funds with similar investment objectives and policies, as measured by
Lipper Analytical Services, Inc.
Lipper Fixed Income Fund Average--an industry benchmark of average fixed
income funds with similar investment objectives and policies, as measured by
Lipper Analytical Services, Inc.
INVESTMENT MANAGEMENT
The Fund receives all investment advisory services on an "internalized,"
at-cost basis from an experienced investment management staff employed
directly by The Vanguard Group, Inc. ("Vanguard"), a subsidiary jointly owned
by the Fund and the other Funds in The Vanguard Group of Investment
Companies. The investment management staff is supervised by the senior
officers of the Fund.
The investment management staff is responsible for: maintaining the
specified standards; making changes in specific issues in light of changes in
the fundamental basis for purchasing such securities; and adjusting the Fund
to meet cash inflow (or outflow), which reflects net purchases and exchanges
of shares by investors (or net redemptions of shares) and reinvestment of the
Fund's income.
A change in securities held by the Fund is known as "portfolio turnover"
and may involve the payment of the Fund of dealer mark-ups, underwriting
commissions and other transaction costs on the sales of securities as well as
on the reinvestment of the proceeds in other securities. The annual portfolio
turnover rate for each of the Fund's portfolios is set forth under the
heading "Financial Highlights" in the California Tax-Free Fund prospectus.
The portfolio turnover rate is not a limiting factor when management deems it
desirable to sell or purchase securities. It is impossible to predict whether
or not the portfolio turnover rate in future years will vary significantly
from the rates in recent years.
During the fiscal years ended November 30, 1993, 1994 and 1995, the Fund
did not pay any brokerage commissions.
PURCHASE OF SHARES
The Fund reserves the right in its sole discretion (i) to suspend the
offering of its shares, (ii) to reject purchase orders when in the judgment
of management such rejection is in the best interest of the Fund, and (iii)
to reduce or waive the minimum investment for or any other restrictions on
initial and subsequent investments under circumstances where certain
economies can be achieved in sales of the Fund's shares.
Stock Certificates. Your purchase will be made in full and fractional
shares of the Fund calculated to three decimal places. Shares are normally
held on deposit for shareholders by the Fund, which will send to shareholders
a statement of shares owned at the time of each transaction. This saves the
shareholders the trouble of safekeeping the certificates and saves the Fund
the cost of issuing certificates. Share certificates for the California
Insured Intermediate-Term and Insured Long-Term Portfolios are, available
upon written request at no additional cost to shareholders. No certificates
will be issued for fractional shares of these Portfolios, or any shares of
the Money Market Portfolio.
REDEMPTION OF SHARES
The Fund may suspend redemption privileges or postpone the date of payment
(i) during any period that the New York Stock Exchange is closed, or trading
on the Exchange is restricted as determined by the Securities and Exchange
Commission (the "Commission"), (ii) during any period when an emergency exists
B-10
<PAGE>
as defined by the rules of the Commission as a result of which it is not
reasonably practicable for the Fund to dispose of securities owned by it, or
fairly to determine the value of its assets, and (iii) for such other periods
as the Commission may permit.
If the Board of Trustees determines that it would be detrimental to the
best interests of the remaining shareholders of the Fund to make payment
wholly or partly in cash, the Fund may pay the redemption price in whole or
in part by a distribution in kind of securities held by the Fund in lieu of
cash in conformity with applicable rules of the Commission. Investors may
incur brokerage charges on the sale of such securities so received in payment
of redemptions.
No charge is made by the Fund for redemptions except for wire redemptions
of under $5000 which may be charged a maximum fee of $5.00. Any redemption
may be more or less than the shareholder's cost depending on the market value
of the securities held by the Fund.
Signature Guarantees. To protect your account, the Fund and Vanguard from
fraud, signature guarantees are required for certain redemptions. Signature
guarantees enable the Fund to verify the identity of the person who has who
has authorized a redemption from your account. Signature guarantees are
required in connection with: (1) all redemptions, regardless of the amount
involved, when the proceeds are to be paid to someone other than the
registered owners; and (2) share transfer requests.
A signature guarantee may be obtained from banks, brokers and any other
guarantor institution that Vanguard deems acceptable. Notaries public are not
acceptable guarantors.
The signature guarantees must appear either: (1) on the written request
for redemption, (2) on a separate instrument for assignment ("stock power")
which should specify the total number of shares to be redeemed, or (3) on all
stock certificates tendered for redemption and, if shares held by the Fund
are also being redeemed, on the letter or stock power.
VALUATION OF SHARES
The valuation of shares of the California Insured Intermediate-Term and
Insured Long-Term Portfolios is described in detail in the Prospectus.
California Money Market Portfolio. The net asset value per share of the
California Money Market Portfolio is determined on each day that the New York
Stock Exchange is open.
It is the policy of the California Money Market Portfolio to attempt to
maintain a net asset value of $1.00 per share for purposes of sales and
redemptions. The Money Market Portfolio seeks to maintain, but does not
guarantee, a constant net asset value of $1.00 per share. Although the Money
Market Portfolio invests in high-quality instruments, the shares of the
Portfolio are not insured or guaranteed by the U.S. Government. The
instruments held by the California Money Market Portfolio are valued on the
basis of amortized cost which does not take into account unrealized capital
gains or losses. This involves valuing an instrument at-cost and thereafter
assuming a constant amortization to maturity of any discount or premium,
regardless of the impact of fluctuating interest rates on the market value of
the instrument. While this method provides certainty in valuation, it may
result in periods during which value, as determined by amortized cost, is
higher or lower than the price the Portfolio would receive if it sold the
instrument. During periods of declining interest rates, the daily yield on
shares of the Portfolio computed as described above may tend to be higher
than a like computation made by a fund with identical investments utilizing a
method of valuation based upon market prices and estimates of market prices
for all of its portfolio instruments. Thus, if the use of amortized cost by
the Portfolio resulted in a lower aggregate portfolio value on a particular
day, a prospective investor in the Portfolio would be able to obtain a
somewhat higher yield than would result from investment in a fund utilizing
solely market values, and existing investors in the Portfolio would receive
less investment income. The converse would apply in a period of rising
interest rates.
The valuation of the California Money Market Portfolio's instruments based
upon their amortized cost and the commitment to maintain the Portfolio's per
share net asset value of $1.00 is based on the conditions set forth in Rule
2a-7 under the Investment Company Act of 1940. The Portfolio will maintain
B-11
<PAGE>
a dollar-weighted average portfolio maturity of 90 days or less, will purchase
instruments having remaining maturities of thirteen months or less only, and
will invest only in securities determined by the Board of Trustees to be of
high quality with minimal credit risks.
It is a fundamental objective of management to maintain the Portfolio's
price per share as computed for the purpose of sales and redemptions at
$1.00. The Trustees have established procedures designed to achieve this
objective. Such procedures will include a review of the Portfolio's holdings
by the Trustees, at such intervals as they may deem appropriate, to determine
whether the Portfolio's net asset value calculated by using available market
quotations deviates from $1.00 per share based on amortized cost. The extent
of any deviation will be examined by the Trustees. If such deviation exceeds
1/2 of 1%, the Trustees will promptly consider what action, if any, will be
initiated. In the event the Trustees determine that a deviation exists which
may result in material dilution or other unfair results to investors or
existing shareholders, they have agreed to take such corrective action as
they regard as necessary and appropriate, including the sale of portfolio
instruments prior to maturity to realize capital gains or losses or to
shorten average portfolio maturity; withholding dividends; making a special
capital distribution; redemptions of shares in kind; or establishing a net
asset value per share by using available market quotations.
MANAGEMENT OF THE FUND
OFFICERS AND TRUSTEES
The Fund's Officers, under the supervision of the Board of Trustees,
manage the day-to-day operations of the Fund. The Trustees set broad policies
for the Fund and choose its Officers. The following is a list of Trustees and
Officers of the Fund and a statement of their present positions and principal
occupations during the past five years is set forth below. As of November 30,
1995, the Trustees owned less than 1% of the Fund's outstanding shares. The
mailing address of the Fund's Trustees and Officers is Post Office Box 876,
Valley Forge, PA 19482.
JOHN C. BOGLE, Chairman and Trustee*
Chairman and Director of The Vanguard Group, Inc., and of each of the
investment companies in The Vanguard Group; Director of The Mead Corporation
and General Accident Insurance.
JOHN J. BRENNAN, President, Chief Executive Officer & Trustee*
President, Chief Executive Officer and Director of The Vanguard Group, Inc.,
and of each of the investment companies in The Vanguard Group.
ROBERT E. CAWTHORN, Trustee
Chairman of Rhone-Poulenc Rorer, Inc.; Director of Sun Company, Inc.
BARBARA BARNES HAUPTFUHRER, Trustee
Director of The Great Atlantic and Pacific Tea Company, Alco Standard Corp.,
Raytheon Company, Knight-Ridder, Inc., and Massachusetts Mutual Life
Insurance Co and Trustee Emerita of Wellesley College.
BURTON G. MALKIEL, Trustee
Chemical Bank Chairman's Professor of Economics, Princeton University;
Director of Prudential Insurance Co. of America, Amdahl Corporation, Baker
Fentress & Co., The Jeffrey Co., and Southern New England Communications
Company.
ALFRED M. RANKIN, Trustee
Chairman, President, and Chief Executive Officer of NACCO Industries, Inc.;
Director of The BFGoodrich Company and The Standard Products Company.
<PAGE>
JOHN C. SAWHILL, Trustee
President and Chief Executive Officer, The Nature Conservancy; formerly,
Director and Senior Partner, McKinsey & Co.; President, New York University;
Director of Pacific Gas and Electric Company and NACCO Industries.
JAMES O. WELCH, JR., Trustee
Retired Chairman of Nabisco Brands, Inc., retired Vice Chairman and Director
of RJR Nabisco; Director of TECO Energy, Inc. and Director of Kmart
Corporation.
J. LAWRENCE WILSON, Trustee
Chairman and Chief Executive Officer of Rohm & Haas Company; Director of
Cummins Engine Company and Trustee of Vanderbilt University.
RICHARD F. HYLAND, Treasurer*
Treasurer of The Vanguard Group, Inc. and of each of the investment
companies in The Vanguard Group.
RAYMOND J. KLAPINSKY, Secretary*
Senior Vice President and Secretary of The Vanguard Group, Inc.; Secretary
of each of the investment companies in The Vanguard Group.
KAREN E. WEST, Controller*
Principal of The Vanguard Group, Inc.; Controller of each of the investment
companies in The Vanguard Group.
- ------
* Officers of Fund are "interested persons" as defined in the Investment
Company Act of 1940.
B-12
<PAGE>
THE VANGUARD GROUP
Vanguard California Tax-Free Fund is a member of The Vanguard Group of
Investment Companies. Through their jointly-owned subsidiary, The Vanguard
Group, Inc. ("Vanguard"), the Fund and the other Funds in the Group obtain
at-cost virtually all of their corporate management, administrative and
distribution services. Vanguard also provides investment advisory services on
an at-cost basis to several of the Vanguard Funds, including the Vanguard
California Tax-Free Fund.
Vanguard employs a supporting staff of management and administrative
personnel needed to provide the requisite services to the Funds and also
furnishes the Funds with necessary office space, furnishings and equipment.
Each Fund pays its share of Vanguard's net expenses which are allocated among
the Funds under methods approved by the Board of Trustees (Directors) of each
Fund. In addition, each Fund bears its own direct expenses such as legal,
auditing and custodian fees. In order to generate additional revenues for
Vanguard and thereby reduce the Fund's expenses, Vanguard also provides
certain administrative services to other organizations.
The Fund's Officers are also Officers and employees of Vanguard. No
Officer or employee owns, or is permitted to own, any securities of any
external adviser for the Funds.
The Vanguard Group adheres to a Code of Ethics established pursuant to
Rule 17j-1 under the Investment Company Act of 1940. The Code is designed to
prevent unlawful practices in connection with the purchase or sale of
securities by persons associated with Vanguard. Under Vanguard's Code of
Ethics certain officers and employees of Vanguard who are considered access
persons are permitted to engage in personal securities transactions. However,
such transactions are subject to procedures and guidelines substantially
similar to those recommended by the mutual fund industry and approved by the
U.S. Securities and Exchange Commission.
The Vanguard Group, Inc. ("Vanguard") was established and operates under a
Funds' Service Agreement which was approved by the shareholders of each of
the Funds. The amounts which each of the Funds has invested are adjusted from
time to time in order to maintain the proportionate relationship between each
Fund's relative net assets and its contribution to Vanguard's capital. At
November 30, 1995 Vanguard California Tax-Free Fund had contributed capital
of $285,000 to Vanguard representing 1.4% of Vanguard's capitalization. The
Fund's Service Agreement provides as follows: (a) each Vanguard Fund may
invest up to 0.40% of its current net assets in Vanguard and (b) there is no
restriction or the maximum cash investment that the Vanguard Funds may make
in Vanguard.
Management. Corporate management and administrative services include: (1)
executive staff; (2) accounting and financial; (3) legal and regulatory; (4)
shareholder account maintenance; (5) monitoring and control of custodian
relationships; (6) shareholder reporting; and (7) review and evaluation of
advisory and other services provided to the Funds by third parties. During
the fiscal year ended November 30, 1995, the Funds' share of Vanguard's
actual net costs of operations relating to management and administrative
services (including transfer agency) totaled approximately $3,387,000.
Distribution. Vanguard provides all distribution and marketing activities
for the Funds in the Group. Vanguard Marketing Corporation, a wholly-owned
subsidiary of The Vanguard Group, Inc. acts as Sales Agent for shares of the
Funds, in connection with any sales made directly to investors in the states
of Florida, Missouri, New York, Ohio, Texas and such other states as it may
be required.
The principal distribution expenses are for advertising, promotional
materials and marketing personnel. Distribution services may also include
organizing and offering to the public, from time to time, one or more new
investment companies which will become members of the Group. The Trustees
(Directors) and Officers of Vanguard determine the amount to be spent
annually on distribution activities, the manner and amount to be spent on
each Fund, and whether to organize new investment companies.
One half of the distribution expenses of a marketing and promotional
nature is allocated among the Funds based upon their relative net assets. The
remaining one half of these expenses is allocated among the Funds based upon
each Fund's sales for the preceding 24 months relative to the total sales of
the Funds as a Group, provided, however, that no Fund's aggregate quarterly
B-13
<PAGE>
rate of contribution for distribution expenses of a marketing and promotional
nature shall exceed 125% of the average distribution expense rate for the
Group, and that no Fund shall incur annual distribution expenses in excess of
20/100 of 1% of its average month-end net assets. During the year ended
November 30, 1995 the Fund paid approximately $534,000 of the Group's
distribution and marketing expenses.
Investment Advisory Services. Vanguard also provides investment advisory
services to the Fund, Vanguard Municipal Bond Fund, Vanguard Money Market
Reserves, Vanguard Admiral Funds; the several Portfolios of Vanguard Fixed
Income Securities Fund; Vanguard Institutional Index Fund; Vanguard Bond
Index Fund; the Vanguard Florida Insured Tax-Free Fund; Vanguard New Jersey
Tax-Free Fund; Vanguard New York Insured Tax-Free Fund; Vanguard Ohio
Tax-Free Fund; Vanguard Pennsylvania Tax-Free Fund; Vanguard Tax-Managed
Fund; the Aggressive Growth Portfolio of Vanguard Horizon Fund; Vanguard
Balanced Index Fund; Vanguard Index Trust; Vanguard International Equity
Index Fund; secured Portfolio of Vanguard Variable Insurance Fund; a portion
of Vanguard/Windsor II, a portion of Vanguard/Morgen Growth Fund as well as
several indexed separate accounts. These services are provided on an at-cost
basis from a money management staff employed directly by Vanguard. The
compensation and other expenses of this staff are paid by the Funds utilizing
these services. During the years ended November 30, 1993, 1994 and 1995, the
Fund paid approximately $174,000, $238,000 and $286,000 respectively, of
Vanguard's investment advisory expenses.
Remuneration of Trustees and Officers. The Fund pays each Trustee, who is
not also an Officer, an annual fee plus travel and other expenses incurred in
attending Board meetings. During the year ended November 30, 1995 the Fund
paid $8,000 in Trustees' expenses. The Fund's Officers and employees are paid
by Vanguard which, in turn, is reimbursed by the Fund, and each other Fund in
the Group, for its proportionate share of Officers' and employees' salaries
and retirement benefits. During the year ended November 30, 1995 the Fund's
proportionate share of remuneration paid to all Officers of the Fund, as a
group, was approximately $74,627.
Trustees who are not Officers are paid an annual fee based on the number
of years of service on the Board upon retirement. The fee is equal to $1,000
for each year of service (up to fifteen years) and each investment company
member of the Vanguard Group contributes a proportionate amount to this fee
based on its relative net assets. Under its Retirement Plan, Vanguard
contributes annually an amount equal to 10% of each eligible officer's annual
compensation plus 5.7% of that part of an eligible officer's compensation
during the year, if any, that exceeds the Social Security Taxable Wage Base
then in effect. Under its Thrift Plan, all eligible Officers are permitted to
make pre-tax contributions in an amount up to 4% of total compensation,
subject to federal tax limitations, which are matched by Vanguard on a 100%
basis. The Fund's proportionate share of retirement contributions made by
Vanguard under its retirement and thrift plans on behalf of all Officers of
the Fund, as a group, during the 1995 fiscal year was approximately $2,100.
The following table provides detailed information with respect to the
amounts paid or accrued for the Trustees for the fiscal year ended November
30, 1995.
B-14
<PAGE>
VANGUARD CALIFORNIA TAX-FREE FUND
COMPENSATION TABLE
<TABLE>
<CAPTION>
Pension or
Retirement Total Compensation
Aggregate Benefits Estimated Annual From All
Compensation Accrued As Part of Benefits Vanguard Funds Paid to
Names of Trustees From Fund Fund Expenses Upon Retirement Trustees(3)
----------------- -------------- ------------------ ---------------- ----------------------
<S> <C> <C> <C> <C>
John C. Bogle(1),(2) ...... -- -- -- --
John J. Brennan(2) ........ -- -- -- --
Barbara Barnes Hauptfuhrer $933 $163 $15,000 $60,000
Robert E. Cawthorn ........ $933 $136 $13,000 $60,000
Burton G. Malkiel ......... $933 $108 $15,000 $60,000
Alfred M. Rankin, Jr. ..... $933 $ 86 $15,000 $60,000
John C. Sawhill ........... $933 $102 $15,000 $60,000
James O. Welch, Jr. ....... $933 $125 $15,000 $60,000
J. Lawrence Wilson ........ $933 $ 90 $15,000 $60,000
</TABLE>
(1) For the period reported in this table, Mr. Bogle was the Fund's Chief
Executive Officer, and therefore an "Interested Trustee".
(2) As "Interested Trustees," Messrs. Bogle and Brennan receive no
compensation for their service as Trustees.
(3) The amounts reported in this column reflect the total compensation paid
to each Trustee for their service as Director or Trustee of 34 Vanguard
Funds.
DESCRIPTION OF SHARES AND VOTING RIGHTS
The Fund was organized as a Pennsylvania Trust on October 16, 1985.
The Declaration of Trust, as amended and restated on January 15, 1986,
permits the Trustees to issue an unlimited number of shares of beneficial
interest, without par value, from an unlimited number of separate classes
("Portfolios") of shares. Currently, the Fund is offering shares of three
Portfolios.
The shares of the Fund are fully paid and nonassessable, except as set
forth under "Shareholder and Trustee Liability," and have no preference as to
conversion, exchange, dividends, retirement or other features. The shares of
the Fund have no pre-emptive rights. The shares of the Fund have non-
cumulative voting rights, which means that the holders of more than 50% of
the shares voting for the election of Trustees can elect 100% of the Trustees
if they choose to do so. A shareholder is entitled to one vote for each full
share held (and a fractional vote for each fractional share held), then
standing in his name on the books of the Fund. On any matter submitted to a
vote of shareholders, all shares of the Fund then issued and outstanding and
entitled to vote, irrespective of the class, shall be voted in the aggregate
and not by class: except (i) when required by the Investment Company Act of
1940, shares shall be voted by individual class; and (ii) when the matter
does not affect any interest of a particular class, then only shareholders of
the affected class or classes shall be entitled to vote thereon.
The Fund will continue without limitation of time, provided, however that:
1) Subject to the majority vote of the holders of shares of the Fund
outstanding, the Trustees may sell or convert the assets of the Fund to
another investment company in exchange for shares of such investment
company, and distribute such shares, ratably among the shareholders of the
Fund.
2) Subject to the majority vote of shares of the Fund outstanding, the
Trustees may sell and convert into money the assets of the Fund and
distribute such assets ratably among the shareholders of the Fund; and
Upon completion of the distribution of the remaining proceeds or the
remaining assets of any Portfolio as provided in paragraphs 1) and 2) above
the Fund shall terminate and the Trustees shall be discharged of any and all
further liabilities and duties hereunder and the right, title and interest of
all parties shall be cancelled and discharged.
B-15
<PAGE>
Shareholder and Trustee Liability. Under Pennsylvania law shareholders of
such a Trust may under certain circumstances, be held personally liable as
partners for the obligations of the Fund. Therefore, the Declaration of Trust
contains an express disclaimer of shareholder liability for acts or
obligations of the Fund and requires that notice of such disclaimer be given
in each agreement, obligation, or instrument entered into or executed by the
Fund or the Trustees. The Declaration of Trust provides for indemnification
out of the Fund property of any shareholder held personally liable for the
obligations of the Fund. The Declaration of Trust also provides that the Fund
shall, upon request, assume the defense of any claim made against any
shareholder for any act or obligation of the Fund and satisfy any judgment
thereon. Thus, the risk of a shareholder incurring financial loss on account
of shareholder liability is limited to circumstances in which the Fund itself
would be unable to meet its obligations.
The Declaration of Trust further provides that the Trustees will not be
liable for errors of judgment or mistakes of fact or law, but nothing in the
Declaration of Trust protects a Trustee against any liability to which he
would otherwise be subject by reason of willful misfeasance, bad faith, gross
negligence, or reckless disregard of the duties involved in the conduct of
his office.
FINANCIAL STATEMENTS
The Fund's financial statements for the year ended November 30, 1995,
including the financial highlights for each of the five years in the period
ended November 30, 1995, appearing in the Fund's 1995 Annual Report to
Shareholders, and the report thereon of Price Waterhouse LLP, independent
accountants, also appearing therein, are incorporated by reference in this
Statement of Additional Information. The Fund's 1995 Annual Report to
Shareholders is enclosed with this Statement of Additional Information. For a
more complete discussion of the Fund's performance, please see the Fund's
1995 Annual Report to Shareholders, which may be obtained without charge.
APPENDIX A-DESCRIPTION OF MUNICIPAL BONDS AND THEIR RATINGS
Municipal Bonds--General. Municipal Bonds generally include debt
obligations issued by states and their political subdivisions, and duly
constituted authorities and corporations, to obtain funds to construct,
repair or improve various public facilities such as airports, bridges,
highways, hospitals, housing, schools, streets and water and sewer works.
Municipal Bonds may also be issued to refinance outstanding obligations as
well as to obtain funds for general operating expenses and for loan to other
public institutions and facilities.
The two principal classifications of Municipal Bonds are "general
obligation" and "revenue" or "special tax" bonds. General obligation bonds
are secured by the issuer's pledge of its full faith, credit and taxing power
for the payment of principal and interest. Revenue or special tax bonds are
payable only from the revenues derived from a particular facility or class of
facilities or, in some cases, from the proceeds of a special excise or other
tax, but not from general tax revenues. The Fund may also invest in
tax-exempt industrial development bonds, short-term municipal obligations
(rated SP-1+ of SP-1 by Standard & Poor's Corp. or MIG. by Moody's Investors
Service), demand notes and tax-exempt commercial papers (rated A-1 by
Standard & Poor's Corp. or P-1 by Moody's Investors Service).
Industrial revenue bonds in most cases are revenue bonds and generally do
not have the pledge of the credit of the issuer. The payment of the principal
and interest on such industrial revenue bonds is dependent solely on the
ability of the user of the facilities financed by the bonds to meet its
financial obligations and the pledge, if any, of real and personal property
so financed as security for such payment. Short-term municipal obligations
issued by states, cities, municipalities or municipal agencies, include Tax
Anticipation Notes, Revenue Anticipation Notes, Bond Anticipation Notes,
Construction Loan Notes and Short-Term Discount Notes.
Note obligations with demand or put options may have a stated maturity in
excess of one year, but permit any holder to demand payment of principal plus
accrued interest upon a specified number of days' notice. Frequently, such
obligations are secured by letters of credit or other credit support
arrangements provided by banks. The issuer of such notes normally has a
B-16
<PAGE>
corresponding right, after a given period, to repay in its discretion the
outstanding principal of the note plus accrued interest upon a specific number
of days' notice to the bondholders. The interest rate on a demand note may be
based upon a known lending rate, such as a bank's prime rate, and be adjusted
when such rate changes, or the interest rate on a demand note may be a market
rate that is adjusted at specified intervals. The demand notes in which the
Fund will invest are payable on not more than one year's notice. Each note
purchased by the Fund will meet the quality criteria set out above for the
Fund.
The yields of Municipal Bonds depend on, among other things, general money
market conditions, conditions in the Municipal Bond market, the size of a
particular offering, the maturity of the obligation, and the rating of the
issue. The ratings of Moody's Investors Service, Inc. and Standard & Poor's
Corporation represent their opinions of the quality of the Municipal Bonds
rated by them. It should be emphasized that such ratings are general and are
not absolute standards of quality. Consequently, Municipal Bonds with the
same maturity, coupon and rating may have different yields, while Municipal
Bonds of the same maturity and coupon, but with different ratings may have
the same yield. It will be the responsibility of the investment management
staff to appraise independently the fundamental quality of the bonds held by
the Fund.
Municipal Bonds are sometimes purchased on a "when-issued" basis meaning
the Fund has committed to purchasing certain specified securities at an
agreed upon price when they are issued. The period between commitment date
and issuance date can be a month or more. It is possible that the securities
will never be issued and the commitment canceled.
From time to time proposals have been introduced before Congress to
restrict or eliminate the Federal income tax exemption for interest on
Municipal Bonds. Similar proposals may be introduced in the future. If any
such proposal were enacted, it might restrict or eliminate the ability of the
Fund to achieve its investment objective. In that event, the Fund's Trustees
and officers would reevaluate its investment objective and policies and
consider recommending to its shareholders changes in such objective and
policies.
Similarly, from time to time proposals have been introduced before State
and local legislatures to restrict or eliminate the State and local income
tax exemption for interest on Municipal Bonds. Similar proposals may be
introduced in the future. If any such proposal were enacted, it might
restrict or eliminate the ability of each Portfolio to achieve its respective
investment objective. In that event, the Fund's trustees and officers would
reevaluate its investment objective and policies and consider recommending to
its shareholders changes in such objective and policies. (For more
information please refer to "Risk Factors" on page 6.)
Ratings. Excerpts from Moody's Investors Service, Inc.'s Municipal Bond
ratings: Aaa--judged to be of the "best quality" and are referred to as "gilt
edge"; interest payments are protected by a large or by an exceptionally
stable margin and principal is secure; Aa--judged to be of "high quality by
all standards" but as to which margins of protection or other elements make
long-term risks appear somewhat larger than Aaa-rated Municipal Bonds;
together with Aaa group they comprise what are generally known as "high grade
bonds"; A--possess many favorable investment attributes and are considered
"upper medium grade obligations." Factors giving security to principal and
interest of A-rated Municipal Bonds are considered adequate, but elements may
be present which suggest a susceptibility to impairment sometime in the
future; Baa--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; Ba-- protection of principal and interest payments may be very
moderate; judged to have speculative elements; their future cannot be
considered as well-assured; B--lack characteristics of a desirable
investment; assurance of interest and principal payments over any long period
of time may be small; Caa--poor standing; may be in default or there may be
present elements of danger with respect to principal and interest;
Ca--speculative in a high degree; often in default; C--lowest rated class of
bonds; issues so rated can be regarded as having extremely poor prospects for
ever attaining any real investment standing.
Description of Moody's ratings of state and municipal notes: Moody's
ratings for state and municipal notes and other short-term obligations are
B-17
<PAGE>
designated Moody's Investment Grade ("MIG"). Symbols used will be as follows:
MIG-1--Best quality, enjoying strong protection from established cash flows of
funds for their servicing or from established and broad-based access to the
market for refinancing, or both; MIG-2--High quality with margins of
protection ample although not so large as in the preceding group.
Description of Moody's highest commercial paper rating: Prime-1
("P-1")--Judged to be of the best quality. Their short-term debt obligations
carry the smallest degree of investment risk.
Excerpts from Standard & Poor's Corporation's Municipal Bond ratings:
AAA--has the highest rating assigned by S&P; extremely strong capacity to pay
principal and interest; AA--has a very strong capacity to pay interest and
repay principal and differs from the higher rated issues only in a small
degree; A--has a strong capacity to pay principal and interest, although
somewhat more susceptible to the adverse changes in circumstances and
economic conditions; BBB--regarded as having an adequate capacity to pay
principal and interest; normally exhibit adequate protection parameters but
adverse economic conditions or changing circumstances are more likely to lead
to a weakened capacity to pay principal and interest than for bonds in A
category; BB--B--CCC--CC--predominantly speculative with respect to capacity
to pay interest and repay principal in accordance with terms of obligation;
BB is being paid; D--in default, and payment of principal and/or interest is
in arrears.
The ratings from "AA" to "B" may be modified by the addition of a plus or
minus sign to show relative standing within the major rating categories.
Excerpt from Standard & Poor's Corporation's rating of municipal note
issues: SP-1+ --very strong capacity to pay principal and interest;
SP-1--strong capacity to pay principal and interest.
Description of S&P's highest commercial papers ratings: A-1+--This
designation indicates the degree of safety regarding timely payment is
overwhelming. A-1--This designation indicates the degree of safety regarding
timely payment is very strong.
B-18
<PAGE>
APPENDIX B-MUNICIPAL LEASE OBLIGATIONS
Each Portfolio may invest in municipal lease obligations. Such securities
will be treated as liquid (excluding short-term obligations) under the
following guidelines have been established by the Board of Trustees:
1. The obligation has been rated "investment grade" by at least one
NRSRO and is considered to be investment grade by the investment adviser.
2. The obligation is secured by payments from a governmental lessee
which is generally recognized and has debt obligations which are actively
traded by a minimum of five broker/dealers.
3. At least $25 million of the lessee debt is outstanding either in a
single transaction or on parity, and owned by a minimum of five
institutional investors.
4. The investment adviser has determined that the obligation, or a
comparable lessee security, trades in the institutional marketplace at
least periodically, with a bid/offer spread of 20 basis points or less.
5. The governmental lessee has a full faith and credit general
obligation rating of at least "A-" as published by at least one NRSRO or
as determined by the investment adviser. If the lessee is a state
government, the general obligation rating must be at least BAA1, BBB+, or
equivalent, as determined above.
6. The projects to be financed by the obligation are determined to be
critical to the lessee's ability to deliver essential services.
7. Specific legal features such as covenants to maintain the tax-exempt
status of the obligation, covenants to make lease payments without the
right of offset or counterclaim, covenants to return leased property to
the lessor in the event of non-appropriation, insurance policies, debt
service reserve fund, are present.
8. The lease must be "triple net" (i.e.--lease payments are net of
property maintenance, taxes and insurance).
9. If the lessor is a private entity, there must be a sale and absolute
assignment of rental payments to the trustee, accompanied by a legal
opinion from recognized bond counsel that lease payments would not be
considered property of the lessor's estate in the event of lessor's
bankruptcy.
B-19
