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THE MAINSTAY FUNDS
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STATEMENT OF ADDITIONAL INFORMATION
MAY 1, 1996
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The MainStay Funds (the "Trust") is an open-end management investment
company (or mutual fund) currently consisting of thirteen series: California
Tax Free Fund, Capital Appreciation Fund, Convertible Fund, Equity Index Fund,
Government Fund, High Yield Corporate Bond Fund, International Bond Fund,
International Equity Fund, Money Market Fund, New York Tax Free Fund, Tax Free
Bond Fund, Total Return Fund and Value Fund (individually or collectively
referred to as a "Fund" or the "Funds"). The investment adviser for twelve of
the Funds is MacKay-Shields Financial Corporation ("MacKay-Shields" or the
"Adviser"). The investment adviser for the Equity Index Fund is Monitor Capital
Advisors, Inc. ("Monitor" or the "Adviser"). MacKay-Shields and Monitor are
sometimes jointly referred to as the "Advisers."
This Statement of Additional Information is not a prospectus and
should be read in conjunction with the Prospectus of the Trust dated May 1,
1996, as amended or supplemented from time to time, a copy of which may be
obtained without charge by writing to NYLIFE Distributors Inc., (the
"Distributor") 260 Cherry Hill Road, Parsippany, NJ 07054 or by calling 1-800-
624-6782.
No dealer, salesman or any other person has been authorized to give
any information or to make any representations, other than those contained in
this Statement of Additional Information or in the related Prospectus, in
connection with the offers contained herein, and, if given or made, such other
information or representations must not be relied upon as having been authorized
by the Funds or the Distributor. This Statement of Additional Information and
the related Prospectus do not constitute an offer by the Trust or by the
Distributor to sell or a solicitation of any offer to buy any of the securities
offered hereby in any jurisdiction to any person to whom it is unlawful to make
such offer in such jurisdiction.
Shareholder inquiries should be made by writing directly to the Distributor,
or by calling 1-800-624-6782. In addition, you can make inquiries through your
registered representative.
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TABLE OF CONTENTS
PAGE IN
STATEMENT OF
ADDITIONAL
INFORMATION
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ADDITIONAL INVESTMENT POLICIES OF THE MONEY MARKET FUND...... 5
INVESTMENT PRACTICES AND INSTRUMENTS COMMON TO MULTIPLE
FUNDS................................................... 7
Repurchase Agreements................................... 7
Lending of Portfolio Securities......................... 9
Bank Obligations........................................ 10
U.S. Government Securities.............................. 11
Foreign Securities...................................... 11
Foreign Currency Transactions........................... 12
Foreign Index-Linked Instruments........................ 16
Brady Bonds............................................. 16
Municipal Securities.................................... 17
Variable Rate Demand Notes ("VRDNs").................... 22
Standby Commitments -- Obligations with Puts Attached... 23
When-Issued Securities.................................. 24
Mortgage-Related and Other Asset-Backed Securities...... 24
Short Sales Against the Box............................. 33
Options on Securities................................... 34
Securities Index Options................................ 40
Futures Transactions.................................... 42
Swap Agreements......................................... 52
Loan Participation Interests............................ 54
Risks Associated with Debt Securities................... 54
Risks of Investing in High Yield Securities ("Junk
Bonds")............................................. 55
HIGH YIELD CORPORATE BOND FUND
SPECIAL CONSIDERATIONS....................................... 55
CALIFORNIA TAX FREE FUND AND NEW YORK TAX FREE FUND
SPECIAL CONSIDERATIONS....................................... 56
Risk Factors Affecting California Municipal Securities.. 56
Risk Factors Affecting New York Municipal Securities.... 67
THE EQUITY INDEX FUND GUARANTEE.............................. 82
ADDITIONAL FUNDAMENTAL INVESTMENT RESTRICTIONS............... 84
ADDITIONAL NON-FUNDAMENTAL INVESTMENT RESTRICTIONS........... 86
TRUSTEES AND OFFICERS........................................ 90
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THE ADVISERS, THE ADMINISTRATOR AND THE DISTRIBUTOR 97
Investment Advisory Agreements.......................... 97
Administration Agreements............................... 100
Distribution Agreement.................................. 103
Other Services.......................................... 110
Expenses Borne by the Trust............................. 111
PORTFOLIO TRANSACTIONS AND BROKERAGE......................... 111
NET ASSET VALUE.............................................. 116
SHAREHOLDER INVESTMENT ACCOUNT............................... 119
SHAREHOLDER SERVICING AGENT.................................. 119
PURCHASES, REDEMPTION AND REPURCHASE......................... 119
Letter of Intent ("LOI")................................ 119
Suspension of Redemptions............................... 120
TAX-SHELTERED RETIREMENT PLANS............................... 120
Cash or Deferred Profit Sharing Plans Under Section
401(k) for Corporations and Self-Employed
Individuals 120
Individual Retirement Account ("IRA")................... 120
403(b)(7) Tax Sheltered Account......................... 121
General Information..................................... 122
CALCULATION OF PERFORMANCE QUOTATIONS........................ 122
TAX STATUS................................................... 130
Taxation of the Funds................................... 130
Character of Distributions to Shareholders -- General... 131
Character of Distributions to Shareholders -- The Tax-
Free Funds............................................. 132
Discount 134
Users of Bond-Financed Facilities....................... 134
Excise Tax.............................................. 135
Taxation of Options, Futures and Similar Instruments.... 135
Passive Foreign Investment Companies.................... 137
Foreign Currency Gains and Losses....................... 138
Commodity Investments................................... 138
Dispositions of Fund Shares............................. 139
Tax Reporting Requirements.............................. 140
Foreign Taxes........................................... 141
State and Local Taxes - General......................... 142
Explanation of Fund Distributions....................... 142
Additional Information Regarding the Equity Index Fund.. 143
Additional Information Regarding the California Tax
Free Fund and New York Tax Free Fund................... 144
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Annual Statements.................................. 145
General Information..................................... 146
ORGANIZATION AND CAPITALIZATION.............................. 146
General 146
Voting Rights........................................... 146
Shareholder and Trustee Liability....................... 147
OTHER INFORMATION............................................ 147
Independent Accountants................................. 147
Legal Counsel........................................... 147
Share Ownership of the Funds............................ 148
Code of Ethics.......................................... 148
FINANCIAL STATEMENTS......................................... 149
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ADDITIONAL INVESTMENT POLICIES OF THE MONEY MARKET FUND
Each Fund has a separate investment objective or objectives which it
pursues through separate investment policies, as described in the Prospectus.
The following discussion elaborates on the presentation of the Money Market
Fund's investment policies contained in the Prospectus.
The Fund may invest its assets in U.S. dollar-denominated securities of
U.S. or foreign issuers and in securities of foreign branches of U.S. banks,
such as negotiable certificates of deposit (Eurodollars). Since the portfolio
of the Fund may contain such securities, an investment therein involves
investment risks that are different in some respects from an investment in a
fund which invests only in debt obligations of U.S. domestic issuers. Such
risks may include future political and economic developments, the possible
imposition of foreign withholding taxes on interest income payable on the
securities held in the portfolio, possible seizure or nationalization of foreign
deposits, the possible establishment of exchange controls or the adoption of
other foreign governmental restrictions which might adversely affect the payment
of the principal of and interest on securities in the portfolio.
All of the assets of the Fund generally will be invested in obligations
which mature in thirteen months or less and substantially all of these
investments will be held to maturity; however, securities collateralizing
repurchase agreements may have maturities in excess of thirteen months. The
Fund will, to the extent feasible, make portfolio investments primarily in
anticipation of or in response to changing economic and money market conditions
and trends. The dollar-weighted average maturity of the Fund's portfolio may
not exceed 90 days. Consistent with the provisions of a rule of the Securities
and Exchange Commission ("SEC"), the Fund invests only in U.S. dollar-
denominated money market instruments that present minimal credit risk and, with
respect to 95% of its total assets, measured at the time of investment, that are
of the highest quality. The Adviser shall determine whether a security presents
minimal credit risk under procedures adopted by the Fund's Board of Trustees. A
money market instrument will be considered to be of the highest quality (1) if
rated in the highest rating category (i.e., Aaa or Prime-1 by Moody's, AAA or A-
1 by S&P's) by (i) any two nationally recognized statistical rating
organizations ("NRSROs") or, (ii) if rated by only one NRSRO, by that NRSRO, and
whose acquisition is approved or ratified by the Board of Trustees; (2) if
issued by an issuer that has short-term debt obligations of comparable maturity,
priority, and security, and that are rated in the highest rating category by (i)
any two NRSRO's or, (ii) if rated by only one NRSRO, by that NRSRO, and
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whose acquisition is approved or ratified by the Board of Trustees; or (3) an
unrated security that is of comparable quality to a security in the highest
rating category as determined by the Adviser and whose acquisition is approved
or ratified by the Board of Trustees. With respect to 5% of its total assets,
measured at the time of investment, the Fund may also invest in money market
instruments that are in the second-highest rating category for short-term debt
obligations (i.e., rated Aa or Prime-2 by Moody's or AA or A-2 by S&P).
The Fund may not invest more than 5% of its total assets, measured at the
time of investment, in securities of any one issuer that are of the highest
quality, except that the Fund may exceed this 5% limitation for up to three
business days after the purchase of a security of any one issuer and except that
this limitation shall not apply to U.S. government securities. The Fund may not
invest more than the greater of 1% of its total assets or one million dollars,
measured at the time of investment, in securities of any one issuer that are in
the second-highest rating category, except that this limitation shall not apply
to U.S. government securities. In the event that an instrument acquired by the
Fund is downgraded or otherwise ceases to be of the quality that is eligible for
the Fund, the Adviser, under procedures approved by the Board of Trustees (or
the Board of Trustees itself if the Adviser becomes aware an unrated security is
downgraded below high quality and the Adviser does not dispose of the security
within five business days) shall promptly reassess whether such security
presents minimal credit risk and determine whether or not to retain the
instrument.
Pursuant to the rule, the Fund uses the amortized cost method of valuing
its investments, which facilitates the maintenance of the Fund's per share net
asset value at $1.00. The amortized cost method, which is normally used to
value all of the Fund's portfolio securities, involves initially valuing a
security at its cost and thereafter amortizing to maturity any discount or
premium, regardless of the impact of fluctuating interest rates on the market
value of the instrument.
The Trustees have also established procedures designed to stabilize, to the
extent reasonably possible, the Fund's price per share as computed for the
purpose of sales and redemptions at $1.00. Such procedures include review of
the Fund's portfolio by the Trustees, at such intervals as they deem
appropriate, to determine whether the Fund's net asset value calculated by using
available market quotations or market equivalents (the determination of value by
reference to interest rate levels, quotations of comparable securities and other
factors) deviates from $1.00 per share based on amortized cost.
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The extent of deviation between the Fund's net asset value based upon
available market quotations or market equivalents and $1.00 per share based on
amortized cost will be periodically 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 will take such corrective action as they regard to be
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 part or all of dividends or payment of distributions from
capital or capital gains; redemptions of shares in kind; or establishing a net
asset value per share by using available market quotations or equivalents. In
addition, in order to stabilize the net asset value per share at $1.00, the
Trustees have the authority (1) to reduce or increase the number of shares
outstanding on a pro rata basis, and (2) to offset each shareholder's pro rata
portion of the deviation between the net asset value per share and $1.00 from
the shareholder's accrued dividend account or from future dividends.
The Fund may hold cash for the purpose of stabilizing its net asset value
per share. Holdings of cash, on which no return is earned, would tend to lower
the yield on the Fund's shares.
The Fund may also, consistent with the provisions of the rule, invest in
securities with a face maturity of more than thirteen months, provided that the
security is either a variable or floating rate U.S. government security, or a
floating or variable rate security with certain demand or interest rate reset
features.
INVESTMENT PRACTICES AND INSTRUMENTS COMMON TO MULTIPLE FUNDS
The Funds may engage in the following investment practices or invest in the
following instruments to the extent permitted in the Prospectus.
REPURCHASE AGREEMENTS
The Funds may enter into repurchase agreements with any member bank of the
Federal Reserve System or a member firm of the National Association of
Securities Dealers, Inc. The Equity Index Fund will enter into repurchase
agreements only with domestic banks with total assets in excess of one billion
dollars or primary government securities dealers reporting to the Federal
Reserve Bank of New York, and with respect to securities of the type in which
the Fund may invest. In addition, the
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International Bond and International Equity Funds may enter into domestic or
foreign repurchase agreements with certain sellers deemed to be creditworthy
pursuant to guidelines adopted by the Trustees.
A repurchase agreement, which provides a means for a Fund to earn income on
uninvested cash for periods as short as overnight, is an arrangement under which
the purchaser (i.e., the Fund) purchases a U.S. government or other high quality
short-term debt obligation (the "Obligation") and the seller agrees, at the time
of sale, to repurchase the Obligation at a specified time (usually not more than
a week in the case of the Equity Index Fund, California Tax Free Fund and New
York Tax Free Fund) and price. A repurchase agreement with foreign banks may be
available with respect to government securities of the particular foreign
jurisdiction. The custody of the Obligation will be maintained by the Fund's
Custodian. The value of the purchased securities, including any accrued
interest, will at all times exceed the value of the repurchase agreement. The
repurchase price may be higher than the purchase price, the difference being
income to the Fund, or the purchase and repurchase prices may be the same, with
interest at a stated rate due to the Fund together with the repurchase price
upon repurchase. In either case, the income to the Fund is unrelated to the
interest rate on the Obligation subject to the repurchase agreement.
The income on repurchase agreements may be subject to federal and state
income taxes when distributed by a Fund as a dividend to shareholders. Subject
to applicable limitations, the Tax Free Bond Fund will enter into repurchase
agreements as a means of earning income on its cash reserves when, in the
judgment of the Adviser, shareholders would benefit more from receiving taxable
income thereon than from earning no income or tax-free income at a lower rate on
such reserves.
For purposes of the 1940 Act, a repurchase agreement is deemed to be a loan
from the Fund to the seller of the Obligation. It is not clear whether a court
would consider the Obligation purchased by the Fund subject to a repurchase
agreement as being owned by the Fund or as being collateral for a loan by the
Fund to the seller. In the event of the commencement of bankruptcy or
insolvency proceedings with respect to the seller of the Obligation before
repurchase of the Obligation under a repurchase agreement, the Fund may
encounter delays and incur costs before being able to sell the security. Delays
may involve loss of interest or decline in price of the Obligation. If the
court characterizes the transaction as a loan and the Fund has not perfected a
security interest in the Obligation, the Fund may be required to return the
Obligation to the seller's estate and be treated as an unsecured creditor of the
seller. As an
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unsecured creditor, the Fund would be at the risk of losing some or all of the
principal and income involved in the transaction. As with any unsecured debt
instrument purchased for the Funds, the Advisers seek to minimize the risk of
loss from repurchase agreements by analyzing the creditworthiness of the
obligor, in this case the seller of the Obligation. Apart from the risk of
bankruptcy or insolvency proceedings, there is also the risk that the seller may
fail to repurchase the security. However, if the market value of the Obligation
subject to the repurchase agreement becomes less than the repurchase price
(including accrued interest), the Fund will direct the seller of the Obligation
to deliver additional securities so that the market value of all securities
subject to the repurchase agreement equals or exceeds the repurchase price.
The California Tax Free Fund and New York Tax Free Fund may enter into
reverse repurchase agreements. A Fund will maintain a segregated account
consisting of cash, U.S. government securities or high-grade debt obligations,
maturing not later than the expiration of the reverse repurchase agreement, to
cover its obligations under reverse repurchase agreements. Each of the
California Tax Free Fund and New York Tax Free Fund will limit its investments
in reverse repurchase agreements and other borrowing to no more than 10% of its
total assets.
LENDING OF PORTFOLIO SECURITIES
Each Fund, except the Tax Free Bond Fund and the Money Market Fund, may
seek to increase its income by lending portfolio securities. Under present
regulatory policies, such loans may be made to institutions, such as broker-
dealers, and would be required to be secured continuously by collateral in cash,
cash equivalents, irrevocable letters of credit, or U.S. government securities
maintained on a current basis at an amount at least equal to the market value of
the securities loaned. The Fund would have the right to call a loan and obtain
the securities loaned at any time on five days' notice. For the duration of a
loan, the Fund would continue to receive the equivalent of the interest or
dividends paid by the issuer on the securities loaned and would also receive
compensation from the investment of the collateral. The Fund would not,
however, have the right to vote any securities having voting rights during the
existence of the loan, but the Fund would call the loan in anticipation of an
important vote to be taken among holders of the securities or of the giving or
withholding of their consent on a material matter affecting the investment. As
with other extensions of credit there are risks of delay in recovery of, or even
loss of rights in, the collateral should the borrower of the securities fail
financially or breach its agreement with a Fund. However, the loans would be
made only to firms deemed by the Adviser to be of
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good standing, and when, in the judgment of the Adviser, the consideration which
can be earned currently from securities loans of this type justifies the
attendant risk. If the Adviser determines to make securities loans, it is
intended that the value of the securities loaned would not exceed 30% of the
value of the total assets of the lending Fund.
Regarding the California Tax Free Fund and New York Tax Free Fund, each
Fund may lend portfolio securities to nonaffiliated brokers, dealers and
financial institutions, provided that cash equal to 102% of the market value of
the securities loaned is deposited by the borrower with the lending Fund and is
maintained each business day. The California Tax Free Fund and New York Tax
Free Fund will not lend more than 10% of the value of each Fund's total assets.
BANK OBLIGATIONS
Time deposits are nonnegotiable deposits maintained in a banking
institution for a specified period of time at a stated interest rate. Time
deposits which may be held by the Funds will not benefit from insurance from the
Bank Insurance Fund or the Savings Association Insurance Fund administered by
the Federal Deposit Insurance Corporation.
Certificates of deposit are certificates evidencing the obligation of a
bank to repay funds deposited with it for a specified period of time.
Bankers' acceptances are credit instruments evidencing the obligation of a
bank to pay a draft drawn on it by a customer. These instruments reflect the
obligation both of the bank and of the drawer to pay the full amount of the
instrument upon maturity.
Investments in the obligations of banks are deemed to be "cash equivalents"
if, at the date of investment, the banks have capital surplus and individual
profits (as of the date of their most recently published financials) in excess
of $100,000,000, or if, with respect to the obligations of other banks and
savings and loan associations, such obligations are federally insured. The
Equity Index Fund will not be subject to the above restriction to the extent it
invests in banks obligations of United States banks (including foreign branches)
which have more than $1 billion in total assets at the time of investment and
are members of the Federal Reserve System or are examined by the Comptroller of
the Currency or whose deposits are insured by the Federal Deposit Insurance
Corporation. The Equity Index Fund also may invest in certificates of deposit
of savings and loan
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associations (federally or state chartered and federally insured) having total
assets in excess of $1 billion.
U.S. GOVERNMENT SECURITIES
Securities issued or guaranteed by the U.S. government or its agencies or
instrumentalities include U.S. Treasury securities, which differ only in their
interest rates, maturities and times of issuance. Treasury bills have initial
maturities of one year or less; Treasury notes have initial maturities of one to
ten years; and Treasury bonds generally have initial maturities of greater than
ten years. Some obligations issued or guaranteed by U.S. government agencies
and instrumentalities, for example, Government National Mortgage Association
("GNMA") pass-through certificates, are supported by the full faith and credit
of the U.S. Treasury; others, such as those of the Federal Home Loan Banks, by
the right of the issuer to borrow from the Treasury; others, such as those
issued by the Federal National Mortgage Association ("FNMA"), by the
discretionary authority of the U.S. government to purchase certain obligations
of the agency or instrumentality; and others, such as those issued by the
Student Loan Marketing Association, only by the credit of the agency or
instrumentality. While the U.S. government provides financial support to such
U.S. government-sponsored agencies or instrumentalities, no assurance can be
given that it will always do so, and it is not so obligated by law. See
"Mortgage-Related and Other Asset-Backed Securities." The Equity Index Fund
will invest in such securities only when it is satisfied that the credit risk
with respect to the issuer is minimal.
FOREIGN SECURITIES
Except for the California Tax Free Fund, Government Fund, New York Tax Free
Fund and Tax Free Bond Fund, each Fund may invest, without limit, subject to the
other investment policies applicable to the Fund, in U.S. dollar-denominated and
non-dollar-denominated foreign debt and equity securities and in certificates of
deposit issued by foreign banks and foreign branches of United States banks, to
any extent deemed appropriate by the Advisers. Under current SEC rules relating
to the use of the amortized cost method of portfolio securities valuation, the
Money Market Fund is restricted to purchasing U.S. dollar-denominated
securities, but it is not otherwise precluded from purchasing securities of
foreign issuers.
Investors should carefully consider the appropriateness of foreign
investing in light of their financial objectives and goals. While foreign
markets may present unique investment opportunities, foreign investing involves
risks not associated with domestic investing. Securities markets in other
countries
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are not always as efficient as those in the U.S. and are sometimes less liquid
and more volatile. Other risks involved in investing in the securities of
foreign issuers include differences in accounting, auditing and financial
reporting standards; limited publicly available information; the difficulty of
assessing economic trends in foreign countries; generally higher commission
rates on foreign portfolio transactions; the possibility of nationalization,
expropriation or confiscatory taxation; adverse changes in investment or
exchange control regulations (which may include suspension of the ability to
transfer currency from a country); government interference, including government
ownership of companies in certain sectors, wage and price controls, or
imposition of trade barriers and other protectionist measures; difficulties in
invoking legal process abroad and enforcing contractual obligations; political,
social or economic instability which could affect U.S. investments in foreign
countries; and potential restrictions on the flow of international capital.
Additionally, foreign securities and dividends and interest payable on those
securities may be subject to foreign taxes, including foreign withholding taxes,
and other foreign taxes may apply with respect to securities transactions.
Additional costs associated with an investment in foreign securities may include
higher transaction, custody and foreign currency conversion costs. In the event
of litigation relating to a portfolio investment, the Funds may encounter
substantial difficulties in obtaining and enforcing judgments against non-U.S.
resident individuals and companies. Investment in emerging market countries
presents risks in greater degree than, and in addition to, those presented by
investment in foreign issuers in general.
FOREIGN CURRENCY TRANSACTIONS
Many of the foreign securities in which the Funds invest will be
denominated in foreign currencies. Changes in foreign exchange rates will
affect the value of securities denominated or quoted in foreign currencies.
Exchange rate movements can be large and can endure for extended periods of
time, affecting either favorably or unfavorably the value of the Funds' assets.
However, each Fund, except the California Tax Free Fund, the Equity Index Fund,
the Government Fund, the Money Market Fund, the New York Tax Free Fund and the
Tax Free Bond Fund, may, to the extent it invests in foreign securities, enter
into forward foreign currency transactions in order to protect against
uncertainty in the level of future foreign currency exchange rates. Each of
these Funds may enter into contracts to purchase foreign currencies to protect
against an anticipated rise in the U.S. dollar price of securities it intends to
purchase and may enter into contracts to sell foreign currencies to protect
against the decline in value of its foreign currency-denominated portfolio
securities due to a
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decline in the value of the foreign currencies against the U.S. dollar. In
addition, a Fund may use one currency (or a basket of currencies) to hedge
against adverse changes in the value of another currency (or a basket of
currencies) when exchange rates between the two currencies are correlated.
Foreign currency transactions in which the Funds may engage include forward
foreign currency contracts, currency exchange transactions on a spot (i.e.,
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cash) basis, put and call options on foreign currencies and foreign exchange
futures contracts. A forward foreign currency exchange contract involves an
obligation to purchase or sell a specific currency at a future date, which may
be any fixed number of days (usually less than one year) from the date of the
contract agreed upon by the parties, at a price set at the time of the contract.
These contracts are traded in the interbank market conducted directly between
traders (usually large commercial banks) and their customers. A forward
contract generally has no deposit requirement, and no commissions are charged at
any stage for trades. Although foreign exchange dealers do not charge a fee for
conversion, they do realize a profit based on the difference (the spread)
between the price at which they are buying and selling various currencies.
Normally, consideration of the prospect for currency parities will be
incorporated in a longer term investment decision made with regard to overall
diversification strategies. However, the Adviser believes that it is important
to have the flexibility to enter into such forward contracts when it determines
that the best interest of a Fund will be served. Generally, the Adviser
believes that the best interest of a Fund will be served if a Fund is permitted
to enter into forward contracts under specified circumstances. First, when a
Fund enters into, or anticipates entering into, a contract for the purchase or
sale of a security denominated in a foreign currency, it may desire to "lock in"
the U.S. dollar price of the security. By entering into a forward contract for
the purchase or sale, for a fixed amount of U.S. dollars, of the amount of
foreign currency involved in the underlying security transaction, a Fund will be
able to insulate itself from a possible loss resulting from a change in the
relationship between the U.S. dollar and the subject foreign currency during the
period between the date on which the security is purchased or sold and the date
on which payment is made or received, although a Fund would also forego any gain
it might have realized had rates moved in the opposite direction. This
technique is sometimes referred to as a "settlement" hedge or "transaction"
hedge.
Second, when the Adviser believes that the currency of a particular foreign
country may suffer a substantial decline against the U.S. dollar, it may enter
into a forward contract to
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sell, for a fixed amount of dollars, the amount of foreign currency
approximating the value of some or all of a Fund's portfolio securities
denominated in such foreign currency. Such a hedge (sometimes referred to as a
"position" hedge) will tend to offset both positive and negative currency
fluctuations, but will not offset changes in security values caused by other
factors. The Fund also may hedge the same position by using another currency
(or a basket of currencies) expected to perform in a manner substantially
similar to the hedged currency ("proxy hedge"). The precise matching of the
forward contract amounts and the value of the securities involved will not
generally be possible since the future value of such securities in foreign
currencies will change as a consequence of market movements in the value of
those securities between the date the forward contract is entered into and the
date it matures. With respect to positions that constitute "transaction" or
"position" hedges (including "proxy" hedges), a Fund will not enter into forward
contracts to sell currency or maintain a net exposure to such contracts if the
consummation of such contracts would obligate the Fund to deliver an amount of
foreign currency in excess of the value of the Fund's portfolio securities or
other assets denominated in that currency (or the related currency, in the case
of a "proxy" hedge).
Finally, a Fund may enter into forward contracts to shift its investment
exposure from one currency into another currency that is expected to perform
inversely with respect to the hedged currency relative to the U.S. dollar. This
type of strategy, sometimes known as a "cross-currency" hedge, will tend to
reduce or eliminate exposure to the currency that is sold, and increase exposure
to the currency that is purchased, much as if the Fund had sold a security
denominated in one currency and purchased an equivalent security denominated in
another. "Cross-currency" hedges protect against losses resulting from a
decline in the hedged currency, but will cause the Fund to assume the risk of
fluctuations in the value of the currency it purchases.
At the consummation of the forward contract, a Fund may either make
delivery of the foreign currency or terminate its contractual obligation to
deliver the foreign currency by purchasing an offsetting contract obligating it
to purchase at the same maturity date the same amount of such foreign currency.
If a Fund chooses to make delivery of the foreign currency, it may be required
to obtain such currency for delivery through the sale of portfolio securities
denominated in such currency or through conversion of other assets of the Fund
into such currency. If a Fund engages in an offsetting transaction, the Fund
will realize a gain or a loss to the extent that there has been a change in
forward contract prices. Closing purchase transactions with respect to forward
contracts are usually
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effected with the currency trader who is a party to the original forward
contract.
A Fund's dealing in forward contracts will be limited to the transactions
described above. Of course, a Fund is not required to enter into such
transactions with regard to its foreign currency-denominated securities and will
not do so unless deemed appropriate by the Adviser. A Fund generally will not
enter into a forward contract with a term of greater than one year.
In cases of transactions which constitute "transaction" hedges, or
"position" hedges (including "proxy" hedges) or "cross-currency" hedges that
involve purchase and sale of two different foreign currencies directly through
the same foreign currency contract, a Fund may deem its forward currency hedge
position to be covered by underlying Fund portfolio securities or may establish
a Segregated Account with its Custodian in an amount equal to the value of the
Fund's total assets committed to the consummation of the subject hedge. The
assets in the Segregated Account will consist of cash (denominated in U.S.
dollars or foreign currency), U.S. government securities, liquid domestic or
foreign debt rated in one of the top three categories by a U.S. nationally
recognized rating organization, or any other asset which may be deemed by the
Securities and Exchange Commission's Division of Investment Management to be
permissible for such purpose. In the case of "anticipatory" hedges and "cross-
currency" hedges that involve the purchase and sale of two different foreign
currencies indirectly through separate forward currency contracts, the Fund will
establish a Segregated Account with its Custodian as described above. In the
event a Fund establishes a Segregated Account, the Fund will mark-to-market the
value of the assets in the Segregated Account. If the value of the securities
placed in the separate account declines, additional cash or securities will be
placed in the account by the Fund on a daily basis so that the value of the
account will equal the amount of the Fund's commitments with respect to such
contracts.
It should be realized that this method of protecting the value of a Fund's
portfolio securities against a decline in the value of a currency does not
eliminate fluctuations in the underlying prices of the securities. It simply
establishes a rate of exchange which can be achieved at some future point in
time. It also reduces any potential gain which may have otherwise occurred had
the currency value increased above the settlement price of the contract. The
Funds cannot assure that the techniques discussed above will always be
successful.
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<PAGE>
A Fund's foreign currency transactions may be limited by the requirements
of Subchapter M of the Code for qualification as a regulated investment company.
FOREIGN INDEX-LINKED INSTRUMENTS
The International Bond Fund and International Equity Fund may, subject to
compliance with each Fund's limitations applicable to its investment in debt
securities, invest in instruments issued by the U.S. or a foreign government or
by private issuers that return principal and/or pay interest to investors in
amounts which are linked to the level of a particular foreign index ("foreign
index-linked instruments"). In the case of foreign index-linked instruments
linking the interest component to a foreign index, the amount of interest
payable will adjust periodically in response to changes in the level of the
foreign index during the term of the foreign index-linked instrument.
BRADY BONDS
Each of the Convertible Fund, High Yield Corporate Bond Fund, International
Bond Fund and Total Return Fund may invest a portion of its assets in Brady
Bonds, which are securities created through the exchange of existing commercial
bank loans to sovereign entities for new obligations in connection with debt
restructurings under a debt restructuring plan introduced by former U.S.
Secretary of the Treasury, Nicholas F. Brady (the "Brady Plan"). Brady Plan
debt restructurings have been implemented in several countries, including
Mexico, Uruguay, Venezuela, Argentina, Costa Rica, Nigeria, the Philippines,
Bulgaria, the Dominican Republic, Bolivia, Ecuador, Niger, Poland and Jordan
(collectively, the "Brady Countries"). In addition, Brazil has concluded a
Brady-like plan. It is expected that other countries will undertake a Brady
Plan debt restructuring in the future, including Peru and Panama.
Brady Bonds have been issued only recently, and, accordingly, do not have a
long payment history. Brady Bonds may be collateralized or uncollateralized,
are issued in various currencies (primarily the U.S. dollar) and are actively
traded in the over-the-counter secondary market.
U.S. dollar-denominated, collateralized Brady Bonds, which may be fixed
rate par bonds or floating rate discount bonds, are generally collateralized in
full as to principal by U.S. Treasury zero coupon bonds having the same maturity
as the Brady Bonds. Interest payments on these Brady Bonds generally are
collateralized on a one-year or longer rolling-forward basis by cash or
securities in an amount that, in the case of fixed rate
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bonds, is equal to at least one year of interest payments or, in the case of
floating rate bonds, initially is equal to at least one year's interest payments
based on the applicable interest rate at that time and is adjusted at regular
intervals thereafter. Certain Brady Bonds are entitled to "value recovery
payments" in certain circumstances, which in effect constitute supplemental
interest payments but generally are not collateralized. Brady Bonds are often
viewed as having three or four valuation components: (i) the collateralized
repayment of principal at final maturity; (ii) the collateralized interest
payments; (iii) the uncollateralized interest payments; and (iv) any
uncollateralized repayment of principal at maturity (these uncollateralized
amounts constitute the "residual risk").
Most Mexican Brady Bonds issued to date have principal repayments at final
maturity fully collateralized by U.S. Treasury zero coupon bonds (or comparable
collateral denominated in other currencies) and interest coupon payments
collateralized on an 18-month rolling-forward basis by funds held in escrow by
an agent for the bondholders. A significant portion of the Venezuelan Brady
Bonds and the Argentine Brady Bonds issued to date have principal repayments at
final maturity collateralized by U.S. Treasury zero coupon bonds (or comparable
collateral denominated in other currencies) and/or interest coupon payments
collateralized on a 14-month (for Venezuela) or 12-month (for Argentina)
rolling-forward basis by securities held by the Federal Reserve Bank of New York
as collateral agent.
Brady Bonds involve various risk factors including residual risk and the
history of defaults with respect to commercial bank loans by public and private
entities of countries issuing Brady Bonds. There can be no assurance that Brady
Bonds in which the Fund may invest will not be subject to restructuring
arrangements or to requests for new credit, which may cause the Fund to suffer a
loss of interest or principal on any of its holdings.
MUNICIPAL SECURITIES
The Prospectus describes the general categories and characteristics of
municipal securities. The following supplements that discussion by providing
additional information concerning certain types of municipal securities.
Municipal securities generally are understood to include debt obligations
issued by, or on behalf of, states, territories and possessions of the United
States and their political sub-divisions, agencies and instrumentalities and the
District of Columbia, to obtain funds for various public purposes, including
construction of a wide range of public facilities, refunding of outstanding
obligations, payment of general operating expenses
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<PAGE>
and extensions of loans to public institutions and facilities. The yields on
municipal securities depend upon a variety of factors, including general
economic and monetary conditions, general money market conditions, general
conditions of the municipal securities market, the financial condition of the
issuer, the size of a particular offering, the maturity of the obligations
offered and the rating of the issue or issues. Municipal securities also may be
subject to the provisions of bankruptcy, insolvency and other laws affecting the
rights and remedies of creditors, such as the Federal Bankruptcy Code, and laws,
if any, which may be enacted by Congress or state legislatures extending the
time for payment of principal or interest, or both, or imposing other
constraints upon enforcement of such obligations or upon the ability of
municipalities to levy taxes. There is also the possibility that, as a result
of litigation or other conditions, the power or ability of any one or more
issuers to pay, when due, the principal of, and interest on, its or their
municipal securities may be materially and adversely affected.
Tax Anticipation Notes are used to finance working capital needs of
municipalities and are issued in anticipation of various seasonal tax revenues,
to be payable from these specific future taxes. They are usually general
obligations of the issuer, secured by the taxing power for the payment of
principal and interest.
Revenue Anticipation Notes are issued in expectation of receipt of other
kinds of revenue, such as federal revenues. They, also, are usually general
obligations of the issuer.
Bond Anticipation Notes are normally issued to provide interim financial
assistance until long-term financing can be arranged. The long-term bonds then
provide funds for the repayment of the notes.
Construction Loan Notes are sold to provide construction financing for
specific projects. After successful completion and acceptance, many projects
receive permanent financing through the FHA under the FNMA or GNMA.
Project Notes are instruments sold by the Department of Housing and Urban
Development ("HUD") but issued by a state or local housing agency to provide
financing for a variety of programs. They are backed by the full faith and
credit of the U.S. government, and generally carry a term of one year or less.
Short-Term Discount Notes (tax-exempt commercial paper) are short-term (365
days or less) promissory notes issued by municipalities to supplement their cash
flow.
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<PAGE>
Municipal Bonds, which meet longer-term capital needs and generally have
maturities of more than one year when issued, have two principal
classifications: general obligation bonds and revenue bonds. Issuers of
general obligation bonds include states, counties, cities, towns and regional
districts. The proceeds of these obligations are used to fund a wide range of
public projects, including construction or improvement of schools, highways and
roads, and water and sewer systems. The basic security behind general
obligation bonds is the issuer's pledge of its full faith, credit and taxing
power for the payment of principal and interest. The taxes that can be levied
for the payment of debt service may be limited or unlimited as to the rate or
amount of special assessments.
A revenue bond is not secured by the full faith, credit and taxing power of
an issuer. Rather, the principal security for a revenue bond is generally the
net revenue derived from a particular facility, group of facilities or, in some
cases, the proceeds of a special excise or other specific revenue source.
Revenue bonds are issued to finance a wide variety of capital projects,
including: electric, gas, water, and sewer systems; highways, bridges, and
tunnels; port and airport facilities; colleges and universities; and hospitals.
Although the principal security behind these bonds may vary, many provide
additional security in the form of a debt service reserve fund which may be used
to make principal and interest payments on the issuer's obligations. Housing
finance authorities have a wide range of security and credit enhancement
guarantees available to them, including partially or fully insured mortgages,
rent subsidized and/or collateralized mortgages, and/or the net revenues from
housing or other public projects. Some authorities are provided further
security in the form of a state's assurance (although without obligation) to
make up deficiencies in the debt service reserve fund.
Industrial Development Bonds which pay tax-exempt interest are, in most
cases, revenue bonds and are issued by, or on behalf of, public authorities to
raise money to finance various privately operated facilities for business,
manufacturing, housing, sports, and pollution control. These bonds are also
used to finance public facilities such as airports, mass transit systems, ports,
and parking. The payment of the principal and interest on such bonds is solely
dependent on the ability of the facility's user to meet its financial
obligations and the pledge, if any, of the real and personal property so
financed as security for such payments.
An entire issue of Municipal Bonds may be purchased by one or a small
number of institutional investors such as the Funds. Thus, the issue may not be
said to be publicly offered. Unlike
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securities which must be registered under the Securities Act of 1933 prior to
offer and sale, unless an exemption from such registration is available,
Municipal Bonds which are not publicly offered may nevertheless be readily
marketable. A secondary market exists for Municipal Bonds which were not
publicly offered initially.
The Tax Free Bond Fund may invest more than 25% of its total assets in
Municipal Bonds the issuers of which are located in the same state and may
invest more than 25% of its total assets in Municipal Bonds the security of
which is derived from any one of the following categories: hospitals and health
facilities; turnpikes and toll roads; ports and airports; colleges and
universities; public housing authorities; general obligations of states and
localities; lease rental obligations of states and local authorities; state and
local housing finance authorities; municipal utilities systems; bonds that are
secured or backed by the Treasury or other U.S. government guaranteed
securities; or industrial development and pollution control bonds. There could
be economic, business or political developments which might affect all Municipal
Bonds of a similar type. However, the Fund believes that the most important
consideration affecting risk is the quality of Municipal Bonds.
The Tax Free Bond Fund may engage in short-term trading (selling securities
held for brief periods of time, usually less than three months) if the Adviser
believes that such transactions, net of costs including taxes, if any, would
improve the overall return on its portfolio. The needs of different classes of
lenders and borrowers and their changing preferences and circumstances have in
the past caused market dislocations unrelated to fundamental creditworthiness
and trends in interest rates which have presented market trading opportunities.
There can be no assurance that such dislocations will occur in the future or
that the Fund will be able to take advantage of them. The Fund generally limits
its voluntary short-term trading to the extent necessary to qualify as a
"regulated investment company" under the Code.
There are, in addition, a variety of hybrid and special types of municipal
obligations, such as municipal lease obligations, as well as numerous
differences in the security of Municipal Bonds both within and between the two
principal classifications described above. Municipal lease obligations are
municipal securities that may be supported by a lease or an installment purchase
contract issued by state and local government authorities to acquire funds to
obtain the use of a wide variety of equipment and facilities such as fire and
sanitation vehicles, computer equipment and other capital assets. These
obligations, which may be secured or unsecured, are not
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<PAGE>
general obligations and have evolved to make it possible for state and local
governments to obtain the use of property and equipment without meeting
constitutional and statutory requirements for the issuance of debt. Thus,
municipal lease obligations have special risks not normally associated with
Municipal Bonds. These obligations frequently contain "non-appropriation"
clauses that provide that the governmental issuer of the obligation has no
obligation to make future payments under the lease or contract unless money is
appropriated for such purposes by the legislative body on a yearly or other
periodic basis. In addition to the "nonappropriation" risk, many municipal
lease obligations have not yet developed the depth of marketability associated
with Municipal Bonds; moreover, although the obligations may be secured by the
leased equipment, the disposition of the equipment in the event of foreclosure
might prove difficult. For the purpose of each Fund's investment restrictions,
the identification of the "issuer" of Municipal Bonds which are not General
Obligation Bonds is made by the Adviser on the basis of the characteristics of
the Municipal Bonds as described above, the most significant of which is the
source of funds for the payment of principal of and interest on such Bonds.
In order to limit certain of these risks, the California Tax Free Fund, New
York Tax Free Fund and Tax Free Bond Fund will not invest more than 10% of its
assets in municipal lease obligations that are illiquid (along with all other
illiquid securities). The liquidity of municipal lease obligations purchased by
the Funds will be determined pursuant to guidelines approved by the Board of
Trustees. Factors considered in making such determinations may include: the
frequency of trades and quotes for the obligation; the number of dealers willing
to purchase or sell the security and the number of other potential buyers; the
willingness of dealers to undertake to make a market in the security; the nature
of marketplace trades; the obligation's rating; and, if the security is unrated,
the factors generally considered by a rating agency.
There may be other types of municipal securities that become available
which are similar to the foregoing described municipal securities in which each
Fund may invest.
INCOME LEVEL AND CREDIT RISK Municipal obligations are subject to the
----------------------------
provisions of bankruptcy, insolvency and other laws affecting the rights and
remedies of creditors, such as the Federal Bankruptcy Code, and laws, if any,
which may be enacted by Congress or state legislatures extending the time for
payment of principal or interest, or both, or imposing other constraints upon
enforcement of such obligations or upon municipalities to levy taxes. There is
also the possibility that as a result of
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<PAGE>
litigation or other conditions, the power or ability of any one or more issuers
to pay, when due, principal or interest on its or their municipal obligations
may be materially affected. Although the Funds' quality standards are designed
to minimize the credit risk of investing in Municipal Bonds, that risk cannot be
entirely eliminated.
TAX CONSIDERATIONS With respect to the California Tax Free Fund, New York
------------------
Tax Free Fund and Tax Free Bond Fund, income derived by a Fund from taxable
investments, including but not limited to securities lending transactions,
repurchase transactions, options and futures transactions, and investments in
commercial paper, bankers' acceptances and certificates of deposit will be
taxable for federal, state and local income tax purposes when distributed to
shareholders. Income derived by a Fund from interest on direct obligations of
the U.S. government will be taxable for federal income tax purposes when
distributed to shareholders but, provided that the Fund meets the requirements
of state law and properly designates distributions to shareholders, such
distributions may be excludable from income for state personal income tax
purposes. A portion of original issue discount relating to stripped Municipal
Bonds and their coupons may also be treated as taxable income under certain
circumstances.
VARIABLE RATE DEMAND NOTES ("VRDNS")
The California Tax Free Fund, New York Tax Free Fund and Tax Free Bond Fund
may invest in tax-exempt obligations which contain a floating or variable
interest rate adjustment formula and an unconditional right of demand to receive
payment of the unpaid principal balance plus accrued interest upon a short
notice period prior to specified dates, generally at 30, 60, 90, 180 or 365-day
intervals. The interest rates are adjustable at various intervals to the
prevailing market rate for similar investments, such adjustment formula being
calculated to maintain the market value of the VRDN at approximately the par
value of the VRDN on the adjustment date. The adjustments are typically based
upon the prime rate of a bank or some other appropriate interest rate adjustment
index.
The California Tax Free Fund, New York Tax Free Fund and Tax Free Bond Fund
may also invest in VRDNs in the form of participation interests ("Participating
VRDNs") in variable rate tax-exempt obligations held by a financial institution,
typically a commercial bank ("Institution"). Participating VRDNs provide a Fund
with a specified undivided interest (up to 100%) of the underlying obligation
and the right to demand payment of the unpaid principal balance plus accrued
interest on the Participating VRDNs from the Institution upon a specified number
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of days' notice, not to exceed seven days. In addition, the Participating VRDN
is backed up by an irrevocable letter of credit or guaranty of the Institution.
A Fund has an undivided interest in the underlying obligation and thus
participates on the same basis as the Institution in such obligation, except
that the Institution typically retains fees out of the interest paid or the
obligation for servicing the obligation, providing the letter of credit and
issuing the repurchase commitment.
STANDBY COMMITMENTS -- OBLIGATIONS WITH PUTS ATTACHED
The California Tax Free Fund, New York Tax Free Fund and Tax Free Bond Fund
may purchase municipal securities together with the right to resell the
securities to the seller at an agreed-upon price or yield within a specified
period prior to the maturity date of the securities. Although it is not a put
option in the usual sense, such a right to resell is commonly known as a "put"
and is also referred to as a "standby commitment." Each Fund may pay for a
standby commitment either separately, in cash, or in the form of a higher price
for the securities which are acquired subject to the standby commitment, thus
increasing the cost of securities and reducing the yield otherwise available
from the same security. The Adviser understands that the Internal Revenue
Service (the "IRS") has issued a revenue ruling to the effect that, under
specified circumstances, a registered investment company will be the owner of
tax-exempt municipal obligations acquired subject to a put option. The IRS has
also issued private letter rulings to certain taxpayers (which do not serve as
precedent for other taxpayers) to the effect that tax-exempt interest received
by a regulated investment company with respect to such obligations will be tax-
exempt in the hands of the company and may be distributed to its shareholders as
exempt-interest dividends. The IRS has subsequently announced that it will not
ordinarily issue advance ruling letters as to the identity of the true owner of
property in cases involving the sale of securities or participation interests
therein if the purchaser has the right to cause the security, or the
participation interest therein, to be purchased by either the seller or a third
party. Each of the California Tax Free Fund, New York Tax Free Fund and Tax
Free Bond Fund intends to take the position that it is the owner of any
municipal obligations acquired subject to a standby commitment and that tax-
exempt interest earned with respect to such municipal obligations will be tax-
exempt in its hands; however, no assurance can be given that this position would
prevail if challenged. In addition, there is no assurance that standby
commitments will be available to a Fund, nor has the California Tax Free Fund,
New York Tax Free Fund or Tax Free Bond Fund assumed that such commitments would
continue to be available under all market conditions.
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<PAGE>
A standby commitment may not be used to affect a Fund's valuation of the
municipal security underlying the commitment. Any consideration paid by a Fund
for the standby commitment, whether paid in cash or by paying a premium for the
underlying security, which increases the cost of the security and reduces the
yield otherwise available from the same security, will be accounted for by the
Fund as unrealized depreciation until the standby commitment is exercised or has
expired.
WHEN-ISSUED SECURITIES
The Funds may from time to time purchase securities on a "when-issued"
basis. Debt securities, including municipal bonds, are often issued in this
manner. The price of such securities, which may be expressed in yield terms, is
fixed at the time a commitment to purchase is made, but delivery of and payment
for the when-issued securities take place at a later date. Normally, the
settlement date occurs within one month of the purchase (60 days for municipal
bonds and notes). During the period between purchase and settlement, no payment
is made by the Fund and no interest accrues to the Fund. To the extent that
assets of a Fund are held in cash pending the settlement of a purchase of
securities, that Fund would earn no income; however, it is the Trust's intention
that each Fund will be fully invested to the extent practicable and subject to
the policies stated herein. Although when-issued securities may be sold prior
to the settlement date, the Trust intends to purchase such securities with the
purpose of actually acquiring them unless a sale appears desirable for
investment reasons.
At the time the Trust makes the commitment on behalf of a Fund to purchase
a security on a when-issued basis, it will record the transaction and reflect
the amount due and the value of the security in determining the Fund's net asset
value. The market value of the when-issued security may be more or less than
the purchase price payable at the settlement date. The Trustees do not believe
that a Fund's net asset value or income will be exposed to additional risk by
the purchase of securities on a when-issued basis. Each Fund will establish a
segregated account in which it will maintain cash and U.S. government securities
or other high-grade debt obligations at least equal in value to commitments for
when-issued securities. Such segregated securities either will mature or, if
necessary, be sold on or before the settlement date.
MORTGAGE-RELATED AND OTHER ASSET-BACKED SECURITIES
Mortgage-related securities are interests in pools of residential or
commercial mortgage loans or leases, including mortgage loans made by savings
and loan institutions, mortgage
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bankers, commercial banks and others. Pools of mortgage loans are assembled as
securities for sale to investors by various governmental, government-related and
private organizations (see "Mortgage Pass-Through Securities"). The Funds, to
the extent permitted in the Prospectus, may also invest in debt securities which
are secured with collateral consisting of mortgage-related securities (see
"Collateralized Mortgage Obligations"), and in other types of mortgage-related
securities. Like other fixed-income securities, when interest rates rise, the
value of a mortgage-related security generally will decline; however, when
interest rates are declining, the value of a mortgage-related security with
prepayment features may not increase as much as other fixed-income securities.
MORTGAGE PASS-THROUGH SECURITIES Interests in pools of mortgage-related
--------------------------------
securities differ from other forms of debt securities, which normally provide
for periodic payment of interest in fixed amounts with principal payments at
maturity or specified call dates. Instead, these securities provide a monthly
payment which consists of both interest and principal payments. In effect,
these payments are a "pass-through" of the monthly payments made by the
individual borrowers on their residential mortgage loans, net of any fees paid
to the issuer or guarantor of such securities. Additional payments are caused
by repayments of principal resulting from the sale of the underlying residential
property, refinancing or foreclosure, net of fees or costs which may be
incurred. Some mortgage-related securities (such as securities issued by the
GNMA) are described as "modified pass-through." These securities entitle the
holder to receive all interest and principal payments owed on the mortgage pool,
net of certain fees, at the scheduled payment dates regardless of whether or not
the mortgagor actually makes the payment. Some mortgage pass-through
certificates may include securities backed by adjustable-rate mortgages which
bear interest at a rate that will be adjusted periodically.
Payment of principal and interest on some mortgage pass-through securities
(but not the market value of the securities themselves) may be guaranteed by the
full faith and credit of the U.S. government (in the case of securities
guaranteed by GNMA); or guaranteed by agencies or instrumentalities of the U.S.
Government (in the case of securities guaranteed by FNMA or FHLMC, which are
supported only by the discretionary authority of the U.S. government to purchase
the agency's obligations).
The principal governmental guarantor of mortgage-related securities is the
GNMA. GNMA is a wholly owned U.S. government corporation within HUD. GNMA is
authorized to guarantee, with the full faith and credit of the U.S. government,
the timely payment of principal and interest on securities issued by
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institutions approved by GNMA (such a savings and loan institutions, commercial
banks and mortgage bankers) and backed by pools of FHA-insured or VA-guaranteed
mortgages.
Government-related guarantors (i.e., not backed by the full faith and
credit of the U.S. government) include the FNMA and the FHLMC. FNMA is a
government-sponsored corporation owned entirely by private stockholders. It is
subject to general regulation by the Secretary of Housing and Urban Development
and acts as a government instrumentality under authority granted by Congress.
FNMA purchases conventional (i.e., not insured or guaranteed by any government
agency) residential mortgages from a list of approved seller/servicers which
include state and federally chartered savings and loan associations, mutual
savings banks, commercial banks and credit unions and mortgage bankers. Pass-
through securities issued by FNMA are guaranteed as to timely payment of
principal and interest by FNMA but are not backed by the full faith and credit
of the U.S. government. FNMA is authorized to borrow from the U.S. Treasury to
meet its obligations.
FHLMC was created by Congress in 1970 for the purpose of increasing the
availability of mortgage credit for residential housing. It is a government-
sponsored corporation and acts as a government instrumentality under authority
granted by Congress. FHLMC was formerly owned by the twelve Federal Home Loan
Banks and is now owned entirely by private stockholders. FHLMC issues
Participation Certificates ("Pcs") which represent interests in conventional
mortgages from FHLMC's national portfolio. FHLMC guarantees the timely payment
of interest and collection of principal, but Pcs are not backed by the full
faith and credit of the U.S. government.
If either fixed or variable rate pass-through securities issued by the U.S.
government or its agencies or instrumentalities are developed in the future, the
Funds reserve the right to invest in them.
Commercial banks, savings and loan institutions, private mortgage insurance
companies, mortgage bankers and other secondary market issuers also create pass-
through pools of conventional residential mortgage loans. Such issuers may, in
addition, be the originators and/or servicers of the underlying mortgage loans
as well as the guarantors of the mortgage-related securities. Pools created by
such non-governmental issuers generally offer a higher rate of interest than
government and government-related pools because there are no direct or indirect
government or agency guarantees of payments in the former pools. However,
timely payment of interest and principal of these pools may be supported by
various forms of insurance or guarantees,
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including individual loan, title, pool and hazard insurance and letters of
credit. The insurance and guarantees are issued by governmental entities,
private insurers and the mortgage poolers. Such insurance and guarantees and
the creditworthiness of the issuers thereof will be considered in determining
whether a mortgage-related security meets the Funds' investment quality
standards. There can be no assurance that the private insurers or guarantors
can meet their obligations under the insurance policies or guarantee
arrangements. The Funds may buy mortgage-related securities without insurance
or guarantees if, through an examination of the loan experience and practices of
the originator/servicers and poolers, the Adviser determines that the securities
meet the Funds' quality standards.
PRIVATELY ISSUED MORTGAGE-RELATED SECURITIES The mortgage-related
--------------------------------------------
securities in which the Funds may invest may be: (i) privately issued securities
which are collateralized by pools of mortgages in which each mortgage is
guaranteed as to payment of principal and interest by an agency or
instrumentality of the U.S. government; (ii) privately issued securities which
are collateralized by pools of mortgages in which payment of principal and
interest is guaranteed by the issuer and such guarantee is collateralized by
U.S. government securities; and (iii) other privately issued securities in which
the proceeds of the issuance are invested in mortgage-backed securities and
payment of the principal and interest is supported by the credit of an agency or
instrumentality of the U.S. government.
The California Tax Free Fund, New York Tax Free Fund and Equity Index Fund,
however, may not invest in non-government mortgage pass-through securities.
Although the market for such securities is becoming increasingly liquid,
securities issued by certain private organizations may not be readily
marketable. No Fund will purchase mortgage-related securities or any other
assets which in the Advisers' opinion are illiquid if, as a result, more than
10% (15% in the case of the International Equity Fund and International Bond
Funds) of the value of the Fund's total assets will be illiquid.
COLLATERALIZED MORTGAGE OBLIGATIONS (CMOS) A CMO is a hybrid between a
------------------------------------------
mortgage-backed bond and a mortgage pass-through security. Similar to a bond,
interest and prepaid principal is paid, in most cases, semiannually. CMOs may
be collateralized by whole mortgage loans, but are more typically collateralized
by portfolios of mortgage pass-through securities guaranteed by GNMA, FHLMC, or
FNMA and their income streams.
CMOs are structured into multiple classes, each bearing a different stated
maturity. Actual maturity and average life will depend upon the prepayment
experience of the collateral. CMOs
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provide for a modified form of call protection through a de facto breakdown of
--------
the underlying pool of mortgages according to how quickly the loans are repaid.
Monthly payment of principal received from the pool of underlying mortgages,
including prepayments, is first returned to investors holding the shortest
maturity class. Investors holding the longer maturity classes receive principal
only after the first class has been retired. An investor is partially guarded
against a sooner than desired return of principal because of the sequential
payments.
In a typical CMO transaction, a corporation ("issuer") issues multiple
series (e.g., A, B, C, Z) of CMO bonds ("Bonds"). Proceeds of the Bond Offering
are used to purchase mortgages or mortgage pass-through certificates
("Collateral"). The Collateral is pledged to a third-party trustee as security
for the Bonds. Principal and interest payments from the Collateral are used to
pay principal on the Bonds in the order A, B, C, Z. The Series A, B, and C
Bonds all bear current interest. Interest on the Series Z Bond is accrued and
added to principal and a like amount is paid as principal on the Series A, B or
C Bond currently being paid off. When the Series A, B and C Bonds are paid in
full, interest and principal on the Series Z Bond begins to be paid currently.
With some CMOs, the issuer serves as a conduit to allow loan originators
(primarily builders or savings and loan associations) to borrow against their
loan portfolios.
FHLMC COLLATERALIZED MORTGAGE OBLIGATIONS FHLMC CMOs are debt obligations
-----------------------------------------
of FHLMC issued in multiple classes having different maturity dates which are
secured by the pledge of a pool of conventional mortgage loans purchased by
FHLMC. Unlike FHLMC Pcs, payments of principal and interest on the CMOs are
made semiannually, as opposed to monthly. The amount of principal payable on
each semiannual payment date is determined in accordance with FHLMC's mandatory
sinking fund schedule, which, in turn, is equal to approximately 100% of FHA
prepayment experience applied to the mortgage collateral pool. All sinking fund
payments in the CMOs are allocated to the retirement of the individual classes
of bonds in the order of their stated maturities. Payment of principal on the
mortgage loans in the collateral pool in excess of the amount of FHLMC's minimum
sinking fund obligation for any payment date are paid to the holders of the CMOs
as additional sinking fund payments. Because of the "pass-through" nature of
all principal payments received on the collateral pool in excess of FHLMC's
minimum sinking fund requirement, the rate at which principal of the CMOs is
actually repaid is likely to be such that each class of bonds will be retired in
advance of its scheduled maturity date.
If collection of principal (including prepayments) on the mortgage loans
during any semiannual payment period is not
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sufficient to meet FHLMC's minimum sinking fund obligation on the next sinking
fund payment date, FHLMC agrees to make up the deficiency from its general
funds.
Criteria for the mortgage loans in the pool backing the CMOs are identical
to those of FHLMC Pcs. FHLMC has the right to substitute collateral in the
event of delinquencies and/or defaults.
OTHER MORTGAGE-RELATED SECURITIES Other mortgage-related securities
---------------------------------
include securities other than those described above that directly or indirectly
represent a participation in, or are secured by and payable from, mortgage loans
on real property, including CMO residuals or stripped mortgage-backed
securities, and may be structured in classes with rights to receive varying
proportions of principal and interest. Other mortgage-related securities may be
equity or debt securities issued by agencies or instrumentalities of the U.S.
government or by private originators of, or investors in, mortgage loans,
including savings and loan associations, homebuilders, mortgage banks,
commercial banks, investment banks, partnerships, trusts and special purpose
entities of the foregoing.
CMO RESIDUALS CMO residuals are derivative mortgage securities issued by
-------------
agencies or instrumentalities of the U.S. government or by private originators
of, or investors in, mortgage loans, including savings and loan associations,
homebuilders, mortgage banks, commercial banks, investment banks and special
purpose entities of the foregoing.
The cash flow generated by the mortgage assets underlying a series of CMOs
is applied first to make required payments of principal and interest on the
CMOs and second to pay the related administrative expenses of the issuer. The
residual in a CMO structure generally represents the interest in any excess cash
flow remaining after making the foregoing payments. Each payment of such excess
cash flow to a holder of the related CMO residual represents income and/or a
return of capital. The amount of residual cash flow resulting from a CMO will
depend on, among other things, the characteristics of the mortgage assets, the
coupon rate of each class of CMO, prevailing interest rates, the amount of
administrative expenses and the prepayment experience on the mortgage assets.
In particular, the yield to maturity on CMO residuals is extremely sensitive to
prepayments on the related underlying mortgage assets, in the same manner as an
interest-only ("IO") class of stripped mortgage-backed securities. See
"Stripped Mortgage-Backed Securities." In addition, if a series of a CMO
includes a class that bears interest at an adjustable rate, the yield to
maturity on the related CMO residual will also be extremely sensitive to changes
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in the level of the index upon which interest rate adjustments are based. As
described below with respect to stripped mortgage-backed securities, in certain
circumstances a portfolio may fail to recoup fully its initial investment in a
CMO residual.
CMO residuals are generally purchased and sold by institutional investors
through several investment banking firms acting as brokers or dealers. The CMO
residual market has only very recently developed and, accordingly, CMO residuals
currently may not have the liquidity of other more established securities
trading in other markets. Transactions in CMO residuals are generally completed
only after careful review of the characteristics of the securities in question.
In addition, CMO residuals may or, pursuant to an exemption therefrom, may not
have been registered under the Securities Act of 1933, as amended. CMO
residuals, whether or not registered under such Act, may be subject to certain
restrictions on transferability, and may be deemed "illiquid" and subject to a
portfolio's limitations on investment in illiquid securities.
Under certain circumstances, a Fund's investment in residual interests in
"real estate mortgage investment conduits" ("REMICs") may cause shareholders of
that Fund to be deemed to have taxable income in addition to their Fund
dividends and distributions and such income may not be eligible to be reduced
for tax purposes by certain deductible amounts, including net operating loss
deductions. In addition, in some cases, the Fund may be required to pay taxes
on certain amounts deemed to be earned from a REMIC residual. Prospective
investors may wish to consult their tax advisors regarding REMIC residual
investments by a Fund.
GOVERNMENT FUND The Government Fund will not invest in any privately
---------------
issued CMOs if, as a result of such investment, more than 5% of the Fund's net
assets would be invested in any one CMO, more than 10% of the Fund's net assets
would be invested in CMOs and other investment company securities in the
aggregate, or the Fund would hold more than 3% of any outstanding issue of CMOs.
The Government Fund may also invest in securities collateralized by
mortgages or pools of mortgages the issuer of which has qualified to be treated
as a "REMIC". CMOs and REMICs may offer a higher yield than U.S. government
securities, but they may also be subject to greater price fluctuation and credit
risk. In addition, CMOs and REMICs typically will be issued in a variety of
classes or series, which have different maturities and are retired in sequence.
Privately issued CMOs and REMICs are not government securities nor are they
supported in any way by
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any governmental agency or instrumentality. In the event of a default by an
issuer of a CMO or a REMIC, there is no assurance that the collateral securing
such CMO or REMIC will be sufficient to pay principal and interest. It is
possible that there will be limited opportunities for trading CMOs and REMICs in
the over-the-counter market, the depth and liquidity of which will vary from
issue to issue and from time to time. Under recent legislation, holders of
"residual" interests in REMICs (including the Fund) could be required to
recognize potential phantom income, as could shareholders (including unrelated
business taxable income for tax-exempt shareholders) of funds that hold such
interests. The Government Fund will consider this legislation in determining
whether to invest in residual interests.
STRIPPED MORTGAGE-BACKED SECURITIES Stripped mortgage-backed securities
-----------------------------------
("SMBS") are derivative multi-class mortgage securities. SMBS may be issued by
agencies or instrumentalities of the U.S. government, or by private originators
of, or investors in, mortgage loans, including savings and loan associations,
mortgage banks, commercial banks, investment banks and special purpose entities
of the foregoing.
SMBS are usually structured with two classes that receive different
proportions of the interest and principal distributions on a pool of mortgage
assets. A common type of SMBS will have one class receiving some of the
interest and most of the principal from the mortgage assets, while the other
class will receive most of the interest and the remainder of the principal. In
the most extreme case, one class will receive all of the interest (the
interest-only or "IO" class), while the other class will receive all of the
principal (the principal-only or "PO" class). The yield to maturity on an IO
class is extremely sensitive to the rate of principal payments (including
prepayments) on the related underlying mortgage assets, and a rapid rate of
principal payments may have a material adverse effect on a Fund's yield to
maturity from these securities. If the underlying mortgage assets experience
greater than anticipated prepayments of principal, a Fund may fail to fully
recoup its initial investment in these securities even if the security is in one
of the highest rating categories.
Although SMBS are purchased and sold by institutional investors through
several investment banking firms acting as brokers or dealers, these securities
were only recently developed. As a result, established trading markets have not
yet developed and, accordingly, these securities may be deemed "illiquid" and
subject to a Fund's limitations on investment in illiquid securities.
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<PAGE>
RISKS ASSOCIATED WITH MORTGAGE-BACKED SECURITIES The value of some
------------------------------------------------
mortgage-backed securities in which the Funds may invest may be particularly
sensitive to changes in prevailing interest rates, and, like the other
investments of the Funds, the ability of a Fund to successfully utilize these
instruments may depend in part upon the ability of an Adviser to forecast
interest rates and other economic factors correctly. If an Adviser incorrectly
forecasts such factors and has taken a position in mortgage-backed securities
that is or becomes contrary to prevailing market trends, the Funds could be
exposed to the risk of a loss.
Investment in mortgage-backed securities poses several risks, including
prepayment, market, and credit risk. Prepayment risk reflects the chance that
borrowers may prepay their mortgages faster than expected, thereby affecting the
investment's average life and perhaps its yield. Whether or not a mortgage loan
is prepaid is almost entirely controlled by the borrower. Borrowers are most
likely to exercise their prepayment options at a time when it is least
advantageous to investors, generally prepaying mortgages as interest rates fall,
and slowing payments as interest rates rise. Besides the effect of prevailing
interest rates, the rate of prepayment and refinancing of mortgages may also be
affected by home value appreciation, ease of the refinancing process and local
economic conditions.
Market risk reflects the chance that the price of the security may
fluctuate over time. The price of mortgage-backed securities may be
particularly sensitive to prevailing interest rates, the length of time the
security is expected to be outstanding, and the liquidity of the issue. In a
period of unstable interest rates, there may be decreased demand for certain
types of mortgage-backed securities, and a Fund invested in such securities and
wishing to sell them may find it difficult to find a buyer, which may in turn
decrease the price at which they may be sold.
Credit risk reflects the chance that a Fund may not receive all or part of
its principal because the issuer or credit enhancer has defaulted on its
obligations. Obligations issued by U.S. government-related entities are
guaranteed as to the payment of principal and interest, but are not backed by
the full faith and credit of the U.S. government. The performance of private
label mortgage-backed securities, issued by private institutions, is based on
the financial health of those institutions.
OTHER ASSET-BACKED SECURITIES Similarly, the Advisers expect that other
-----------------------------
asset-backed securities (unrelated to mortgage loans) will be offered to
investors in the future, which the Funds may invest in. Several types of asset-
backed securities
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<PAGE>
have already been offered to investors, including CARS/SM/ ("Certificates for
Automobile Receivables/SM/"). CARS/SM/ represent undivided fractional interests
in a trust ("trust") whose assets consist of a pool of motor vehicle retail
installment sales contracts and security interests in the vehicles securing the
contracts. Payments of principal and interest on CARS/SM/ are passed-through
monthly to certificate holders, and are guaranteed up to certain amounts and for
a certain time period by a letter of credit issued by a financial institution
unaffiliated with the trustee or originator of the trust. An investor's return
on CARS/SM/ may be affected by early prepayment of principal on the underlying
vehicle sales contracts. If the letter of credit is exhausted, the trust may be
prevented from realizing the full amount due on a sales contract because of
state law requirements and restrictions relating to foreclosure sales of
vehicles and the obtaining of deficiency judgments following such sales or
because of depreciation, damage or loss of a vehicle, the application of federal
and state bankruptcy and insolvency laws, or other factors. As a result,
certificate holders may experience delays in payments or losses if the letter of
credit is exhausted.
Consistent with its investment objectives and policies, a Fund also may
invest in other types of asset-backed securities.
SHORT SALES AGAINST THE BOX
A short sale is a transaction in which a Fund sells through a broker a
security it does not own in anticipation of a possible decline in market price.
A short sale "against the box" is a short sale in which, at the time of the
short sale, a Fund owns or has the right to obtain securities equivalent in kind
and amount. Each of the Funds will only enter into short sales against the box.
A Fund may enter into a short sale against the box among other reasons, to hedge
against a possible market decline in the value of the security owned or to defer
recognition of a gain or loss for federal income tax purposes on the security
owned by the Fund. If the value of a security sold short against the box
increases, the Fund would suffer a loss when it purchases or delivers to the
selling broker the security sold short. The proceeds of the short sale are
retained by the broker pursuant to applicable margin rules. In addition, the
Fund may segregate assets, equal in value to 50% of the value of the short
sale, in a special account with the Fund's custodian. The segregated assets are
pledged to the broker pursuant to applicable margin rules. If a broker, with
which the Fund has open short sales, were to become bankrupt, a Fund could
experience losses or delays in recovering gains on short sales. The Funds will
only enter into short sales against the box with brokers they believe are
creditworthy. Short sales against the box will be limited to no more than 25% of
a Fund's net assets.
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<PAGE>
OPTIONS ON SECURITIES
WRITING CALL OPTIONS Any Fund, except the Equity Index Fund, the Money
--------------------
Market Fund and the Tax Free Bond Fund, may sell ("write") covered call options
on the portfolio securities of such Fund in an attempt to enhance investment
performance. The California Tax Free Fund and New York Tax Free Fund may
purchase and sell both put and call options on debt securities in standardized
contracts traded on national securities exchanges, boards of trade, or similar
entities, or quoted on NASDAQ, and agreements, sometimes called "cash puts,"
which may accompany the purchase of a new issue of bonds from a dealer. A call
option sold by a Fund is a short-term contract, having a duration of nine months
or less, which gives the purchaser of the option the right to buy, and imposes
on the writer of the option--in return for a premium received--the obligation to
sell, the underlying security at the exercise price upon the exercise of the
option at any time prior to the expiration date, regardless of the market price
of the security during the option period. A call option may be covered by,
among other things, the writer's owning the underlying security throughout the
option period, or by holding, on a share-for-share basis, a call on the same
security as the call written, where the exercise price of the call held is equal
to or less than the price of the call written, or greater than the exercise
price of a call written if the difference is maintained by the Fund in cash or
high grade liquid debt securities in a segregated account with its custodian.
A Fund will write covered call options both to reduce the risks associated
with certain of its investments and to increase total investment return through
the receipt of premiums. In return for the premium income, the Fund will give
up the opportunity to profit from an increase in the market price of the
underlying security above the exercise price so long as its obligations under
the contract continue, except insofar as the premium represents a profit.
Moreover, in writing the call option, the Fund will retain the risk of loss
should the price of the security decline, which loss the premium is intended to
offset in whole or in part. A Fund, in writing call options, must assume that
the call may be exercised at any time prior to the expiration of its obligations
as a writer, and that in such circumstances the net proceeds realized from the
sale of the underlying securities pursuant to the call may be substantially
below the prevailing market price. Covered call options and the securities
underlying such options will be listed on national securities exchanges, except
for certain transactions in options on debt securities and foreign securities.
During the option period, the covered call writer has, in return for the
premium received on the option, given up the
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<PAGE>
opportunity to profit from a price increase in the underlying securities above
the exercise price, but, as long as its obligation as a writer continues, has
retained the risk of loss should the price of the underlying security decline.
A Fund may protect itself from further losses due to a decline in value of
the underlying security or from the loss of ability to profit from appreciation
by buying an identical option, in which case the purchase cost may offset the
premium. In order to do this, the Fund makes a "closing purchase transaction"--
the purchase of a call option on the same security with the same exercise price
and expiration date as the covered call option which it has previously written
on any particular security. The Fund will realize a gain or loss from a closing
purchase transaction if the amount paid to purchase a call option in a closing
transaction is less or more than the amount received from the sale of the
covered call option. Also, because increases in the market price of a call
option will generally reflect increases in the market price of the underlying
security, any loss resulting from the closing out of a call option is likely to
be offset in whole or in part by unrealized appreciation of the underlying
security owned by the Fund. When a security is to be sold from the Fund's
portfolio, the Fund will first effect a closing purchase transaction so as to
close out any existing covered call option on that security.
A closing purchase transaction may be made only on a national or foreign
securities exchange (an "Exchange") which provides a secondary market for an
option with the same exercise price and expiration date. There is no assurance
that a liquid secondary market on an Exchange or otherwise will exist for any
particular option, or at any particular time, and for some options no secondary
market on an Exchange or otherwise may exist. If the Fund is unable to effect a
closing purchase transaction involving an exchange-traded option, the Fund will
not sell the underlying security until the option expires or the Fund delivers
the underlying security upon exercise. A closing purchase transaction for an
over-the-counter option may be made only with the other party to the option.
Once an option writer has received an exercise notice, it cannot effect a
closing purchase transaction in order to terminate its obligation under the
option and must deliver or purchase the underlying securities at the exercise
price.
Each Fund pays brokerage commissions and dealer spreads in connection with
writing covered call options and effecting closing purchase transactions, as
well as for purchases and sales of underlying securities. The writing of
covered call options could result in significant increases in a Fund's portfolio
turnover rate, especially during periods when market prices of
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<PAGE>
the underlying securities appreciate. Subject to the limitation that all call
and put option writing transactions be covered, the Funds may, to the extent
determined appropriate by the Advisers, engage without limitation in the writing
of options on U.S. government securities. Subject to the limitation that all
call and put option writing transactions be covered, and limitations imposed on
regulated investment companies under federal tax law, the International Bond
Fund and International Equity Fund may, to the extent determined appropriate by
the Adviser, engage without limitation in the writing of options on their
portfolio securities.
WRITING PUT OPTIONS Each Fund, except the Equity Index Fund, the Money
-------------------
Market Fund and the Tax Free Bond Fund, may also write covered put options. A
put option written by the Fund is "covered" if the Fund maintains cash or cash
equivalents (high quality liquid debt securities) with a value equal to the
exercise price in a segregated account with its custodian. A put option is also
"covered" if the Fund holds on a share-for-share basis a put on the same
security as the put written, where the exercise price of the put held is equal
to or greater than the exercise price of the put written, or less than the
exercise price of the put written if the difference is maintained by the Fund in
cash or high grade liquid debt securities in a segregated account with its
custodian.
The premium which the Funds receive from writing a put option will reflect,
among other things, the current market price of the underlying security, the
relationship of the exercise price to such market price, the historical price
volatility of the underlying security, the option period, supply and demand and
interest rates.
A covered put writer assumes the risk that the market price for the
underlying security will fall below the exercise price, in which case the writer
could be required to purchase the security at a higher price than the then-
current market price of the security. In both cases, the writer has no control
over the time when it may be required to fulfill its obligation as a writer of
the option.
The Funds may effect a closing purchase transaction to realize a profit on
an outstanding put option or to prevent an outstanding put option from being
exercised. The Funds also may effect a closing purchase transaction, in the
case of a put option, to permit the Funds to maintain their holdings of the
deposited U.S. Treasury obligations, to write another put option to the extent
that the exercise price thereof is secured by the deposited U.S. Treasury
obligations, or to utilize the proceeds from the sale of such obligations to
make other investments.
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<PAGE>
If a Fund is able to enter into a closing purchase transaction, the Fund
will realize a profit or loss from such transaction if the cost of such
transaction is less or more than the premium received from the writing of the
option. After writing a put option, the Fund may incur a loss equal to the
difference between the exercise price of the option and the sum of the market
value of the underlying security plus the premium received from the sale of the
option.
In addition, the Funds may also write straddles (combinations of covered
puts and calls on the same underlying security). The extent to which the Funds
may write covered put and call options and enter into so-called "straddle"
transactions involving put or call options may be limited by the requirements of
the Internal Revenue Code of 1986, as amended (the "Code") for qualification as
a regulated investment company and the Trust's intention that each Fund qualify
as such. Subject to the limitation that all call and put option writing
transactions be covered, the Funds may, to the extent determined appropriate by
the Advisers, engage without limitation in the writing of options on U.S.
government securities.
PURCHASING OPTIONS Each Fund, except the Equity Index Fund, the Money
------------------
Market Fund and the Tax Free Bond Fund, may purchase put or call options which
are traded on an Exchange or in the over-the-counter market. Options traded in
the over-the-counter market may not be as actively traded as those listed on an
Exchange. Accordingly, it may be more difficult to value such options and to be
assured that they can be closed out at any time. The Funds will engage in such
transactions only with firms of sufficient creditworthiness so as to minimize
these risks.
The Funds may purchase put options on securities to protect their holdings
in an underlying or related security against a substantial decline in market
value. Securities are considered related if their price movements generally
correlate with one another. A Fund would buy a put option in anticipation of a
decline in the market value of such securities. The purchase of a put option
would entitle the Fund, in exchange for the premium paid, to sell a security at
a specified price upon exercise of the option during the option period. The
purchase of put options on securities held in the portfolio or related to such
securities will enable a Fund to preserve, at least partially, unrealized gains
occurring prior to the purchase of the option on a portfolio security without
actually selling the security. In addition, the Fund will continue to receive
interest or dividend income on the security. The put options purchased by the
Fund may include, but are not limited to, "protective puts" in which the
security to be sold is identical or substantially identical to a security
already held by the Fund or to a security which the
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<PAGE>
Fund has the right to purchase. The Fund would ordinarily recognize a gain if
the value of the securities decreased during the option period below the
exercise price sufficiently to cover the premium. The Fund would recognize a
loss if the value of the securities remained above the difference between the
exercise price and the premium.
The Funds may also purchase call options on securities the Funds intend to
purchase to protect against substantial increases in prices of such securities
pending their ability to invest in an orderly manner in such securities. The
purchase of a call option would entitle the Fund, in exchange for the premium
paid, to purchase a security at a specified price upon exercise of the option
during the option period. The Fund would ordinarily realize a gain if the value
of the securities increased during the option period above the exercise price
sufficiently to cover the premium. The Fund would have a loss if the value of
the securities remained below the sum of the premium and the exercise price
during the option period. In order to terminate an option position, the Funds
may sell put or call options identical to those previously purchased, which
could result in a net gain or loss depending on whether the amount received on
the sale is more or less than the premium and other transaction costs paid on
the put or call option when it was purchased.
SPECIAL RISKS ASSOCIATED WITH OPTIONS ON SECURITIES Exchange markets in
---------------------------------------------------
U.S. government securities options are a relatively new and untested concept,
and it is impossible to predict the amount of trading interest that may exist
in such options. The same types of risk apply to over-the-counter trading in
options. There can be no assurance that viable markets will develop or continue
in the United States or abroad.
If a put or call option purchased by a Fund is not sold when it has
remaining value, and if the market price of the underlying security, in the case
of a put, remains equal to or greater than the exercise price, or, in the case
of a call, remains less than or equal to the exercise price, the Fund will not
be able to exercise profitably the option and will lose its entire investment in
the option. Also, the price of a put or call option purchased to hedge against
price movements in a related security may move more or less than the price of
the related security. The Capital Appreciation Fund, Convertible Fund,
Government Fund, High Yield Corporate Bond Fund, Money Market Fund, Total Return
Fund and Value Fund will not purchase a put or call option if, as a result, the
amount of premiums paid for all put and call options then outstanding would
exceed 10% of the value of the Fund's total assets. Regarding the International
Bond Fund and International Equity Fund, each Fund has undertaken to a state
securities commission that it will not purchase a put,
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<PAGE>
call, straddle or spread if, as a result, the amount of premiums paid for such
positions would exceed 5% of the value of the Fund's net assets.
The hours of trading for options on securities may not conform to the hours
during which the underlying securities are traded. To the extent that the
options markets close before the markets for the underlying securities,
significant price and rate movements can take place in the underlying markets
that cannot be reflected in the options markets.
OPTIONS ON FOREIGN CURRENCIES Each Fund, except the California Tax Free
-----------------------------
Fund, the Equity Index Fund, the Government Fund, the Money Market Fund, the New
York Tax Free Fund and the Tax Free Bond Fund, may, to the extent that it
invests in foreign securities, purchase and write options on foreign currencies
for hedging purposes in a manner similar to that of the Fund's transactions in
currency futures contracts or forward contracts. For example, a decline in the
dollar value of a foreign currency in which portfolio securities are denominated
will reduce the dollar value of such securities, even if their value in the
foreign currency remains constant. In order to protect against such declines in
the value of portfolio securities, a Fund may purchase put options on the
foreign currency. If the value of the currency does decline, that Fund will
have the right to sell such currency for a fixed amount of dollars which exceeds
the market value of such currency, resulting in a gain that may offset, in whole
or in part, the negative effect of currency depreciation on the value of the
Fund's securities denominated in that currency.
Conversely, if a rise in the dollar value of a currency in which securities
to be acquired are denominated is projected, thereby increasing the cost of such
securities, a Fund may purchase call options on such currency. If the value of
such currency does increase, the purchase of such call options would enable the
Fund to purchase currency for a fixed amount of dollars which is less than the
market value of such currency, resulting in a gain that may offset, at least
partially, the effect of any currency-related increase in the price of
securities the Fund intends to acquire. As in the case of other types of
options transactions, however, the benefit a Fund derives from purchasing
foreign currency options will be reduced by the amount of the premium and
related transaction costs. In addition, if currency exchange rates do not move
in the direction or to the extent anticipated, a Fund could sustain losses on
transactions in foreign currency options which would deprive it of a portion or
all of the benefits of advantageous changes in such rates.
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<PAGE>
A Fund may also write options on foreign currencies for hedging purposes.
For example, if a Fund anticipates a decline in the dollar value of foreign
currency-denominated securities due to declining exchange rates, it could,
instead of purchasing a put option, write a call option on the relevant
currency. If the expected decline occurs, the option will most likely not be
exercised, and the decrease in value of portfolio securities will be offset by
the amount of the premium received by the Fund.
Similarly, instead of purchasing a call option to hedge against an
anticipated increase in the dollar cost of securities to be acquired, a Fund
could write a put option on the relevant currency. If rates move in the manner
projected, the put option will expire unexercised and allow the Fund to offset
such increased cost up to the amount of the premium. As in the case of other
types of options transactions, however, the writing of a foreign currency option
will constitute only a partial hedge up to the amount of the premium, and only
if rates move in the expected direction. If unanticipated exchange rate
fluctuations occur, the option may be exercised and a Fund would be required to
purchase or sell the underlying currency at a loss which may not be fully offset
by the amount of the premium. As a result of writing options on foreign
currencies, a Fund also may be required to forgo all or a portion of the
benefits which might otherwise have been obtained from favorable movements in
currency exchange rates.
A call option written on foreign currency by a Fund is "covered" if that
Fund owns the underlying foreign currency subject to the call or securities
denominated in that currency or has an absolute and immediate right to acquire
that foreign currency without additional cash consideration (or for additional
cash consideration held in a segregated account by its custodian) upon
conversion or exchange of other foreign currency held in its portfolio. A call
option is also covered if a Fund holds a call on the same foreign currency for
the same principal amount as the call written where the exercise price of the
call held (a) is equal to or less than the exercise price of the call written or
(b) is greater than the exercise price of the call written if the amount of the
difference is maintained by a Fund in cash and liquid high grade debt securities
in a segregated account with its custodian.
SECURITIES INDEX OPTIONS
The Funds may purchase call and put options on securities indexes (only
call options on the S&P 500 Index in the case of the Equity Index Fund) for the
purpose of hedging against the risk of unfavorable price movements adversely
affecting the value of a Fund's securities. The Equity Index Fund may purchase
call
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options on the S&P 500 Index to protect against increases in the prices of
securities underlying the Index that the Equity Index Fund intends to purchase
pending its ability to invest in such securities in an orderly manner.
Unlike a securities option, which gives the holder the right to purchase or
sell specified securities at a specified price, an option on a securities index
gives the holder the right to receive a cash "exercise settlement amount" equal
to (i) the difference between the value of the underlying securities index on
the exercise date and the exercise price of the option, multiplied by (ii) a
fixed "index multiplier." In exchange for undertaking the obligation to make
such a cash payment, the writer of the securities index option receives a
premium.
A securities index fluctuates with changes in the market values of the
securities so included. For example, some securities index options are based on
a broad market index such as the S&P 500 Index or the N.Y.S.E. Composite Index,
or a narrower market index such as the S&P 100 Index. Indexes may also be based
on an industry or market segment such as the AMEX Oil and Gas Index or the
Computer and Business Equipment Index. Options on stock indexes are currently
traded on the following exchanges, among others: The Chicago Board Options
Exchange, New York Stock Exchange, and American Stock Exchange. Options on
other types of securities indexes, which do not currently exist, including
indexes on debt securities, may be introduced and traded on exchanges in the
future. If such options are introduced, the Funds will not purchase them until
they have appropriately amended or supplemented the Prospectus or Statement of
Additional Information, or both.
The effectiveness of hedging through the purchase of securities index
options will depend upon the extent to which price movements in the portion of
the securities portfolio being hedged correlate with price movements in the
selected securities index. Perfect correlation is not possible because the
securities held or to be acquired by a Fund will not exactly match the
securities represented in the securities indexes on which options are based. In
addition, the purchase of securities index options involves essentially the same
risks as the purchase of options on futures contracts. The principal risk is
that the premium and transaction costs paid by a Fund in purchasing an option
will be lost as a result of unanticipated movements in prices of the securities
comprising the securities index on which the option is based. Gains or losses
on a Fund's transactions in securities index options depend on price movements
in the securities market generally (or, for narrow market indexes, in a
particular industry or segment of the market) rather than the price movements of
individual securities held by a Fund. In this
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respect, purchasing a securities index put (or call) option is analogous to the
purchase of a put (or call) on a securities index futures contract.
A Fund may sell securities index options prior to expiration in order to
close out its positions in securities index options which it has purchased. A
Fund may also allow options to expire unexercised.
FUTURES TRANSACTIONS
The California Tax Free Fund, Convertible Fund, Government Fund, High Yield
Corporate Bond Fund, International Bond Fund, International Equity Fund, New
York Tax Free Fund, Tax Free Bond Fund and Total Return Fund may purchase and
sell futures contracts on debt securities and on indexes of debt securities to
hedge against anticipated changes in interest rates that might otherwise have an
adverse effect upon the value of a Fund's portfolio securities. Each of such
Funds may also enter into such futures contracts in order to lengthen or shorten
the average maturity or duration of the Fund's portfolio. For example, a Fund
may purchase futures contracts as a substitute for the purchase of longer-term
debt securities to lengthen the average duration of a Fund's portfolio of fixed-
income securities. The Capital Appreciation Fund, Convertible Fund, Equity
Index Fund, International Equity Fund, Total Return Fund and Value Fund may
purchase and sell stock index futures to hedge the equity portion of those
Funds' securities portfolios with regard to market (systematic) risk (involving
the market's assessment of overall economic prospects), as distinguished from
stock-specific risk (involving the market's evaluation of the merits of the
issuer of a particular security). These Funds, and the International Bond Fund,
may also purchase and sell other futures when deemed appropriate, in order to
hedge the equity or non-equity portions of their portfolios. In addition, each
Fund, except the California Tax Free Fund, Equity Index Fund, Government Fund,
Money Market Fund, New York Tax Free Fund and Tax Free Bond Fund may, to the
extent it invests in foreign securities, enter into contracts for the future
delivery of foreign currencies to hedge against changes in currency exchange
rates. Each of the Funds may also purchase and write put and call options on
futures contracts of the type into which such Fund is authorized to enter and
may engage in related closing transactions. In the United States, all such
futures on debt securities, debt index futures, stock index futures, foreign
currency futures and related options will be traded on exchanges that are
regulated by the Commodity Futures Trading Commission ("CFTC"). Subject to
applicable CFTC rules, the Funds also may enter into futures contracts traded on
the following foreign futures exchanges: Frankfurt, Tokyo, London and Paris, as
long
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as trading on the aforesaid foreign futures exchanges does not subject a Fund to
risks that are materially greater than the risks associated with trading on U.S.
exchanges. The International Bond Fund and International Equity Fund are not
limited to the above-listed exchanges.
A futures contract is an agreement to buy or sell a security or currency
(or to deliver a final cash settlement price in the case of a contract relating
to an index or otherwise not calling for physical delivery at the end of trading
in the contracts), for a set price in a future month. When interest rates are
changing and portfolio values are falling, futures contracts can offset a
decline in the value of a Fund's current portfolio securities. When interest
rates are changing and portfolio values are rising, the purchase of futures
contracts can secure better effective rates or prices for the Fund than might
later be available in the market when the Fund makes anticipated purchases. In
the United States, futures contracts are traded on boards of trade which have
been designated "contract markets" by the CFTC. Futures contracts trade on
these markets through an "open outcry" auction on the exchange floor.
Currently, there are futures contracts based on a variety of instruments,
indexes and currencies, including long-term U.S. Treasury bonds, Treasury notes,
GNMA certificates, three-month U.S. Treasury bills, three-month domestic bank
certificates of deposit, a municipal bond index and various stock indexes.
When a purchase or sale of a futures contract is made by a Fund, the Fund
is required to deposit with its custodian (or broker, if legally permitted) a
specified amount of cash or U.S. government securities ("initial margin"). The
margin required for a futures contract is set by the exchange on which the
contract is traded and may be modified during the term of the contract. The
initial margin is in the nature of a performance bond or good faith deposit on
the futures contract which is returned to the Fund upon termination of the
contract assuming all contractual obligations have been satisfied. Each Fund
expects to earn interest income on its initial margin deposits. A futures
contract held by a Fund is valued daily at the official settlement price of the
exchange on which it is traded. Each day the Fund pays or receives cash, called
"variation margin," equal to the daily change in value of the futures contract.
This process is known as "marking-to-market." Variation margin does not
represent a borrowing or loan by a Fund but is instead a settlement between the
Fund and the broker of the amount one would owe the other if the futures
contract expired. In computing daily net asset value, each Fund will mark-to-
market its open futures positions.
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A Fund is also required to deposit and maintain margin with respect to put
and call options on futures contracts written by it. Such margin deposits will
vary depending on the nature of the underlying futures contract (and the related
initial margin requirements), the current market value of the option, and other
futures positions held by the Fund.
Positions taken in the futures markets are not normally held until delivery
or final cash settlement is required, but are instead liquidated through
offsetting transactions which may result in a gain or a loss. While futures
positions taken by a Fund will usually be liquidated in this manner, the Fund
may instead make or take delivery of underlying securities or currencies
whenever it appears economically advantageous to the Fund to do so. A clearing
organization associated with the exchange on which futures are traded assumes
responsibility for closing-out transactions and guarantees that as between the
clearing members of an exchange, the sale and purchase obligations will be
performed with regard to all positions that remain open at the termination of
the contract.
FUTURES ON DEBT SECURITIES A futures contract on a debt security is a
--------------------------
binding contractual commitment which, if held to maturity, will result in an
obligation to make or accept delivery, during a particular future month, of
securities having a standardized face value and rate of return. By purchasing
futures on debt securities--assuming a "long" position--a Fund will legally
obligate itself to accept the future delivery of the underlying security and pay
the agreed-upon price. By selling futures on debt securities--assuming a
"short" position--it will legally obligate itself to make the future delivery of
the security against payment of the agreed-upon price. Open futures positions
on debt securities will be valued at the most recent settlement price, unless
such price does not appear to the Trustees to reflect the fair value of the
contract, in which case the positions will be valued by or under the direction
of the Trustees.
Hedging by use of futures on debt securities seeks to establish, more
certainly than would otherwise be possible, the effective rate of return on
portfolio securities. A Fund may, for example, take a "short" position in the
futures market by selling contracts for the future delivery of debt securities
held by the Fund (or securities having characteristics similar to those held by
the Fund) in order to hedge against an anticipated rise in interest rates that
would adversely affect the value of the Fund's portfolio securities. When
hedging of this character is successful, any depreciation in the value of
portfolio securities will be substantially offset by appreciation in the value
of the futures position.
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On other occasions, a Fund may take a "long" position by purchasing futures
on debt securities. This would be done, for example, when the Fund intends to
purchase particular securities and it has the necessary cash, but expects the
rate of return available in the securities markets at that time to be less
favorable than rates currently available in the futures markets. If the
anticipated rise in the price of the securities should occur (with its
concomitant reduction in yield), the increased cost to the Fund of purchasing
the securities will be offset, at least to some extent, by the rise in the value
of the futures position taken in anticipation of the subsequent securities
purchase. A Fund may also purchase futures contracts as a substitute for the
purchase of longer-term securities to lengthen the average duration of the
Fund's portfolio.
The Fund could accomplish similar results by selling securities with long
maturities and investing in securities with short maturities when interest rates
are expected to increase or by buying securities with long maturities and
selling securities with short maturities when interest rates are expected to
decline. However, by using futures contracts as a risk management technique,
given the greater liquidity in the futures market than in the cash market, it
may be possible to accomplish the same result more easily and more quickly.
Because the only futures contracts currently available to hedge the Tax
Free Bond Fund's portfolio of municipal obligations are futures on various U.S.
government securities and futures on a municipal securities index, perfect
correlation between that Fund's futures positions and portfolio positions may be
difficult to achieve.
SECURITIES INDEX FUTURES A securities index futures contract does not
------------------------
require the physical delivery of securities, but merely provides for profits and
losses resulting from changes in the market value of the contract to be credited
or debited at the close of each trading day to the respective accounts of the
parties to the contract. On the contract's expiration date a final cash
settlement occurs and the futures positions are simply closed out. Changes in
the market value of a particular stock index futures contract reflect changes in
the specified index of equity securities on which the contract is based. A
stock index is designed to reflect overall price trends in the market for equity
securities.
Stock index futures may be used to hedge the equity portion of a Fund's
securities portfolio with regard to market (systematic) risk, as distinguished
from stock-specific risk. The Funds may enter into stock index futures to the
extent that they have equity securities in their portfolios. Similarly, the
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Funds may enter into futures on debt securities indexes (including the municipal
bond index) to the extent they have debt securities in their portfolios. By
establishing an appropriate "short" position in securities index futures, a Fund
may seek to protect the value of its portfolio against an overall decline in the
market for securities. Alternatively, in anticipation of a generally rising
market, a Fund can seek to avoid losing the benefit of apparently low current
prices by establishing a "long" position in securities index futures and later
liquidating that position as particular securities are in fact acquired. To the
extent that these hedging strategies are successful, the Fund will be affected
to a lesser degree by adverse overall market price movements, unrelated to the
merits of specific portfolio securities, than would otherwise be the case. A
Fund may also purchase futures on debt securities or indexes as a substitute for
the purchase of longer-term debt securities to lengthen the average duration of
the Fund's debt portfolio.
CURRENCY FUTURES A sale of a currency futures contract creates an
----------------
obligation by a Fund, as seller, to deliver the amount of currency called for in
the contract at a specified future time for a specified price. A purchase of a
currency futures contract creates an obligation by a Fund, as purchaser, to take
delivery of an amount of currency at a specified future time at a specified
price. A Fund may sell a currency futures contract, if the Adviser anticipates
that exchange rates for a particular currency will fall, as a hedge against a
decline in the value of the Fund's securities denominated in such currency. If
the Adviser anticipates that exchange rates will rise, the Fund may purchase a
currency futures contract to protect against an increase in the price of
securities denominated in a particular currency the Fund intends to purchase.
Although the terms of currency futures contracts specify actual delivery or
receipt, in most instances the contracts are closed out before the settlement
date without the making or taking of delivery of the currency. Closing out of a
currency futures contract is effected by entering into an offsetting purchase or
sale transaction. To offset a currency futures contract sold by a Fund, the
Fund purchases a currency futures contract for the same aggregate amount of
currency and delivery date. If the price in the sale exceeds the price in the
offsetting purchase, the Fund is immediately paid the difference. Similarly, to
close out a currency futures contract purchased by the Fund, the Fund sells a
currency futures contract. If the offsetting sale price exceeds the purchase
price, the Fund realizes a gain, and if the offsetting sale price is less than
the purchase price, the Fund realizes a loss.
A risk in employing currency futures contracts to protect against the price
volatility of portfolio securities denominated
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in a particular currency is that changes in currency exchange rates or in the
value of the futures position may correlate imperfectly with changes in the cash
prices of a Fund's securities. The degree of correlation may be distorted by
the fact that the currency futures market may be dominated by short-term
traders seeking to profit from changes in exchange rates. This would reduce the
value of such contracts for hedging purposes over a short-term period. Such
distortions are generally minor and would diminish as the contract approached
maturity. Another risk is that the Adviser could be incorrect in its
expectation as to the direction or extent of various exchange rate movements or
the time span within which the movements take place.
OPTIONS ON FUTURES For bona fide hedging and other appropriate risk
------------------
management purposes, the Funds also may purchase and write call and put options
on futures contracts which are traded on exchanges that are licensed and
regulated by the CFTC for the purpose of options trading, or, subject to
applicable CFTC rules, on foreign exchanges. The Funds also may engage in
related closing transactions with respect to options on futures. A "call"
option on a futures contract gives the purchaser the right, in return for the
premium paid, to purchase a futures contract (assume a "long" position) at a
specified exercise price at any time before the option expires. A "put" option
gives the purchaser the right, in return for the premium paid, to sell a futures
contract (assume a "short" position), for a specified exercise price at any time
before the option expires.
Upon the exercise of a "call," the writer of the option is obligated to
sell the futures contract (to deliver a "long" position to the option holder) at
the option exercise price, which will presumably be lower than the current
market price of the contract in the futures market. Upon exercise of a "put,"
the writer of the option is obligated to purchase the futures contract (deliver
a "short" position to the option holder) at the option exercise price, which
will presumably be higher than the current market price of the contract in the
futures market. When an entity exercises an option and assumes a "long" futures
position, in the case of a "call," or a "short" futures position, in the case of
a "put," its gain will be credited to its futures margin account, while the loss
suffered by the writer of the option will be debited to its account. However,
as with the trading of futures, most participants in the options markets do not
seek to realize their gains or losses by exercise of their option rights.
Instead, the writer or holder of an option will usually realize a gain or loss
by buying or selling an offsetting option at a market price that will reflect an
increase or a decrease from the premium originally paid.
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Options on futures contracts can be used by a Fund to hedge substantially
the same risks and for the same duration and risk management purposes as might
be addressed or served by the direct purchase or sale of the underlying futures
contracts. If the Fund purchases an option on a futures contract, it may obtain
benefits similar to those that would result if it held the futures position
itself.
The purchase of put options on futures contracts is a means of hedging a
Fund's portfolio against the risk of rising interest rates, declining securities
prices or declining exchange rates for a particular currency. The purchase of a
call option on a futures contract represents a means of hedging against a market
advance affecting securities prices or currency exchange rates when the Fund is
not fully invested or of lengthening the average maturity or duration of a
Fund's portfolio. Depending on the pricing of the option compared to either the
futures contract upon which it is based or upon the price of the underlying
securities or currencies, it may or may not be less risky than ownership of the
futures contract or underlying securities or currencies.
In contrast to a futures transaction, in which only transaction costs are
involved, benefits received in an option transaction will be reduced by the
amount of the premium paid as well as by transaction costs. In the event of an
adverse market movement, however, the Fund will not be subject to a risk of loss
on the option transaction beyond the price of the premium it paid plus its
transaction costs, and may consequently benefit from a favorable movement in the
value of its portfolio securities or the currencies in which such securities are
denominated that would have been more completely offset if the hedge had been
effected through the use of futures.
If a Fund writes options on futures contracts, the Fund will receive a
premium but will assume a risk of adverse movement in the price of the
underlying futures contract comparable to that involved in holding a futures
position. If the option is not exercised, the Fund will realize a gain in the
amount of the premium, which may partially offset unfavorable changes in the
value of securities held by or to be acquired for the Fund. If the option is
exercised, the Fund will incur a loss in the option transaction, which will be
reduced by the amount of the premium it has received, but which may partially
offset favorable changes in the value of its portfolio securities or the
currencies in which such securities are denominated.
The writing of a call option on a futures contract constitutes a partial
hedge against declining prices of the underlying securities or the currencies in
which such securities
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are denominated. If the futures price at expiration is below the exercise
price, the Fund will retain the full amount of the option premium, which
provides a partial hedge against any decline that may have occurred in the
Fund's holdings of securities or the currencies in which such securities are
denominated.
The writing of a put option on a futures contract is analogous to the
purchase of a futures contract. For example, if the Fund writes a put option on
a futures contract on debt securities related to securities that the Fund
expects to acquire and the market price of such securities increases, the net
cost to a Fund of the debt securities acquired by it will be reduced by the
amount of the option premium received. Of course, if market prices have
declined, the Fund's purchase price upon exercise may be greater than the price
at which the debt securities might be purchased in the securities market.
While the holder or writer of an option on a futures contract may normally
terminate its position by selling or purchasing an offsetting option of the same
series, a Fund's ability to establish and close out options positions at fairly
established prices will be subject to the maintenance of a liquid market. The
Funds will not purchase or write options on futures contracts unless the market
for such options has sufficient liquidity such that the risks associated with
such options transactions are not at unacceptable levels.
LIMITATIONS ON PURCHASE AND SALE OF FUTURES CONTRACTS AND OPTIONS ON
--------------------------------------------------------------------
FUTURES CONTRACTS In general, the Funds will engage in transactions in futures
- -----------------
contracts and related options only for bona fide hedging and other appropriate
risk management purposes, and not for speculation. A Fund will not enter into a
futures contract or futures option contract if, immediately thereafter, the
aggregate initial margin deposits relating to such positions plus premiums paid
by it for open futures option positions, less the amount by which any such
options are "in-the-money," would exceed 5% of the Fund's total assets.
Regarding the California Tax Free Fund, New York Tax Free Fund, International
Bond Fund and International Equity Fund, with respect to positions in futures
and related options that do not constitute bona fide hedging positions, a Fund
will not enter into a futures contract or futures option contract if,
immediately thereafter, the aggregate initial margin deposits relating to such
positions plus premiums paid by it for open futures option positions, less the
amount by which any such options are "in-the-money," would exceed 5% of the
Fund's total assets. A call option is "in-the-money" if the value of the
futures contract that is the subject of the option exceeds the exercise price.
A put option is
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"in-the-money" if the exercise price exceeds the value of the futures contract
that is the subject of the option.
When purchasing a futures contract, a Fund will maintain with its custodian
(and mark-to-market on a daily basis) cash, U.S. government securities, or other
highly liquid debt securities that, when added to the amounts deposited with a
futures commission merchant as margin, are equal to the market value of the
futures contract. Alternatively, the Fund may "cover" its position by
purchasing a put option on the same futures contract with a strike price as high
or higher than the price of the contract held by the Fund.
When selling a futures contract, a Fund will maintain with its custodian
(and mark-to-market on a daily basis) cash, U.S. government securities, or other
high quality liquid debt securities that, when added to the amount deposited
with a futures commission merchant as margin, are equal to the market value of
the instruments underlying the contract. Alternatively, the Fund may "cover"
its position by owning the instruments underlying the contract (or, in the case
of an index futures contract, a portfolio with a volatility substantially
similar to that of the index on which the futures contract is based), or by
holding a call option permitting the Fund to purchase the same futures contract
at a price no higher than the price of the contract written by the Fund (or at a
higher price if the difference is maintained in liquid assets with the Fund's
custodian).
When selling a call option on a futures contract, a Fund will maintain with
its custodian (and mark-to-market on a daily basis) cash, U.S. Government
securities, or other high quality liquid debt securities that, when added to the
amounts deposited with a futures commission merchant as margin, equal the total
market value of the futures contract underlying the call option. Alternatively,
the Fund may cover its position by entering into a long position in the same
futures contract at a price no higher than the strike price of the call option,
by owning the instruments underlying the futures contract, or by holding a
separate call option permitting the Fund to purchase the same futures contract
at a price not higher than the strike price of the call option sold by the Fund.
When selling a put option on a futures contract, a Fund will maintain with
its custodian (and mark-to-market on a daily basis) cash, U.S. Government
securities, or other high quality liquid debt securities that equal the purchase
price of the futures contract, less any margin on deposit. Alternatively, the
Fund may cover the position either by entering into a short position in the same
futures contract, or by owning a separate put option
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permitting it to sell the same futures contract so long as the strike price of
the purchased put option is the same or higher than the strike price of the put
option sold by the Fund.
The requirements for qualification as a regulated investment company also
may limit the extent to which a Fund may enter into futures, futures options or
forward contracts. See "Tax Status."
RISKS ASSOCIATED WITH FUTURES AND FUTURES OPTIONS There are several risks
-------------------------------------------------
associated with the use of futures contracts and futures options as hedging
techniques. A purchase or sale of a futures contract may result in losses in
excess of the amount invested in the futures contract. There can be no
guarantee that there will be a correlation between price movements in the
hedging vehicle and in the Fund's securities being hedged. In addition, there
are significant differences between the securities and futures markets that
could result in an imperfect correlation between the markets, causing a given
hedge not to achieve its objectives. The degree of imperfection of correlation
depends on circumstances such as variations in speculative market demand for
futures and futures options on securities, including technical influences in
futures trading and futures options, and differences between the financial
instruments being hedged and the instruments underlying the standard contracts
available for trading in such respects as interest rate levels, maturities, and
creditworthiness of issuers. A decision as to whether, when and how to hedge
involves the exercise of skill and judgment, and even a well-conceived hedge may
be unsuccessful to some degree because of market behavior or unexpected interest
rate trends.
Futures exchanges may limit the amount of fluctuation permitted in certain
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 the
current trading session. Once the daily limit has been reached in a futures
contract subject to the limit, no more trades may be made on that day at a price
beyond that limit. The daily limit governs only price movements during a
particular trading day and therefore does not limit potential losses because the
limit may work to prevent the liquidation of unfavorable positions. For
example, futures prices have occasionally moved to the daily limit for several
consecutive trading days with little or no trading, thereby preventing prompt
liquidation of positions and subjecting some holders of futures contracts to
substantial losses.
There can be no assurance that a liquid market will exist at a time when a
Fund seeks to close out a futures or a futures
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option position, and the Fund would remain obligated to meet margin requirements
until the position is closed. In addition, many of the contracts discussed
above are relatively new instruments without a significant trading history. As
a result, there can be no assurance that an active secondary market will develop
or continue to exist. If the price of a futures contract changes more than the
price of the securities or currencies, the Fund will experience either a loss or
a gain on the futures contracts which will not be completely offset by changes
in the price of the securities or currencies which are the subject of the hedge.
In addition, it is not possible to hedge fully or perfectly against currency
fluctuations affecting the value of securities denominated in foreign currencies
because the value of such securities is likely to fluctuate as a result of
independent factors not related to currency fluctuations.
SWAP AGREEMENTS
The International Bond Fund and International Equity Fund may enter into
interest rate, index and currency exchange rate swap agreements for purposes of
attempting to obtain a particular desired return at a lower cost to the Fund
than if the Fund had invested directly in an instrument that yielded that
desired return or for other portfolio management purposes. Swap agreements are
two party contracts entered into primarily by institutional investors for
periods ranging from a few weeks to more than one year. In a standard "swap"
transaction, two parties agree to exchange the returns (or differentials in
rates of return) earned or realized on particular predetermined investments or
instruments. The gross returns to be exchanged or "swapped" between the parties
are calculated with respect to a "notional amount," i.e., the return on or
----
increase in value of a particular dollar amount invested at a particular
interest rate, in a particular foreign currency, or in a "basket" of securities
representing a particular index. The "notional amount" of the swap agreement is
only a fictive basis on which to calculate the obligations which the parties to
a swap agreement have agreed to exchange. A Fund's obligations (or rights)
under a swap agreement will generally be equal only to the net amount to be paid
or received under the agreement based on the relative values of the positions
held by each party to the agreement (the "net amount"). A Fund's obligations
under a swap agreement will be accrued daily (offset against any amounts owing
to the Fund) and any accrued but unpaid net amounts owed to a swap counterparty
will be covered by the maintenance of a segregated account consisting of cash,
U.S. government securities, or high grade debt obligations, to avoid any
potential leveraging of the Fund's portfolio. A Fund will not enter into a swap
agreement with any single party if the net amount owed or to be received under
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existing contracts with that party would exceed 5% of the Fund's assets.
Whether a Fund's use of swap agreements will be successful in furthering
its investment objective will depend on the Adviser's ability correctly to
predict whether certain types of investments are likely to produce greater
returns than other investments. Because they are two party contracts and
because they may have terms of greater than seven days, swap agreements may be
considered to be illiquid. Moreover, a Fund bears the risk of loss of the
amount expected to be received under a swap agreement in the event of the
default or bankruptcy of a swap agreement counterparty. The Adviser will cause
a Fund to enter into swap agreements only with counterparties that would be
eligible for consideration as repurchase agreement counterparties under the
Fund's repurchase agreement guidelines. Certain restrictions imposed on the
Funds by the Code may limit the Funds' ability to use swap agreements. The
swaps market is a relatively new market and is largely unregulated. It is
possible that developments in the swaps market, including potential government
regulation, could adversely affect a Fund's ability to terminate existing swap
agreements or to realize amounts to be received under such agreements.
Certain swap agreements are exempt from most provisions of the Commodity
Exchange Act ("CEA") and, therefore, are not regulated as futures or commodity
option transactions under the CEA, pursuant to regulations approved by the CFTC
effective February 22, 1993. To qualify for this exemption, a swap agreement
must be entered into by "eligible participants," which include the following,
provided the participants' total assets exceed established levels: a bank or
trust company, savings association or credit union, insurance company,
investment company subject to regulation under the Investment Company Act of
1940, commodity pool, corporation, partnership, proprietorship, organization,
trust or other entity, employee benefit plan, governmental entity, broker-
dealer, futures commission merchant, natural person, or regulated foreign
person. To be eligible, natural persons and most other entities must have total
assets exceeding $10 million; commodity pools and employee benefit plans must
have assets exceeding $5 million. In addition, an eligible swap transaction
must meet three conditions. First, the swap agreement may not be part of a
fungible class of agreements that are standardized as to their material economic
terms. Second, the creditworthiness of parties with actual or potential
obligations under the swap agreement must be a material consideration in
entering into or determining the terms of the swap agreement, including pricing,
cost or credit enhancement terms. Third, swap agreements may not be entered
into and traded on or through a multilateral transaction execution facility.
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This exemption is not exclusive, and participants may continue to rely on
existing exclusions for swaps, such as the Policy Statement issued in July 1989
which recognized a safe harbor for swap transactions from regulation as futures
or commodity option transactions under the CEA or its regulations. The Policy
Statement applies to swap transactions settled in cash that (1) have
individually tailored terms, (2) lack exchange-style offset and the use of a
clearing organization or margin system, (3) are undertaken in conjunction with a
line of business, and (4) are not marketed to the public.
LOAN PARTICIPATION INTERESTS
Loan participation interests may take the form of interests in, or
assignments of, loans. Loan participation interests entail the payment by a
Fund of a sum to a U.S. or foreign bank or other financial institution which has
lent or will lend money to a U.S. or foreign corporation. In exchange for such
payment, the bank agrees to pay to the Fund, to the extent it is received, a
specified portion of the principal and interest in respect of such loan. The
Fund has no contractual relationship with the borrower. Loan participation
interests will be considered illiquid investments and may entail the credit of
both the underlying borrower and the bank or financial institution which is the
intermediary. Loan participation interests are typically unrated but, with
respect to the High Yield Corporate Bond Fund, the Adviser will limit its
investment in loan participation interests based upon its opinion of the quality
of the investment and the Fund's limitations with respect to lower rated
securities.
RISKS ASSOCIATED WITH DEBT SECURITIES
To the extent that a Fund invests in debt securities, it will be subject to
certain risks. The value of the debt securities held by a Fund, and thus the
net asset value of the shares of beneficial interest of the Fund, generally will
fluctuate depending on a number of factors, including, among others, changes in
the perceived creditworthiness of the issuers of those securities, movements in
interest rates, the average maturity of the Fund's investments, changes in the
relative values of the currencies in which the Fund's investments are
denominated relative to the U.S. dollar, and the extent to which the Fund hedges
its interest rate, credit and currency exchange rate risks. Generally, a rise
in interest rates will reduce the value of fixed income securities held by a
Fund, and a decline in interest rates will increase the value of fixed income
securities held by a Fund.
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RISKS OF INVESTING IN HIGH YIELD SECURITIES ("JUNK BONDS")
High yield bonds may be more susceptible to real or perceived adverse
economic and competitive industry conditions than higher grade bonds. The
prices of high yield bonds have been found to be less sensitive to interest-rate
changes than more highly rated investments, but more sensitive to adverse
economic downturns or individual corporate developments. A projection of an
economic downturn or of a period of rising interest rates, for example, could
cause a decline in high yield bond prices because the advent of a recession
could lessen the ability of a highly leveraged company to make principal and
interest payments on its debt securities.
Adverse publicity and investor perceptions, whether or not based on
fundamental analysis, may decrease the values and liquidity of high yield bonds,
especially in a thinly traded market.
Legislation designed to limit the use of high yield bonds in corporate
transactions may have a material adverse effect on a Fund's net asset value and
investment practices. In addition, there may be special tax considerations
associated with investing in high yield bonds structured as zero coupon or
payment-in-kind securities. A Fund records the interest on these securities
annually as income even though it receives no cash interest until the security's
maturity or payment date. Also, distributions of such amounts generally will be
taxable to shareholders even if the Fund does not distribute cash to them.
Therefore, in order to pay taxes on this interest, shareholders may have to
redeem some of their shares to pay the tax or the Fund may have to sell some of
its assets to reduce the Fund's assets and may thereby increase its expense
ratio and decrease its rate of return.
HIGH YIELD CORPORATE BOND FUND
SPECIAL CONSIDERATIONS
Corporate debt securities may bear fixed, contingent, or variable rates of
interest and may involve equity features, such as conversion or exchange rights
or warrants for the acquisition of stock of the same or a different issuer,
participations based on revenues, sales or profits, or the purchase of common
stock in a unit transaction (where corporate debt securities and common stock
are offered as a unit).
When- and if-available, debt securities may be purchased at a discount from
face value. However, the Fund does not intend to hold such securities to
maturity for the purpose of achieving potential capital gains, unless current
yields on these
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securities remain attractive. From time to time, the Fund may purchase
securities not paying interest or dividends at the time acquired if, in the
opinion of the Adviser, such securities have the potential for future income (or
capital appreciation, if any).
Since shares of the Fund represent an investment in securities with
fluctuating market prices, the value of shares of the Fund will vary as the
aggregate value of the Fund's portfolio securities increases or decreases.
Moreover, the value of the debt securities that the Fund purchases may fluctuate
more than the value of higher rated debt securities. These lower rated fixed
income securities generally tend to reflect short-term corporate and market
developments to a greater extent than higher rated securities which react
primarily to fluctuations in the general level of interest rates. Changes in
the value of securities subsequent to their acquisition will not affect cash
income or yields to maturity to the Fund but will be reflected in the net asset
value of the Fund's shares.
CALIFORNIA TAX FREE FUND AND NEW YORK TAX FREE FUND
SPECIAL CONSIDERATIONS
RISK FACTORS AFFECTING CALIFORNIA MUNICIPAL SECURITIES
The following information as to certain California State ("State") risk
factors is given to investors in view of the policy of the MainStay California
Tax Free Fund of concentrating its investments in California municipal issuers.
Such information constitutes only a brief discussion, does not purport to be a
complete description and is based on information from sources believed by the
Trust to be reliable, including official statements relating to securities
offerings of California and municipal issuers, and periodic publications by
national ratings organizations. Such information, however, has not been
independently verified by the Trust.
Certain of the California municipal securities in which the Fund may invest
may be obligations of issuers which rely in whole or in part on California State
revenues for payment of these obligations. Property tax revenues and a portion
of the State's General Fund surplus are distributed to counties, cities and
their various taxing entities and the State assumes certain obligations
theretofore paid out of local funds. Whether and to what extent a portion of
the State's General Fund will be distributed in the future to counties, cities
and their various entities, is unclear.
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Certain of the California municipal securities may be obligations of
issuers who rely in whole or in part on ad valorem real property taxes as a
source of revenue. On June 6, 1978, Proposition 13 added Article XIIIA to the
California Constitution. The effect of Article XIIIA is to limit ad valorem
taxes on real property and to restrict the ability of taxing entities to
increase real property tax revenues.
Legislation enacted by the California Legislature to implement Article
XIIIA (Statutes of 1978, Chapter 292, as amended) provides that notwithstanding
any other law, local agencies may not levy any ad valorem property tax except to
pay debt service on indebtedness approved by the voters prior to July 1, 1978,
and that each county will levy the maximum tax permitted by Article XIIIA of
$4.00 per $100 assessed valuation. The apportionment of property taxes in
fiscal years after 1978-79 was revised pursuant to Statutes of 1979, Chapter
282, which provides relief funds from State moneys beginning in fiscal year
1979-80 and is designed to provide a permanent system for sharing State taxes
and budget funds with local agencies. Under Chapter 282, cities and counties
receive more of the remaining property tax revenues collected under Proposition
13 instead of direct State aid. School districts receive a correspondingly
reduced amount of property taxes, but receive compensation directly from the
State and are given additional relief.
The application and interpretation of Article XIIIA has been and will
probably continue to be the subject of numerous lawsuits in the California
courts. It is not possible to predict the outcome of litigation or the ultimate
scope and impact of Article XIIIA, its implementing legislation and regulations
issued by the California State Board of Equalization. The outcome of such
litigation, however, could substantially impact local property tax collections
and the ability of State agencies, local governments and districts to make
future payments on outstanding debt obligations.
On November 4, 1986, California voters approved an initiative statute known
as "Proposition 62." This statute (i) requires that any tax for general
governmental purposes imposed by local governments be approved by resolution or
ordinance adopted by a two-thirds vote of the governmental entity's legislative
body and by a majority vote of the electorate of the governmental entity; (ii)
requires that any special tax (defined as taxes levied for other than general
governmental purposes) imposed by a local governmental entity be approved by a
two-thirds vote of the voters within that jurisdiction; (iii) restricts the use
of revenues from a special tax to the purposes or for the service for which the
special tax was imposed; (iv) prohibits the imposition of ad valorem taxes on
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real property by local governmental entities except as permitted by Article
XIIIA of the California Constitution; (v) prohibits the imposition of
transaction taxes and sales taxes on the sale of real property by local
governments; (vi) requires that any tax imposed by a local government on or
after August 1, 1985 be ratified by a majority of the electorate within two
years of the adoption of the initiative or be terminated by November 15, 1988;
(vii) requires that, in the event a local government fails to comply with the
provisions of this measure, a reduction in the amount of tax revenue allocated
to such local government occur in an amount equal to the revenues received by
such entity attributable to the tax levied in violation of the initiative; and
(viii) permits these provisions to be amended exclusively by the voters of the
State of California. In September 1988, the California Court of Appeals held
that it was unconstitutional to require that local tax measures be submitted to
the electorate, as described in (vi) above.
The State is subject to an annual appropriations limit imposed by Article
XIIIB of the State Constitution (the "Appropriations Limit"). The
Appropriations Limit does not restrict appropriations to pay debt service on the
bonds or other voter-authorized bonds. Article XIIIB prohibits the State from
spending "appropriations subject to limitation" in excess of the Appropriations
Limit. "Appropriations subject to limitation," with respect to the State, are
authorizations to spend "proceeds of taxes," which consist of tax revenues, and
certain other funds, including proceeds from regulatory licenses, user charges
or other fees to the extent that such proceeds exceed "the cost reasonably borne
by that entity in providing the regulation, product or service," but "proceeds
of taxes" exclude most State subventions to local governments, tax refunds and
some benefit payments such as unemployment insurance. No limit is imposed on
appropriations of funds which are not "proceeds of taxes," such as reasonable
user charges or fees and certain other non-tax funds.
Not included in the Appropriations Limit are appropriations for the debt
service costs of bonds existing or authorized by January 1, 1979, or
subsequently authorized by the voters, appropriations required to comply with
mandates of courts or the federal government and, pursuant to Proposition 111,
appropriations for qualified capital outlay projects and appropriations of
revenues derived from any increase in gasoline taxes and motor vehicle weight
fees above January 1, 1990 levels. In addition, a number of recent initiatives
were structured or proposed to create new tax revenues dedicated to certain
specific uses, with such new taxes expressly exempted from the Article XIIIB
limits (e.g., increased cigarette and tobacco taxes enacted
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by Proposition 99 in 1988). The Appropriations Limit may also be exceeded in
cases of emergency.
The State's Appropriations Limit in each year is based on the limit for the
prior year, adjusted annually for changes in State per capita personal income
and changes in population, and adjusted, when applicable, for any transfer of
financial responsibility of providing services to or from another unit of
government. The measurement of change in population is a blended average of
statewide overall population growth, and change in attendance at local school
and community college ("K-14") districts. As amended by Proposition 111, the
Appropriations Limit is tested over consecutive two-year periods. Any excess of
the aggregate "proceeds of taxes" received over such a two-year period above the
combined Appropriations Limits for those two years is divided equally between
transfers to K-14 districts and refunds to taxpayers.
The legislature enacted legislation to implement Article XIIIB which
defines certain terms used in Article XIIIB and sets forth the methods for
determining the Appropriations Limit. California Government Code Section 7912
requires an estimate of the Appropriations Limit to be included in the
Governor's Budget, and thereafter to be subject to the budget process and
established in the Budget Act.
On November 9, 1988, the State's voters approved Proposition 98, a combined
initiative constitutional amendment and statute called the "Classroom
Instructional Improvement and Accountability Act." Proposition 98 changed State
funding of public education below the university level and the operation of the
State Appropriations Limit, primarily by guaranteeing K-14 schools a minimum
share of General Fund revenues. Under Proposition 98 (as modified by
Proposition 111, enacted on June 5, 1990), K-14 schools are guaranteed the
greater of (a) in general, a fixed percent of General Fund revenues ("Test 1"),
(b) the amount appropriated to K-14 schools in the prior year, adjusted for
changes in the cost of living (measured as in Article XIIIB by reference to
State per capita personal income) and enrollment ("Test 2"), or (c) a third
test, which would replace Test 2 in any year when the percentage growth in per
capita General Fund revenues from the prior year plus one half of one percent is
less than the percentage growth in State per capita personal income ("Test 3").
Under Test 3, schools would receive the amount appropriated in the prior year
adjusted for changes in enrollment and per capita General Fund revenues, plus an
additional small adjustment factor. If Test 3 is used in any year, the
difference between Test 3 and Test 2 would become a "credit" to schools which
would be the basis of payments in future years when per capita General Fund
revenue growth exceeds
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per capita personal income growth. Legislation adopted prior to the end of the
1988-89 fiscal year, implementing Proposition 98, determined the K-14 schools'
funding guarantee under Test 1 to be 40.3 percent of the General Fund tax
revenues, based on 1986-87 appropriations. The percentage has been adjusted to
35 percent, however, to account for a subsequent redirection of local property
taxes, since such redirection directly affects the share of General Fund
revenues to schools. This change is subject to a legal challenge as described
below.
Proposition 98 permits the legislature by two-thirds vote of both houses,
with the Governor's concurrence, to suspend the K-14 schools' minimum funding
formula for a one-year period. Proposition 98 also contains provisions
transferring certain State tax revenues in excess of the Article XIIIB limit to
K-14 schools.
During the recent recession, General Fund revenues for several years were
less than originally projected, so that the original Proposition 98
appropriations turned out to be higher than the minimum percentage provided in
the law. The legislature responded to these developments by designating "extra"
Proposition 98 payments in one year as a "loan" from future years' Proposition
98 entitlements, and also intended that the "extra" payments would not be
included in the Proposition 98 "base" for calculating future years'
entitlements. In 1992, a lawsuit was filed, called California Teachers'
--------------------
Association v. Gould, which challenged the validity of these off-budget loans.
- --------------------
As part of the negotiations leading to the 1995-96 Budget Act, an oral agreement
was reached to settle this case. It is expected that a formal settlement
reflecting these conditions will be entered into in the near future.
The oral agreement provides that both the State and K-14 schools share in
the repayment of prior years' emergency loans to schools. Of the total $1.76
billion in loans, the State will repay $935 million by forgiveness of the amount
owed, while the K-14 schools will repay $825 million. The State share of the
repayment will be reflected as expenditures above the current Proposition 98
base calculation. The schools' share of the repayment will count as
appropriations that count toward satisfying the Proposition 98 guarantee, or
from "below" the current base. Repayments are spread over the eight-year period
of 1994-95 through 2001-02 to mitigate any adverse fiscal impact. Once a court
settlement is reached, and the Director of Finance certifies that such a
settlement has occurred, approximately $377 million in appropriations from the
1995-96 fiscal year to schools will be disbursed in August 1996.
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Certain California municipal securities in the Fund may be obligations
which are secured in whole or in part by a mortgage or deed of trust on real
property. Upon the default of a mortgage or deed of trust with respect to
California real property, the creditor's nonjudicial foreclosure rights under
the power of sale contained in the mortgage or deed of trust are subject to the
constraints imposed by California law upon transfers of title to real property
by private power of sale. During the three-month period beginning with the
filing of a formal notice of default, the debtor is entitled to reinstate the
home mortgage by making any overdue payments. Under standard loan servicing
procedures, the filing of the formal notice of default does not occur unless at
least three full monthly payments have become due and remain unpaid. The power
of sale is exercised by posting and publishing a notice of sale for at least 20
days after expiration of the three-month reinstatement period. Therefore, the
effective minimum period for foreclosing on a mortgage could be in excess of
seven months after the initial default. Such time delays in collections could
disrupt the flow of revenues available to an issuer for the payment of debt
service on the outstanding obligations if such defaults occur with respect to a
substantial number of home mortgages or deeds of trust securing an issuer's
obligations.
Certain California municipal securities in the Fund may be obligations
which finance the acquisition of single family home mortgages for low- and
moderate-income mortgagors. These obligations may be payable solely from
revenues derived from the home mortgages, and are subject to the California
statutory limitations described above applicable to obligations secured by real
property. Under California anti-deficiency legislation, there is no personal
recourse against a mortgagor of a single family residence purchased with the
loan secured by the mortgage.
Under California law, mortgage loans secured by single family owner-
occupied dwellings may be prepaid at any time. Prepayment charges on such
mortgage loans may be imposed only with respect to voluntary prepayments made
during the first five years of the term of the mortgage loan, and cannot in any
event exceed six months' advance interest on the amount prepaid in excess of 20
percent of the original principal amount of the mortgage loan. This limitation
could affect the flow of revenues available to an issuer for debt service on the
outstanding debt obligations which financed such home mortgages.
On November 8, 1994, California voters approved "Proposition 187," which
bars public schooling, social services and non-emergency health care to illegal
immigrants. Since its adoption, at least eight lawsuits challenging Proposition
187 have been filed in State and federal courts throughout California. A
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federal district court judge has imposed a preliminary injunction blocking
enforcement of nearly all provisions of Proposition 187 until a trial scheduled
for September 1995 determines the constitutionality of the initiative.
Implementation of certain of Proposition 187's provisions could jeopardize the
State's receipt of some federal funds.
From mid-1990 to late 1993, the State suffered a recession with the worst
economic, fiscal and budget conditions since the 1930's. Construction,
manufacturing (especially aerospace), and financial services, among others, were
all severely affected. Job losses were the worst of any post-war recession.
Employment levels stabilized by late 1993 and California's economy has been on a
steady recovery since the start of 1994. Employment has grown by over 500,000
in 1994 and 1995, and the pre-recession level of total employment is expected to
be matched by early 1996. The strongest growth has been in export-related
industries, business services, electronics, entertainment and tourism, all of
which have offset the recession-related losses which were heaviest in aerospace
and defense-related industries, finance and insurance. Residential housing
construction, with new permits for under 100,000 annual new units issued in 1994
and 1995, is weaker than in previous recoveries, but has been growing slowly
since 1993.
The recession seriously affected State tax revenues, which basically mirror
economic conditions. It also caused increased expenditures for health and
welfare programs. The State also faced a structural imbalance in its budget,
with the largest programs supported by the General Fund - education, health,
welfare and corrections - growing at rates significantly higher than the growth
rates for the principal revenue sources of the General Fund. As a result, the
State experienced recurring budget deficits in the late 1980's and early 1990's.
The State Controller reports that expenditures exceeded revenues for four of the
five fiscal years ending with 1991-92; revenues and expenditures were equal in
1992-93; and the State had an operating surplus of $1.1 billion in 1993-94.
However, at June 30, 1994, according to the Department of Finance, the State's
Special Fund for Economic Uncertainties still had an accumulated deficit, on a
budget basis, of approximately $1.5 billion.
The accumulated budget deficits over the past several years, together with
expenditures for school funding, which have not been reflected in the budget,
and reduction of available internal borrowable funds, have combined to
significantly deplete the State's cash resources to pay its ongoing expenses.
As part of its cash management program, the State has regularly issued short-
term obligations to meet cash flow needs. Between spring 1992 and summer 1994,
the State depended upon external borrowing,
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including borrowings extending into the subsequent fiscal year, to meet its cash
needs, including repayment of maturing notes and warrants. The State
anticipates that it will not have to resort to such cross-year borrowing during
the 1995-96 fiscal year. The State expects to issue up to $2.0 billion of
revenue anticipation notes for the 1995-96 fiscal year in April, 1996, to mature
by June 30, 1996. The Governor's Proposed Budget for the 1996-97 fiscal year
projects issuance of $3.2 billion of revenue anticipation notes in that year.
During the 1993-1994 fiscal year, the State implemented the Deficit
Retirement Plan, which was part of the 1993-94 Budget Act, by issuing $1.2
billion of revenue anticipation warrants in February 1994, maturing December 21,
1994. The law also created in the State Treasury a Deficit Retirement Fund.
The State Controller transferred from the General Fund to the Deficit Retirement
Fund the sum of $1.2 billion in two equal installments on September 15, 1994 and
December 15, 1994, which moneys were used to retire the revenue anticipation
warrants.
The Deficit Retirement Plan anticipated a combined program to balance the
budget over the 1993-94 and 1994-95 fiscal years, and projected a General Fund
balance of $260 million on June 30, 1995. Because fiscal conditions did not
improve as projected in the 1993-94 fiscal year, the revenue assumptions of the
Deficit Retirement Plan could not be met, and the Governor indicated in the June
1994 Revision that the General Fund condition would be about $1 billion worse at
June 30, 1994 than was projected at the start of the year. Accordingly, the
1994-95 Budget Act anticipated deferring retirement of about $1 billion of the
carryover budget deficit to the 1995-96 fiscal year, when it is intended to be
fully retired. This 22-month Deficit Reduction Plan uses existing statutory
authority to borrow $4 billion externally of which approximately $1 billion is
the carryover budget deficit. In addition, Chapter 136, Statutes of 1994,
created in the State Treasury the Warrant Payment Fund. The State Controller
was directed to transfer from the General Fund to the Warrant Payment Fund in
September 1995, November 1995, January 1996, and April 1996 in four equal
installments the amount necessary to retire the $4.0 billion of revenue
anticipation warrants maturing on April 25, 1996.
On January 17, 1994, a major earthquake measuring an estimated 6.8 on the
Richter Scale struck Los Angeles. Significant property damage to private and
public facilities occurred in a four-county area including northern Los Angeles
County, Ventura County, and parts of Orange and San Bernardino Counties.
Although some individuals and businesses suffered losses totaling in the
billions of dollars, the overall effect of
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the earthquake on the regional and State economy is not expected to be serious.
The State of California entered the 1995-96 budget negotiations with the
smallest nominal "budget gap" to be closed in many years, with strengthening
revenues and reduced caseload growth based on an improving economy.
Nonetheless, serious policy differences between the Governor and the legislature
prevented timely enactment of the budget.
The 1995-96 Budget Act was signed by the Governor on August 3, 1995, 34
days after the start of the fiscal year. The Budget Act projects General Fund
revenues and transfers of $44.1 billion, a 3.5 percent increase over 1994-95.
Also included in this figure was the projected receipt of $494 million from the
federal government to reimburse the State's cost of incarceration and health
care costs of illegal immigrants, above commitments already made by the federal
government. Expenditures were budgeted at $43.4 billion, a four percent
increase over 1994-95. The Department of Finance projects that, after repaying
the last of the carryover budget deficit, there will be a positive balance of
$28 million in the budget reserve, the Special Fund for Economic Uncertainties,
at June 30, 1996. The Budget Act further projects Special Fund revenues of $12.7
billion and appropriated Special Fund expenditures of $13.0 billion.
Other major features of the 1995-96 Budget Act include an additional $543
million appropriated to the 1994-95 Proposition 98 entitlement, reductions in
health and welfare costs, increases in educational funding, and increased
funding for anticipated growth of the States' prison inmate population. The
1995-96 Budget Act contained no tax increases. Under legislation enacted for
the 1993-94 Budget Act, the renters' tax credit after this year failed at the
June 1994 election. The legislature enacted a further one-year suspension of
the renters' tax credit, for 1995, saving about $390 million in the 1995-96
fiscal year.
The State's cash flow management plan for the 1994-95 fiscal year included
the issuance of $4.0 billion of revenue anticipation warrants on July 26, 1994,
to mature on April 25, 1996, as part of a two-year plan to retire the
accumulated State budget deficit. To assure repayment of the revenue
anticipation warrants, the legislature enacted a backup mechanism which could
result in automatic expenditure cuts if projected revenues did not meet certain
targets (Section 12467 of the California Government Code, enacted by Chapter
135, Statutes of 1994, the "Budget Adjustment Law").
Pursuant to the Budget Adjustment Law, the State Controller issued the
October Trigger Report on October 16, 1995, reviewing
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the estimated cash condition of the General Fund for the 1995-96 fiscal year.
The State Controller estimated that the General Fund would have at least $1.4
billion of internal cash resources on June 30, 1996 (i.e. external borrowing
would not be needed on June 30, 1996). As a result of this finding, certain
provisions of the Budget Adjustment Law, which could have ultimately led to
automatic, across-the-board cuts in the General Fund budget, will not have to be
implemented. Likewise, an earlier report issued on November 15, 1994, avoided
implementation of any automatic budget cuts in the 1994-95 fiscal year.
On January 10, 1996, the Governor presented his 1996-97 fiscal year Budget
Proposal (the "Proposed Budget" or the "Governor's Budget"). The Proposed
Budget estimates General Fund revenues and transfers of $45.0 billion, and
expenditures to be $44.2 billion. The Special Fund for Economic Uncertainties
is projected to have a positive balance of about $50 million at June 30, 1996,
and on that date available internal borrowable resources (available cash, after
payment of all obligations due) will be about $2.2 billion. The Administration
projects it will issue up to $2.0 billion of revenue anticipation notes in
April, 1996, to mature by June 30, 1996, to assist in cash flow management for
the final two months of the year, after repayment of the $4.0 billion revenue
anticipation warrants issue on April 25, 1996.
The Governor renewed a proposal, which had been rejected by the legislature
in 1995, for a 15 percent phased cut in individual and corporate tax rates over
three years (the budget proposal assumes this will be enacted, reducing revenues
in 1996-97 by about $600 million). There was also a proposal to restructure
trial court funding in a way which would result in a $300 million decrease in
General Fund revenues. The Governor requested legislation to make permanent a
moratorium on cost of living increases for welfare payments, and suspension of a
renters' tax credit, which would otherwise go back into effect in the 1996-97
fiscal year. He further proposed additional cuts in certain health and welfare
programs, and assumed that cuts previously approved by the legislature will
receive federal approval. The Governor's Budget proposes increases in funding
for K-12 schools under Proposition 98, for State higher education systems (with
a second year of no student fee increases), and for corrections. The Governor's
Budget projects external cash flow borrowing of up to $3.2 billion, to mature by
June 30, 1997.
On December 6, 1994, Orange County, California (the "County"), together
with its pooled investment funds (the "Funds") filed for protection under
Chapter 9 of the federal Bankruptcy Code, after reports that the Funds had
suffered significant market losses in their investments, causing a
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liquidity crisis for the Funds and the County. More than 200 other public
entities, most of which, but not all, are located in the County, were also
depositors in the Funds. Orange County has reported the Funds' loss at about
$1.69 billion, or about 23 percent of their initial deposits of approximately
$7.5 billion. Many of the entities which deposited moneys in the Funds,
including the County, faced interim and/or extended cash flow difficulties
because of the bankruptcy filing and may be required to reduce programs or
capital projects. The County has embarked on a fiscal recovery plan based on
sharp reductions in services and personnel, and rescheduling of outstanding
short term debt using certain new revenues transferred to the County from other
local governments pursuant to special legislation enacted in October, 1995. The
State has no existing obligation with respect to any outstanding obligations or
securities of the County or any of the other participating entities.
The State is a party to numerous legal proceedings, many of which normally
recur in governmental operations. In addition, the State is involved in certain
other legal proceedings which, if decided against the State, may require the
State to make significant future expenditures or may impair future revenue
sources.
Among the more significant lawsuits pending against the State are the
following: (i) lawsuits involving the exclusion of small business stock gains
from taxation, one of which was decided against the State, resulting in an $80
million loss to the State; (ii) cases relating to the State's method of
determining the tax on gross insurance premiums, in which the State faces losses
of approximately $200 million; (iii) a lawsuit seeking reimbursement for alleged
state-mandated costs; (iv) lawsuits related to contamination at the Stringfellow
toxic waste site; (v) an action involving damages caused by the Yuba River flood
of February 1986 with potential liability to 3,000 plaintiffs, ranging from $800
million to $1.5 billion; (vi) a claim that payment of wages in registered
warrants violated the Fair Labor Standards Act, which involves maximum damages
of approximately $500 million; (vii) a claim involving the constitutionality of
the 1992-93 Budget Act-related legislation which redirected approximately $1.3
billion in local tax revenues from localities to schools wherein the parties are
currently negotiating a settlement, subject to court approval; (viii) lawsuits
challenging the shift of property taxes included in the 1993-94 Budget Act; (ix)
a lawsuit involving the reduction of the State's Aid to Families with Dependent
Children ("AFDC") payments in 1992, 1993, and 1994; (x) a lawsuit involving the
1994-95 Budget Act's 2.3 percent reduction in AFDC payments; (xi) a lawsuit
challenging the purposes of appropriations of funds from the Cigarette and
Tobacco Products Surtax Fund in the budgets for
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fiscal years 1994-95 and 1995-96; (xii) a lawsuit challenging the
constitutionality of legislation that deferred payment of the State's employer
contribution to the Public Employees' Retirement System beginning in fiscal year
1992-93; (xiii) a lawsuit involving potential damages of approximately $350
million, in which prison inmate plaintiffs claim they are entitled to minimum
wages while working for the Prison Industry Authority; (xiv) lawsuits
challenging the transfer of moneys from the special fund accounts within the
State Treasury to the State's General Fund; and (xv) a lawsuit challenging the
Secretary of the United States Department of Health and Human Services' approval
of California's Assistance Payment Demonstration Project, which, in part,
granted California a waiver from complying with requirements for state
participation in the federal program for medical assistance.
In December 1991, S&P downgraded its rating of the State's general
obligation bonds to "AA" from "AAA". As the State's economy worsened and its
budget deficit swelled, rating agency officials closely monitored the State's
budget progress. In February 1992, Moody's downgraded its rating of the State's
general obligation bonds to "Aa1" from "Aaa". In April 1992, S&P placed the
State's general obligation bonds on its CreditWatch, indicating the possibility
of further downgrades should the State's budget and recessionary problems
persist. In July 1992, Moody's and S&P downgraded their ratings of the State's
general obligation bonds to "Aa" from "Aa1", and to "A+" from "AA",
respectively. On July 15, 1993, Moody's confirmed its "Aa" rating of the
State's general obligation bonds. On July 15, 1994, however, Moody's and S&P
downgraded their ratings of the State's general obligation bonds from "Aa" to
"A1" and "A+" to "A", respectively. There can be no assurance that such ratings
will continue for any given period of time or that they will not in the future
be further revised or withdrawn.
RISK FACTORS AFFECTING NEW YORK MUNICIPAL SECURITIES
The following information as to certain New York State ("State") and New
York City ("City") risk factors is given to investors in view of the policy of
the MainStay New York Tax Free Fund of concentrating its investments in New York
municipal issuers. Such information constitutes only a brief discussion, does
not purport to be a complete description and is based on information from
sources believed by the Trust to be reliable, including official statements
relating to securities offerings of New York and municipal issuers, and periodic
publications by national ratings organizations. Such information, however, has
not been independently verified by the Trust.
There are a number of methods by which the State may incur debt. The State
may issue general obligations bonds. Under the
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State Constitution, the State may not, with limited exceptions for emergencies,
undertake long-term general obligation borrowing (i.e., borrowing for more than
one year) unless the borrowing is authorized in a specific amount for a single
work or purpose by the legislature and approved by the voters. There is no
limitation on the amount of long-term general obligation debt that may be so
authorized and subsequently incurred by the State. As of March 31, 1995, the
total amount of outstanding general obligation debt was $5.181 billion,
including $149.3 million in bond anticipation notes.
The State may undertake short-term borrowings without voter approval (i) in
anticipation of the receipt of taxes and revenues, by issuing tax and revenue
anticipation notes; and (ii) in anticipation of the receipt of proceeds from the
sale of duly authorized but unissued general obligation bonds, by issuing bond
anticipation notes. The State may also, pursuant to specific constitutional
authorization, directly guarantee certain obligations of the State's authorities
and public benefit corporations ("Authorities"). Payments of debt service on
State general obligation and State-guaranteed bonds and notes are legally
enforceable obligations of the State.
The State also employs two other types of long-term financing mechanisms
that are State-supported but do not result in general obligations of the State:
moral obligation and lease-purchase or contractual-obligation financing.
Payments for principal and interest due on general obligation bonds,
interest due on bond anticipation notes and tax and revenue anticipation notes
were $793.3 million in the aggregate for the 1994-95 fiscal year, and are
estimated to be $774.4 million for 1995-96. These figures do not include the
interest payable on either State General Obligation Refunding Bonds issued in
July 1992 ("Refunding Bonds") to the extent that such interest is to be paid
from an escrow fund established with the proceeds of such Refunding Bonds or the
State's installment payments relating to the issuance of certificates of
participation.
The State has never defaulted on any of its general obligation indebtedness
or its obligations under lease-purchase or contractual-obligation financing
arrangements and has never been called upon to make any direct payments pursuant
to its guarantees. There has never been a default on any moral obligation debt
of any Authority.
As of September 30, 1994, the date of the latest data available, 18
municipal authorities had outstanding debt of $100 million or more. The
aggregate outstanding debt, including
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refunding bonds, of these 18 authorities was $70.3 billion. As of March 31,
1995, aggregate public authority debt outstanding as State-supported debt was
$27.9 billion and as State-related debt was $36.1 billion.
In recent years the State has provided financial assistance through
appropriations, in some cases of a recurring nature, to certain of the 18
Authorities for operating and other expenses and in fulfillment of its
commitments on moral obligation indebtedness or otherwise, for debt service.
During the 1992-93 fiscal year, the State provided operating assistance of
$935.6 million for the Metropolitan Transportation Authority (the "MTA") and
$19.9 million for four non-transit Authorities (i.e., the Housing Finance Agency
(the "HFA"), the Urban Development Corporation (the "UDC"), the Energy Research
and Development Authority and the Environmental Facilities Corporation). For
the 1994-95 State fiscal year, total State assistance to the MTA is estimated at
approximately $1.3 billion. This operating assistance (possibly in increasing
amounts) is expected to continue to be required in future years. The State's
experience has been that if an Authority suffers serious financial difficulties,
both the ability of the State and the Authorities to obtain financing in the
public credit markets and the market price of the State's outstanding bonds and
notes may be adversely affected.
Over the past several years the State has enacted several taxes - including
a surcharge on the profits of banks, insurance corporations and general business
corporations doing business in the 12-county Metropolitan Transportation Region
served by the MTA and a special one-quarter of 1 percent regional sales and use
tax -that provide revenues for mass transit purposes, including assistance to
the MTA. In addition, since 1987, State law has required that the proceeds of a
one-quarter of 1 percent mortgage recording tax paid on certain mortgages in the
Metropolitan Transportation Region be deposited in a special MTA fund for
operating or capital expenses. Further, in 1993, the State dedicated a portion
of the State petroleum business tax to fund operating or capital assistance to
the MTA. For the 1995-96 State fiscal year, total State assistance to the MTA
is estimated at approximately $1.1 billion.
In 1993, State legislation authorized the funding of a $9.56 billion MTA
capital plan for the five-year period extending from 1992 through 1996 (the
"1992-96 Capital Program"). The 1992-96 Capital Program was expected to be
financed in significant part through dedication of State petroleum business
taxes referred to above. In December 1994, however, the proposed bond
resolution based on such tax receipts was not approved by the MTA Capital
Program Review Board. There can be no assurance that all the
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necessary governmental actions for the 1992-96 Capital Program will be taken,
that funding sources currently identified will not be decreased or eliminated,
or that the 1992-96 Capital Program, or parts thereof, will not be delayed or
reduced. If the 1992-96 Capital Program is delayed or reduced, ridership and
fare revenues may decline, which could, among other things, impair the MTA's
ability to meet its operating expenses without additional State assistance.
Certain localities, including the City, could have financial problems
leading to requests for additional State assistance during the State's 1995-96
fiscal years and thereafter. The potential impact on the State of such requests
by localities is not included in the projections of the State's receipts and
disbursements for the 1995-96 fiscal year.
Fiscal difficulties experienced by the City of Yonkers resulted in the re-
establishment of the Financial Control Board for the fiscal affairs of Yonkers.
Future actions taken by the State to assist Yonkers could result in allocation
of State resources in amounts that cannot yet be determined.
Municipalities and school districts have engaged in substantial short-term
and long-term borrowings. To the extent State agencies and local governments
require State assistance to meet their financial obligations, the ability of the
State of New York to meet its own obligations as they become due or to obtain
additional financing could be adversely affected. This financial situation
could result not only in defaults of State and agency obligations but also
impairment of the marketability of securities issued by the State, its agencies
and local governments.
In 1990, as part of a State fiscal reform program, legislation was enacted
creating the "New York Local Government Assistance Corporation" ("LGAC"), a
public benefit corporation empowered to issue long-term obligations to fund
certain payments to local governments traditionally funded through the State's
annual seasonal borrowing. Over a period of years, the issuance of those long-
term obligations, which are to be amortized over no more than 30 years, was
expected to eliminate the need for continued short-term seasonal borrowing. The
legislation also dedicated revenues equal to one-quarter of the four cent State
sales and use tax to pay debt service on these bonds. In addition, the
legislation imposed a cap on the annual seasonal borrowing of the State at $4.7
billion, less net proceeds of bonds issued by LGAC and bonds issued to provide
for capitalized interest, except in cases where the Governor and the legislative
leaders have certified both the need for additional borrowing and a schedule for
reducing it to the cap. If borrowing above the
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cap is thus permitted in any fiscal year, it is required by law to be reduced to
the cap by the fourth fiscal year after the limit was first exceeded.
As of June 1995, LGAC had issued bonds and notes to provide net proceeds of
$4.7 billion completing the program. The impact of LGAC's borrowing is that the
State is able to meet its cash flow needs in the first quarter of the fiscal
year without relying on short-term seasonal borrowings. The 1995-96 State
Financial Plan includes no spring borrowing, nor did the 1994-95 State Financial
Plan, which represented the first time in 35 years there was no short-term
seasonal borrowing. This reflects the success of the LGAC program in permitting
the State to accelerate local aid payments from the first quarter of the current
fiscal year to the fourth quarter of the previous fiscal year.
In June 1994, the legislature passed a proposed constitutional amendment
that would significantly change the long-term financing practices of the State
and its public Authorities. The proposed amendment would permit the State,
within a formula-based cap, to issue revenue bonds, which would be debt of the
State secured solely by a pledge of certain State tax receipts (including those
allocated to State funds dedicated for transportation purposes), and not by the
full faith and credit of the State. In addition, the proposed constitutional
amendment would (i) permit multiple purpose general obligation bond proposals to
be proposed on the same ballot; (ii) require that State debt be incurred only
for capital projects included in a multi-year capital financing plan; and (iii)
prohibit, after its effective date, lease-purchase and contractual-obligation
financing mechanisms for State facilities.
Before the approved constitutional amendment can be presented to the voters
for their consideration, it must be passed by a separately elected legislature.
The amendment must therefore be passed by the newly elected legislature in 1995
prior to presentation to the voters in November 1995. The amendment was passed
by the Senate in June 1995, and the Assembly is expected to pass the amendment
shortly. If approved by the voters, the amendment would become effective
January 1, 1996.
On January 6, 1992, Moody's lowered from "A" to "Baa1" its rating of those
State bonds that are backed by annual legislative appropriations. Moody's also
placed its "A" rating of the State's general obligation bonds under review for
possible downgrading. On January 13, 1992, S&P lowered its rating of the
State's general obligation bonds from "A" to "A-". Moody's and S&P variously
cited the State's continued economic deterioration, chronic operating deficits,
and the legislative stalemate in
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closing the budget gap, as factors contributing to the downgrades. On February
14, 1994, S&P raised its outlook to positive and, on July 13, 1995, Moody's
reconfirmed its "A" rating on the State's general obligation bonds.
The State's budget for the 1995-96 fiscal year was enacted by the
legislature on June 7, 1995, more than two months after the start of the fiscal
year. Prior to adoption of the budget, the legislature enacted appropriations
for disbursements considered to be necessary for State operations and other
purposes, including all necessary appropriations for debt service. The State
Financial Plan for the 1995-96 fiscal year was formulated on June 20, 1995 and
is based on the State's budget as enacted by the legislature and signed into law
by the Governor.
The State revised the cash-basis 1995-96 State Financial Plan on December
15, 1995, in conjunction with the release of the Executive Budget for the 1996-
97 fiscal year. The 1995-96 General Fund Financial Plan continues to be
balanced, with reductions in projected receipts offset by an equivalent
reduction in projected disbursements. Total General Fund receipts are expected
to be approximately $73 million lower than estimated at the time of the mid-year
update. Tax receipts are now projected to be $29.7 billion, $8 million less
than in the earlier plan. Miscellaneous receipts and transfers from other funds
are estimated at $3.15 billion, $65 million lower than in the mid-year update.
The largest single change in these estimates is attributable to the lag in
achieving $50 million in proceeds from sales of State assets, which are unlikely
to be completed prior to the end of the fiscal year.
Projected General Fund disbursements are reduced by a total of $73 million,
with changes made in most major categories of the 1995-96 State Financial Plan.
The reduction in overall spending masks the impact of deficiency requests
totaling more than $140 million, primarily for school aid and tuition assistance
to college students. Offsetting reductions in spending are attributable to the
continued maintenance of strict controls on spending through the fiscal year by
State agencies, yielding savings of $50 million. Reductions of $49 million in
support for capital projects reflect a stringent review of all capital spending.
Reductions of $30 million in debt service costs reflect savings from refundings
undertaken in the current fiscal year, as well as savings from lower interest
rates in the financial market. Finally, the 1995-96 Financial Plan reflects re-
estimates based on actual results through November, the largest of which is a
reduction of $70 million in projected costs for income maintenance. This
reduction is consistent with declining caseload projections.
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The net impact of these and other factors is expected to produce a
potential imbalance in receipts and disbursements in the State fiscal year 1996-
97. The Governor has proposed to close this potential imbalance primarily
through General Fund expenditure reductions and without increases in taxes or
deferrals of scheduled tax reductions.
The State Comptroller prepares a comprehensive annual financial report on
the basis of generally accepted accounting principles ("GAAP") for governments.
In 1996-97, the General Fund GAAP-basis Financial Plan shows revenues of $30.40
billion, total expenditures of $30.98 billion, and net other financing source
and uses of $741 million. The surplus of $168 million reflects the expected
reservation of $85 million of cash in the Contingency Reserve Fund, as well as
the positive fiscal impact of the recommendations proposed in the Executive
Budget. After the accrual of liabilities expected to be paid in 1997-98, at
lower levels than in 1996-97, the General Fund benefits by another $300 million
in savings beyond the levels budgeted on a cash basis. This positive impact is
offset by a decline of $180 million in revenue accruals.
On December 15, 1995, the Governor presented his 1996-97 Executive Budget
to the legislature. There can be no assurance that the legislature will enact
the proposed Executive Budget into law, or that actual results will not differ
materially and adversely from the Executive Budget's projections. As of April
1, 1996, the beginning of fiscal year 1996-97, the legislature had failed to
pass a 1996-97 budget.
The Executive Budget proposes $3.9 billion in actions to balance the 1996-
97 Financial Plan. Before reflecting any actions proposed by the Governor to
restrain spending, General Fund disbursements for 1996-97 were projected at $35
billion, an increase of $2.3 billion or 7 percent from 1995-96. This increase
would have resulted from growth in Medicaid, inflationary increases in school
aid, higher fixed costs such as pensions and debt service, collective bargaining
agreements, inflation, and the loss of non-recurring resources that offset
spending in 1995-96. Receipts would have been expected to fall by $1.6 billion.
This reduction would have been attributable to modest growth in the State's
economy and underlying tax base, the loss of non-recurring revenues available in
1995-96 and implementation of previously enacted tax reduction programs.
The Executive Budget proposes to close this gap primarily through a series
of spending reductions and cost containment measures. The Executive Budget
projects (1) over $1.8 billion in savings from cost containment and other
actions in social welfare programs, including Medicaid, welfare and various
health and
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mental health programs; (2) $1.3 billion in savings from a reduced State General
Fund share of Medicaid made available from anticipated changes in the federal
Medicaid program, including an increase in the federal share of Medicaid; (iii)
over $450 million in savings from reforms and cost avoidance in educational
services (including school aid and higher education), while providing fiscal
relief from certain State mandates that increase local spending; and (iv) $350
million in savings from efficiencies and reductions in other State programs.
The assumption regarding an increased share of federal Medicaid funding has
received bipartisan congressional support and would benefit 32 states, including
New York State.
The Governor has also submitted several amendments to the Executive Budget.
These amendments have a nominal impact on the State's Financial Plan for 1996-97
and the subsequent years. The net impact of the amendments leaves unchanged the
total estimated amount of General Fund spending in 1996-97, which continues to
be projected at $31.22 billion. All funds spending in 1996-97 is increased by
$68 million, primarily reflecting adjustments to projections of federal funds,
and now totals $68.37 billion. The budget amendments advanced by the Governor
involve largely technical revisions, with General Fund spending increases fully
offset by spending decreases. Reductions in estimated 1996-97 disbursements are
recommended primarily for welfare (associated with updated projections showing a
declining caseload) and debt service (reflecting lower interest rates and recent
bond sales). Disbursement increases are projected for snow and ice control, the
AIDS Institute, Health Department utilization review programs and other items.
Estimated disbursements for other funds are increased to accommodate updated
projections of federal funding in certain categorical grant programs and reduced
for welfare as noted for the General Fund.
The annual growth rates of most economic indicators for the State improved
from 1994 to 1995, as the pace of private sector employment expansion, personal
income and wage growth all accelerated. Government employment fell as workforce
reductions were implemented at federal, State and local levels. Similar to the
nation, some moderation of growth is expected in the year ahead. Private sector
employment is expected to continue to rise, although somewhat more slowly than
in 1995, while public employment should continue to fall, reflecting government
budget cutbacks. Anticipated continued restraint in wage settlements, a lower
rate of employment growth and falling interest rates are expected to slow
personal income growth significantly.
The 1996-97 Financial Plan projects General Fund receipts (including
transfers from other funds) of $31.32 billion, a decrease of $1.40 billion from
the 1995-96 projected level.
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Measured against 1995-96 levels that have been adjusted for purposes of
comparability, the decline is $1.83 billion, or 5.5 percent.
General Fund disbursements totalled $29.842 billion in the State's 1991-92
fiscal year and $30.829 billion in the State's 1992-93 fiscal year and $31.897
billion in the State's 1993-94 fiscal year.
Constitutional challenges to State laws have limited the amount of taxes
which political subdivisions can impose on real property. In 1979, the State's
highest court declared unconstitutional a State law allowing localities and
school districts to impose a special increase in real estate property taxes in
order to raise funds for pensions and other uses. Additional court actions have
been brought against the State, certain agencies and municipalities relating to
financing, the amount of real estate tax, the use of tax revenues and other
matters.
Certain litigation pending against the State, its subdivisions and their
officers and employees could have a substantial and long-term adverse effect on
State finances. The State is a party to numerous legal proceedings, many of
which normally recur in governmental operations. Because of the prospective
nature of these proceedings, no estimate of the potential loss can be made.
Among the more significant of these cases are those that involve: (i) the
validity and fairness of agreements and treaties by which various Indian tribes
transferred title to the State of approximately six million acres of land in
central New York; (ii) certain aspects of the State's Medicaid policies and its
rates and regulations, including reimbursements to providers of mandatory and
optional Medicaid services; (iii) contamination in the Love Canal area of
Niagara Falls; (iv) alleged employment discrimination by the State of New York
and its agencies; (v) a challenge to the practice of reimbursing certain Office
of Mental Health patient care expenses from the client's Social Security
benefits; (vi) a challenge to the methods by which the State reimburses
localities for the administrative costs of food stamp programs; (vii) an action
in which the State is a third party defendant for injunctive or other
appropriate relief concerning liability for the maintenance of stone groins
constructed along certain areas of Long Island's shoreline; (viii) an action
against New York State and New York City officials alleging inadequate shelter
allowances to maintain proper housing; (ix) the constitutionality of legislation
enacted during the 1990 legislative session which changed actuarial funding
methods for determining state and local contributions to state employee
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retirement systems; (x) action by school districts and their employees
challenging the constitutionality of Chapter 175 of the Laws of 1990 which
deferred school district contributions to the public retirement system and
reduced by like amount state aid to the school districts; (xi) the
constitutionality of various public authority financing programs; and (xii) the
constitutionality of bridge and mass transportation bonding programs of the New
York State Thruway Authority and the MTA authorized by Chapter 56 of the Laws of
1993.
The legal proceedings noted above involve State finances, State programs
and miscellaneous tort, real property and contract claims in which the State is
a defendant and the monetary damages sought are substantial. These proceedings
could affect adversely the financial condition of the State. Adverse
developments in these proceedings or the initiation of new proceedings could
affect the ability of the State to maintain a balanced State Financial Plan. An
adverse decision in any of these proceedings could exceed the amount of the
State Financial Plan reserve for the payment of judgments and, therefore, could
affect the ability of the State to maintain a balanced State Financial Plan.
In addition, New York has reached a settlement agreement with Delaware and
Massachusetts under State of Delaware v. State of New York; however, the claims
--------------------------------------
of other states and the District of Columbia against the State of New York
remain. Although the amount of potential payments, if any, are not presently
determinable, it is the State's opinion that its ultimate liability in these
cases is not expected to have a material adverse effect on the State's financial
position.
The fiscal health of the State of New York is closely related to the fiscal
health of its localities, particularly the City of New York, which has required
and continues to require significant financial assistance from New York State.
In 1975, the City suffered a fiscal crisis that impaired the borrowing ability
of both the City and the State. In that year the City lost access to public
credit markets and was not able to sell debt to the public again until 1979. In
response to the City's fiscal crisis, the State created the Municipal Assistance
Corporation ("MAC") to provide financing assistance to the City, the New York
State Financial Control Board (the "Control Board") to oversee the City's
financial affairs, and a "Control Period" which existed from 1975 to 1986 during
which the City was subject to certain statutorily-prescribed fiscal controls.
Although the Control Board terminated the Control Period in 1986 when certain
statutory conditions were met, thus suspending certain Control Board powers, the
Control Board, MAC and the Office of the State Deputy Comptroller for the City
("OSDC") continue to exercise various fiscal monitoring functions over the City,
and upon the
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occurrence or "substantial likelihood and imminence" of the occurrence of
certain events, including, but not limited to, a City operating budget deficit
of more than $100 million, the Control Board is required by law to reimpose a
Control Period. Currently, the City and its Covered Organizations (i.e., those
which receive or may receive moneys from the City directly, indirectly or
contingently) operate under a four-year financial plan (the "Financial Plan")
which the City prepares annually and periodically updates.
The staffs of OSDC, the Control Board and City Comptroller issue periodic
reports on the City's Financial Plans, as modified, analyzing forecasts of
revenues and expenditures, cash flow, and debt service requirements, as well as
compliance with the Financial Plan, as modified, by the City and its Covered
Organizations. OSDC staff reports issued during the mid-1980's noted that the
City's budgets benefitted from a rapid rise in the City's economy, which boosted
the City's collection of property, business and income taxes. These resources
were used to increase the City's workforce and the scope of discretionary and
mandated City services. Subsequent OSDC staff reports, including its periodic
economic reports, examined the 1987 stock market crash and the 1989-92
recession, which affected the New York City region more severely than the
nation, and these reports attributed an erosion of City revenues and increasing
strain on City expenditures to that recession. According to a recent OSDC
economic report, the City's economy was slow to recover from the recession and
is expected to experience a weak employment situation, and moderate wage and
income growth, during the 1995-96 period. Also, Financial Plan reports of OSDC,
the Control Board, and the City Comptroller have variously indicated that many
of the City's balance budgets have been accomplished, in part, through the use
of non-recurring resources, tax and fee increases, personnel reductions and
additional State assistance; that the City has not yet brought its long-term
expenditures in line with recurring revenues; that the City's proposed gap-
closing programs, if implemented, would narrow future budget gaps; that these
programs tend to rely heavily on actions outside the direct control of the City;
and that the City is therefore likely to continue face future projected budget
gaps requiring the City to reduce expenditures and/or increase revenues.
According to the most recent staff reports of the OSDC, the Control Board and
the City Comptroller during the four-year period covered by the current
Financial Plan, the City is relying on obtaining substantial resources from
initiatives needing approval and cooperation of its municipal labor unions,
Covered Organizations, and City Council, as well as the State and federal
governments, among other, and there can be no assurance that such approval can
be obtained.
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The Mayor is responsible for preparing the City's four-year financial plan.
On February 10, 1994, the City released a financial plan for the 1996 through
1999 fiscal year (the "1996-1999 Financial Plan" or "Financial Plan"). The
City's projections set forth in the Financial Plan are based on various
assumptions and contingencies which are uncertain and which may not materialize.
Changes in major assumptions could significantly affect the City's ability to
balance its budget as required by State law and to meet its annual cash flow and
financing requirements. Such assumptions and contingencies include the
condition of the regional and local economies, the impact on real estate tax
revenues of the real estate market, wage increases for City employees consistent
with those assumed in the Financial Plan, employment growth, the ability to
implement proposed reductions in City personnel and other cost reduction
initiatives which may require in certain cases the cooperation of the City's
municipal unions, the ability of the New York City Health and Hospitals
Corporation ("HHC") and the Board of Education ("BOE") to take actions to offset
reduced revenues, the ability to complete revenue generating transactions,
provision of State and federal aid and mandate relief and the impact on City
revenues of proposals for federal and State welfare reform.
The 1996-1999 Financial Plan projects revenues and expenditures for the
1996 fiscal year balanced in accordance with GAAP. The projections for the 1996
fiscal year reflect proposed actions to close a previously projected gap of
approximately $3.1 billion for the 1996 fiscal year. The proposed actions in
the Financial Plan for the 1996 fiscal year include (i) a reduction in spending
of $400 million, primarily affecting public assistance and Medicaid payments by
the City; (ii) expenditure reductions in agencies, totaling $1.2 billion; (iii)
transitional labor savings, totaling $600 million; and (iv) the phase-in of the
increased annual pension funding cost due to revisions resulting from an
actuarial audit of the City pension systems, which would reduce such costs in
the 1996 fiscal year.
The Financial Plan also sets forth projections for the 1997 through 1999
fiscal years and outlines a proposed gap-closing program to close projected
budget gaps of $888 million, $1.5 billion and $1.4 billion for the 1997 through
1999 fiscal years, respectively, after successful implementation of the $3.1
billion gap closing program for the 1996 fiscal year. The proposed gap-closing
actions, a substantial number of which are not specified in detail, include
additional agency expenditure reductions, primarily resulting from a partial
hiring freeze, totaling between $388 million and $684 million in each of the
1997 through 1999 fiscal years; reductions in expenditures resulting from
proposed procurement initiatives totaling between $50 million and
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$100 million in each of the 1997 through 1999 fiscal years; the availability in
each of the 1997, 1998 and 1999 fiscal years of $100 million of the general
reserve appropriated in the prior year; and additional reduced expenditures
resulting from further revisions in entitlement programs to reduce City
expenditures by $250 million in the 1997 fiscal year, and by $400 million in
each of the 1998 and 1999 fiscal years, which may be subject to State or federal
approval.
On July 24, 1995, the City Comptroller issued a report on the Financial
Plan. The report concluded that the Financial Plan includes total risks of $749
million to $1.034 billion for the 1996 fiscal year.
With respect to the 1997 through 1999 fiscal years, the report noted that
the gap-closing program in the Financial Plan does not include information about
how the City will implement the various gap-closing programs, and that the
entitlement cost containment and revenue initiatives will require approval of
the State legislature. Taking into account the same categories of risks for the
1997 through 1999 fiscal years as the report identified for the 1996 fiscal year
and the uncertainty concerning the gap-closing program, the report estimated
that the Financial Plan includes total risks of $2.0 billion to $2.5 billion in
the 1997 fiscal year, $2.8 billion to $3.3 billion in the 1998 fiscal year and
$2.9 billion to $3.4 billion in the 1999 fiscal year.
In early December, 1994, the City Comptroller issued a report which noted
that the City is currently seeking to develop and implement plans which will
satisfy the Federal Environmental Protection Agency that the water supplied by
the City watershed areas does not need to be filtered. The City Comptroller
noted that, if the City is ordered to build filtration plants, they could costs
as much as $4.57 billion to construct, with annual debt service and operating
costs of more than $500 million, leading to a water rate increase of 45 percent.
On December 16, 1994, the City Comptroller issued a report noting that the
capacity of the City to issue general obligation debt could be greatly reduced
in future years due to the decline in value of taxable real property. The
report noted that under the State Constitution, the City is permitted to issue
debt in an amount not greater than ten percent of the average full value of
taxable real estate for the current year and preceding four years, that the
latest estimates produced by the State Board of Equalization and Assessment
relating to the full value of real property, using data from a 1992 survey,
indicate a 19 percent decline in the market value of taxable real property from
the previous survey in 1990, and that the State Board has decided to
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use a projected annual growth rate of 8.94 percent, as compared to its previous
projection of 14 percent for estimating full value after 1992. The report
concludes that the City will be within the projected legal debt incurring limit
in the 1996 fiscal year. However, the report noted that, based on the most
likely forecast of full value of real property, the debt incurring power of the
City would be curtailed in the 1997 and 1998 fiscal years substantially. The
City Comptroller recommended, among other things, prioritization of capital
projects to determine which can be delayed or canceled, and better maintenance
of the City's physical plant and infrastructure, which would result in less
capital spending for repair and replacement of capital structures.
On July 21, 1995, the staff of the Control Board issued a report on the
Financial Plan which identified risks of $873 million, $2.1 billion, $2.8
billion and $2.8 billion for the 1996 through 1999 fiscal years, respectively.
The report noted that substantially more information is needed concerning the
proposed gap-closing actions for the 1997-1999 fiscal years.
On June 14, 1995, the staff of the Office of the State Deputy Comptroller
for the City of New York ("OSDC") issued a report on the Financial Plan with
respect to the 1995 fiscal year. The report noted that, during the 1995 fiscal
year, the City faced adverse financial developments totaling over $2 billion
resulting from the inability to initiate approximately 35 percent of the City's
gap-closing program, as well as newly-identified spending needs and revenue
shortfalls resulting from the adverse impact on the City's personal income,
general corporation and other tax revenues of the policy of the Federal Reserve
of increasing short-term interest rates and the related down turn in the bond
market and profits and bonus income on Wall Street. The report noted that the
City relied heavily on one-time actions to offset these adverse developments,
using $2 billion in one-time resources in the 1995 fiscal year, or nearly double
the 1994 amount.
On July 24, 1995, the staff of the OSDC issued a report on the Financial
Plan. The report concluded that there remains a budget gap for the 1996 fiscal
year of $392 million, largely because the City and its unions have yet to reach
an agreement on how to achieve $160 million in unspecified labor savings and the
remaining $100 million in recurring health insurance savings from last year's
agreement. The report also identified a number of issues that present a net
potential risk of $409 million to the City's revenue and expenditure forecasts
for the 1996 fiscal year. The report further noted that growth in the City
revenues is being constrained by the weak economy in the City, which is likely
to be compounded by the slowing national economy, and that
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there is a likelihood of a national recession during the course of the Financial
Plan. Moreover, the report noted that the State and federal budgets are
undergoing tumultuous changes, and that the potential for far-reaching
reductions in inter-governmental assistance is clearly on the horizon, with
greater uncertainty about the impact on City finances and services.
Estimates of the City's revenues and expenditures is based on numerous
assumptions and are subject to various uncertainties. If expected federal or
State aid is not forthcoming, if unforeseen developments in the economy
significantly reduce revenues derived from economically sensitive taxes or
necessitate increased expenditures for public assistance, if the City should
negotiate wage increases for its employees greater than the amounts provided for
in the City's financial plan or if other uncertainties materialize that reduce
expected revenues or increase projected expenditures, then, to avoid operating
deficits, the City may be required to implement additional actions, including
increases in taxes and reductions in essential City services. The City might
also seek additional assistance from the State.
On February 11, 1991, Moody's lowered its rating on the City's general
obligations bonds to "Baa1" from "A." Moody's expressed doubts about whether
the City's January 16, 1991 Financial Plan presented a "reasonable program to
achieve budget balance in fiscal 1991 and 1992 and assure long-term structural
integrity." Moody's stated "the enormity of the current problem, the severity
of required expenditure cuts, the substantial revenue enhancements that will be
required to achieve balance, the vulnerability to exogenous factors, and the
extremely short time frame within which all this must be accomplished introduce
substantial new risk to the City's short- and long-term credit outlook."
Nevertheless, on October 19, 1992, Moody's confirmed its Baa1 rating noting that
the City's "financial operations continue to be satisfactorily maintained."
On July 10, 1995, S&P revised its rating on the City's general obligation
bonds downward to "BBB+." S&P stated that "structural budgetary balance remains
elusive because of persistent softness in the City's economy, highlighted by
weak job growth and a growing dependence on the historically volatile financial
services sector." Other factors identified by S&P in lowering its ratings on
City general obligation bonds, included a trend of using one-time measures,
including debt refinancings, to close projected budget gaps, dependence on
unratified labor savings to help balance the City's financial plan, optimistic
projections of additional federal and State aid or mandate relief, a history of
cash flow difficulties caused by State budget delays and continued high debt
levels. Since July 15,
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1993, Fitch has maintained an "A-" rating on the City's general obligation
bonds. On July 12, 1995, Fitch stated that the City's credit trend remains
"declining."
Both the State and City face potential economic problems which could
seriously affect the ability of both the State and City to meet their financial
obligations. The economic problems of New York City adversely affect the State
in numerous ways. In addition, for decades the State economy has grown more
slowly than that of the nation as a whole, resulting in a decline in the
position of New York as one of the country's wealthier states. The causes of
this decline are varied and complex and some causes reflect international and
national trends beyond the State's and City's control.
THE EQUITY INDEX FUND GUARANTEE
NYLIFE Inc. ("NYLIFE") and the Equity Index Fund have entered into a
Guaranty Agreement (the "Guarantee") for the benefit of shareholders. The
Guarantee has been issued for the benefit of all shareholders and has been
issued at no cost to the Equity Index Fund or its shareholders. The Guarantee
Date (as defined in the Prospectus) with respect to a particular Equity Index
Fund share will be 10 years after the purchase date of such share. If, on a
particular Guarantee Date, payments must be made under the terms of the
Guarantee, the terms of the Guarantee will obligate NYLIFE unconditionally and
irrevocably to pay to the Equity Index Fund's transfer and dividend disbursing
agent for the benefit of shareholders with that Guarantee Date an amount equal
to the difference between the Guaranteed Amount and net asset value per each
Guaranteed Share (as defined in the Prospectus) outstanding. The Equity Index
Fund's transfer and dividend disbursing agent will forward the difference
between the Guaranteed Amount and the net asset value directly to each
individual shareholder.
A Guaranteed Share is a unit that will at all times be equal to the net
asset value of one share initially purchased by the investor plus the net asset
value of all dividends and distributions attributable to such share (which
includes cumulative dividends and distributions paid with respect to any
additional shares of the Fund received as dividends and distributions) paid
during the period from the date of purchase to the Guarantee Date. A Guaranteed
Share (the unit to which the Guaranteed Amount will apply) is not the same as a
share of the Fund. Shareholders who redeem shares, or who elect to receive
dividends and distributions in cash, will own fewer units to which the
Guaranteed Amount applies (i.e., they will own fewer Guaranteed Shares) and
----
therefore will lose a portion of the
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benefit of the Guarantee with respect to any such redemption or dividends or
distributions received in cash.
NYLIFE will pay any amounts owing under the Guarantee to the Fund's
transfer and dividend disbursing agent on the third business day following a
Guarantee Date. A pro rata portion of any amounts so paid will then be
forwarded to each shareholder holding, as of the close of business on such date,
Guaranteed Shares with that Guarantee Date. If the Guarantee Date should fall
on a weekend or on a holiday, the Guarantee Date shall be the first business day
following the Guarantee Date. The Guarantee is intended to assure each owner of
Guaranteed Shares on a Guarantee Date that he or she will be able to recover, as
of the Guarantee Date, at a minimum, the Guaranteed Amount (with no adjustment
for inflation or the time value of money). The Guarantee will benefit any
holder of such Guaranteed Shares on the relevant Guarantee Date, who need not be
the original purchaser, and who, for example, may own such shares by gift or
inheritance.
Although the Equity Index Fund does not intend to pay dividends and
distributions in cash to shareholders (unless a shareholder elects to receive
payments in cash), such dividends and distributions which are reinvested will be
taxable to shareholders. See "Tax Status." The Guaranteed Amount does not
reflect any adjustment for the payment of taxes by a shareholder on dividends
and distributions received from the Equity Index Fund.
The obligations, if any, of NYLIFE under the Guarantee shall be discharged
when all required payments are made in full to the transfer and dividend
disbursing agent for the benefit of the shareholders or if the Equity Index
Fund's net asset value on a Guarantee Date is such that no amounts are payable
to shareholders under the terms of the Guarantee. Payment obligations under the
Guarantee will be solely the obligations of NYLIFE. Neither the Equity Index
Fund, New York Life Insurance Company, Monitor, NYLIFE Distributors, any of
their affiliates nor any other party is undertaking any obligation to the Equity
Index Fund or its shareholders with respect to the Guarantee.
Although the Guarantee has been arranged for by the Equity Index Fund and
is created under contract between the Equity Index Fund and NYLIFE, the Equity
Index Fund has no interest in, and specifically disclaims any interest in, the
proceeds payable under the Guarantee, which are payable solely to the
shareholders with a particular Guarantee Date. The designation of such
shareholders as the sole beneficiaries of the Guarantee may not be changed by
either the Equity Index Fund or such shareholders. The Guarantee is neither
transferable nor assignable by the
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Equity Index Fund or the shareholders it benefits, nor may the Equity Index Fund
or its shareholders cancel or waive rights under the Guarantee. The Guarantee
cannot be surrendered by either the Fund or its shareholders for cash, except in
the event that payment is made pursuant to its terms. Neither the Equity Index
Fund nor its shareholders may use the Guarantee as a pledge for a loan, nor may
the Equity Index Fund or its shareholders obtain any loan from NYLIFE with
respect to amounts that may be payable pursuant to the Guarantee.
The foregoing is only a summary, and not a complete statement of the
principal terms of the Guarantee. Reference is made to the Guarantee, a
specimen copy of which has been filed as an exhibit to the Registration
Statement. This summary is subject thereto and qualified in its entirety by
such reference.
ADDITIONAL FUNDAMENTAL INVESTMENT RESTRICTIONS
In addition to the fundamental investment restrictions contained in the
Prospectus, the Trustees of the Trust also have adopted the following
fundamental investment restrictions, which may not be changed with respect to
any Fund without the approval of the majority of the outstanding voting
securities of that Fund, as defined under the 1940 Act.
The Trust may not, on behalf of any Fund:
1. Act as an underwriter of securities issued by others, except to the
extent that a Fund may be considered an underwriter within the meaning of the
1933 Act, as amended, in the disposition of portfolio securities.
2. Issue senior securities, except as appropriate to evidence indebtedness
that a Fund is permitted to incur and except for shares of existing or
additional series of the Trust.
The following fundamental investment restriction is applicable to the Tax
Free Bond Fund only. The Tax Free Bond Fund must:
1. Invest at least 80% of the Fund's net assets in securities the interest
on which is exempt from regular federal income tax, except that the Fund may
temporarily invest more than 20% of its net assets in securities the interest
income on which may be subject to regular federal income tax.
The following fundamental investment restrictions are applicable to the
Equity Index Fund only. The Equity Index Fund may not:
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1. Purchase securities of any company having less than three years'
continuous operations (including operations of any predecessors) if such
purchase would cause the value of the Fund's investments in all such companies
to exceed 5% of the value of its total assets.
2. Purchase securities of closed-end investment companies except (a) in
the open market where no commission other than the ordinary broker's commission
is paid, which purchases are limited to a maximum of (i) 3% of the total
outstanding voting stock of any one closed-end investment company, (ii) 5% of
the Fund's net assets with respect to the securities issued by any one closed-
end investment company, and (iii) 10% of the Fund's net assets in the aggregate,
or (b) those received as part of a merger or consolidation. The Fund may not
purchase the securities of other open-end investment companies.
3. Hold the securities of any issuer when more than 1/2 of 1% of the
issuer's securities are owned beneficially by one or more of the Fund's officers
or Trustees or by one or more of the officers or directors of the Fund's
underwriter or investment manager.
4. Enter into repurchase agreements providing for settlement in more than
seven days after notice or purchase securities which are not readily marketable,
if, in the aggregate, more than 10% of the value of the Fund's total assets
would be so invested.
5. Invest in the securities of a company for the purpose of exercising
management or control, but the Fund will vote the securities it owns in its
portfolio as a shareholder in accordance with its views.
6. Purchase, sell or write puts, calls or combinations thereof, except
that the Fund may enter into transactions in stock index options and futures as
described in the Prospectus and in this Statement of Additional Information.
The following fundamental investment restrictions are applicable only to
the California Tax Free Fund and New York Tax Free Fund. The California Tax
Free Fund and New York Tax Free Fund may not:
1. Sell securities short, or purchase securities on margin, except that
the Fund may enter into and make margin deposits in connection with transactions
in options, futures and options on futures.
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2. Invest in companies for the purpose of exercising control.
3. Invest in securities of other investment companies, except as they may
be acquired as part of a merger, consolidation or acquisition of assets.
ADDITIONAL NON-FUNDAMENTAL INVESTMENT RESTRICTIONS
In addition to the Trust's fundamental investment restrictions, the
Trustees of the Trust have voluntarily adopted certain policies and restrictions
which are observed in the conduct of the affairs of the Funds, except the
California Tax Free Fund, New York Tax Free Fund, International Bond Fund,
International Equity Fund and Equity Index Fund. These represent intentions of
the Trustees based upon current circumstances. They differ from fundamental
investment policies in that the following additional investment restrictions may
be changed or amended by action of the Trustees without requiring prior notice
to or approval of shareholders.
In accordance with such policies and restrictions, a Fund may not:
(a) purchase securities of any issuer with a record of less than three
years' continuous operation, including predecessors, except Municipal Bonds
and except obligations issued or guaranteed by the U.S. government or its
agencies or instrumentalities, if such purchase would cause the investments
of a Fund in all such issuers to exceed 5% of the value of the total assets
of that Fund;
(b) purchase from or sell portfolio securities of a Fund to any of the
officers or Trustees of the Trust, its investment advisers, its principal
underwriter or the officers, or directors of its investment advisers or
principal underwriter;
(c) invest more than 10% of the assets of a Fund (taken at market
value at the time of the investment) in "illiquid securities," illiquid
securities being defined to include securities subject to legal or
contractual restrictions on resale (other than restricted securities
eligible for resale pursuant to Rule 144A under the Securities Act of
1933), repurchase agreements maturing in more than seven days, certain
options traded over the counter that a Fund has written, securities for
which market quotations are not available, or other securities which
legally or in the opinion of the Adviser is deemed illiquid;
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(d) invest assets in securities of other open-end investment
companies, but a Fund may invest in shares of the Money Market Fund if
double advisory fees are not assessed, may invest up to 5% of its assets in
closed-end investment companies (which would cause a Fund to pay duplicate
fees), and may purchase or acquire up to 10% of the outstanding voting
stock of a closed-end investment company (foreign banks or their agencies
or subsidiaries are not considered investment companies for the purposes of
this limitation);
(e) purchase warrants of any issuer, except on a limited basis when,
as a result of such purchases by a Fund, no more than 2% of the value of
the Fund's total assets would be invested in warrants which are not listed
on the New York Stock Exchange or the American Stock Exchange, and no more
than 5% of the value of the total assets of a Fund may be invested in
warrants whether or not so listed, such warrants in each case to be valued
at the lesser of cost or market, but assigning no value to warrants
acquired by a Fund in units with or attached to debt securities;
(f) invest in other companies for the purpose of exercising control or
management;
(g) purchase or retain securities of an issuer any of whose officers,
directors, trustees or security holders is an officer or Trustee of the
Trust or a member, officer, director or trustee of the investment advisers
of the Trust if one or more of such individuals owns beneficially more than
one-half of one percent (1/2 of 1%) of the securities (taken at market
value) of such issuer and such individuals owning more than one-half of one
percent (1/2 of 1%) of such securities together own beneficially more than
5% of such securities or both;
(h) purchase securities on margin or make short sales, except in
connection with arbitrage transactions or unless, by virtue of its
ownership of other securities, it has the right to obtain securities
equivalent in kind and amount to the securities sold and, if the right is
conditional, the sale is made upon the same conditions, except that the
Trust may obtain such short-term credits as may be necessary for the
clearance of purchases and sales of securities and in connection with
transactions involving forward foreign currency exchange contracts;
(i) purchase or sell any put or call options or any combination
thereof, except that the Trust may purchase and sell or write (i) options
on any futures contracts into which it may enter, (ii) put and call options
on currencies,
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securities indexes and covered put and call options on securities, and
(iii) may also engage in closing purchase transactions with respect to any
put and call option position it has entered into; and except that the
Government Fund may not write any covered put options on U.S. government
securities if, as a result, more than 50% of its total assets (taken at
current value) would be subject to put options written by such Fund; or
(j) purchase, with respect to the Government Fund, any call option,
long futures contract or long option on a futures contract if, at the date
of purchase, realized net losses from such transactions during the fiscal
year to date exceed 5% of such Fund's average net assets during such
period.
The following investment restrictions are non-fundamental, operating
policies of the International Bond Fund and International Equity Fund, and may
be amended by the Board of Trustees without shareholder approval:
(a) As an operating policy, a Fund may not sell securities short,
except for covered short sales or unless it owns or has the right to obtain
securities equivalent in kind and amount to the securities sold short, and
provided that transactions in options, futures and forward contracts are
deemed not to constitute short sales of securities.
(b) As an operating policy, a Fund may not purchase securities on
margin, except that the Fund may obtain such short-term credits as are
necessary for the clearance of transactions, and provided that margin
payments in connection with futures contracts and options on futures
contracts shall not constitute the purchase of securities on margin.
(c) As an operating policy, a Fund may not purchase warrants, valued
at the lower of cost or market, in excess of 5% of the Fund's net assets.
Included within that amount, but not to exceed 2% of net assets, are
warrants whose underlying securities are not traded on principal domestic
or foreign exchanges. Warrants acquired by the Fund in units or attached
to securities are not subject to these restrictions.
(d) As an operating policy, a Fund may not invest in securities which
are not readily marketable, or the disposition of which is restricted under
federal securities laws (collectively, "illiquid securities"), other than
Rule 144A securities determined to be liquid pursuant to
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guidelines adopted by the Trust's Board of Trustees if, as a result, more
than 15% of the Fund's net assets would be invested in illiquid securities.
A Fund may not invest more than 15% of its net assets in repurchase
agreements providing for settlement in more than seven days, or in other
instruments which for regulatory purposes or in the Adviser's opinion may
be deemed to be illiquid, such as a certain portion of options traded in
the over-the-counter market, and securities being used to cover options a
Fund has written.
(e) As an operating policy, a Fund may not acquire or retain the
securities of any other investment company if, as a result, more than 3% of
such investment company's outstanding shares would be held by the Fund,
more than 5% of the value of the Fund's total assets would be invested in
shares of such investment company or more than 10% of the value of the
Fund's assets would be invested in shares of investment companies in the
aggregate, except in connection with a merger, consolidation, acquisition,
or reorganization.
(f) As an operating policy, a Fund may not invest in securities of an
issuer which, together with any predecessor, has been in operation for less
than three years if, as a result, more than 5% of the total assets of the
Fund would then be invested in such securities.
"Value" for the purposes of all investment restrictions shall mean the
value used in determining a Fund's net asset value.
The MainStay California Tax Free Fund has undertaken to a state securities
commission that: the aggregate premiums paid on all options held at any time by
the Fund will be limited to 20% of the Fund's total net asset value; when
writing a put or call option, the aggregate value of securities underlying the
put or call shall not exceed 25% of the net assets of the Fund; and margin
deposits on all options purchased by the Fund shall not, in the aggregate,
exceed 5% of the Fund's total assets. In addition, though not a fundamental
policy, the Funds will not sell securities short, except that each Fund reserves
the right to sell securities short "against the box."
In addition, though not a fundamental policy, the Equity Index Fund may not
engage in arbitrage transactions, nor may it purchase warrants (excluding those
acquired by the Equity Index Fund in units or attached to securities), nor will
the Equity Index Fund sell securities short or buy on margin, except that
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the Fund reserves the right to sell securities short "against the box."
The Equity Index Fund has undertaken with various state securities
commissions that, as a non-fundamental, operating policy, it (i) will not
purchase the securities of any issuer if such purchase at the time thereof would
cause more than ten percent of the voting securities of any issuer to be held by
the Fund, (ii) will not invest in mineral leases, and (iii) will not invest in
real estate limited partnerships.
If a percentage restriction is adhered to at the time of investment, a
later change in percentage resulting from a change in values or assets will not
constitute a violation of such restriction.
TRUSTEES AND OFFICERS
Information pertaining to the Trustees and officers of the Trust is set
forth below. Trustees deemed to be "interested persons" of the Trust for
purposes of the 1940 Act are indicated by an asterisk.
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<TABLE>
<CAPTION>
PRINCIPAL OCCUPATION(S)
NAME, ADDRESS AND AGE POSITION(S) WITH TRUST DURING PAST 5 YEARS
- -------------------------------- ---------------------- --------------------------------------------
<S> <C> <C>
Alice T. Kane* Chairperson and Executive Vice President, New York Life
51 Madison Avenue Trustee Insurance Company, 1992 to present;
New York, NY 10010 General Counsel, 1992 to 1995;
Age: 48 Corporate Secretary, 1989 to 1994;
Senior Vice President and General
Counsel, 1986 to 1992; Vice President
and General Counsel, 1985 to 1986;
Director and Chairperson, MainStay
Institutional Funds Inc., 1994 to present;
Director, New York Life Foundation,
1992 to 1995; Director, New York Life
International Investment Inc., 1988 to
present; Director, NYLIFE Inc., 1990 to
present; Vice President, NYLIFE Inc.,
1989 to present; Secretary, NYLIFE Inc.,
1989 to 1994; Director, Greystone Realty
Corporation, 1994 to present; Director,
Monitor Capital Advisors, Inc., 1994 to
present; Director, Sanus Corp. Health
Systems, 1984 to present; Director,
MacKay-Shields Financial Corporation,
1994 to present; Director, NYL Benefit
Services Co. (pension consultant and
third party administrator), 1994 to
present; Director, NYLIFE Securities
Inc., 1994 to present; Director, Eagle
Strategies Corp. (broker-dealer and
registered investment adviser), 1994 to
present; Director, NYLIFE Distributors
Inc., 1994 to present; Director, Quorum
Capital Management Limited, 1995 to
present; Director, NYL Trust Company,
1995 to present; Member, Board of
Governors of the National Association
of Securities Dealers, Inc., 1994 to
present; Member, American Council of
Life Insurance Deputies Solvency
Oversight Committee, 1991 to 1995; and
Board of Governors, Association of Life
Insurance Counsel, 1992 to present.
Walter W. Ubl* President, Chief Senior Vice President, New York Life
51 Madison Avenue Executive Officer and Insurance Company, 1995 to present;
New York, NY 10010 Trustee Vice President, 1984 to 1995; Vice
Age: 54 President in charge of Mutual Funds
Department, 1989 to present; Director
and Vice President, NYLIFE
</TABLE>
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<TABLE>
<CAPTION>
PRINCIPAL OCCUPATION(S)
NAME, ADDRESS AND AGE POSITION(S) WITH TRUST DURING PAST 5 YEARS
- -------------------------------- ---------------------- --------------------------------------------
<S> <C> <C>
Distributors Inc., 1993 to present; and
Vice President, Marketing Department,
1984 to 1987.
Harry G. Hohn* Trustee Chairman of the Board and Chief
51 Madison Avenue Executive Officer, New York Life
New York, NY 10010 Insurance Company, 1990 to present;
Age 64 Vice Chairman of the Board, New York
Life Insurance Company, 1986 to 1990;
Director, New York Life Insurance
Company, 1985 to 1986; Executive Vice
President and General Counsel, New
York Life Insurance Company, 1982 to
1986; Senior Vice President and General
Counsel, New York Life Insurance
Company, 1977 to 1982; and Chairman,
American Council of Life Insurance,
1995 to 1996.
Donald K. Ross* Trustee Retired Chairman and Chief Executive
953 Cherokee Lane Officer, New York Life Insurance
Franklin Lakes, NJ 07417 Company; Director, New York Life Insurance
Age: 70 Company, 1978 to 1996; President, New
York Life Insurance Company, 1986 to
1990; Chairman of the Board, New York
Life Insurance Company, 1981 to 1990;
Chief Executive Officer, New York Life
Insurance Company, 1981 to 1990; and
Trustee, Consolidated Edison Company
of New York, Inc., 1976 to present.
Nancy Maginnes Trustee Member, Board of Overseers of the
Kissinger Nelson A. Rockefeller Institute of
Hendersons Road Government, State University of New
Kent, CT 06757 York, Albany, NY, 1983 to present; and
Age: 62 Member, Board of Advisers of the Naval
Postgraduate School, 1985 to present.
Ralph A. Pfeiffer, Jr. Trustee Senior Vice President, IBM Corporation,
90 Field Point Circle 1974 to 1986; Chairman and Chief
Greenwich, CT 06830 Executive Officer, IBM World Trade
Age: 69 Asia Pacific Group, 1974 to 1986;
Chairman and Chief Executive Officer,
IBM World Trade Corporation, 1984 to
1986, and Director, 1974 to present;
Director, Arthur D. Little, Inc.
(management consultant), 1987 to
present; Director, Campbell Soup
Company, 1987 to present;
Director,
</TABLE>
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<TABLE>
<CAPTION>
PRINCIPAL OCCUPATION(S)
NAME, ADDRESS AND AGE POSITION(S) WITH TRUST DURING PAST 5 YEARS
- -------------------------------- ---------------------- --------------------------------------------
<S> <C> <C>
Alexander Proudfoot PLC and Alexander
Proudfoot Japan, Ltd. (management
consultants), 1987 to 1994; Director, The
Royal Bank of Canada, 1984 to present;
Director, SmithKline Beecham
(pharmaceutical corporation), 1989 to
1993; Director, NIKE, Inc., 1992 to
present; and Director Osiris
Therapeutics, Inc., 1993 to present.
Terry L. Lierman Trustee President, Capitol Associates, Inc., 1984
426 C Street, N.E. to present; President, Employee
Washington, D.C. 20002 Health Programs, 1990 to present; and Vice
Age: 48 Chairman, Dresing, Lierman, Weicker,
Inc., 1995 to present.
Donald E. Nickelson Trustee Vice Chairman, Harbour Group
1701 Highway A-1-A Industries, Inc., 1991 to present;
Suite 101 Director, PaineWebber Group, 1980 to
Vero Beach, FL 32963 1993; President, PaineWebber Group,
Age: 63 1988 to 1990; Chairman of the Board,
PaineWebber Properties, 1985 to 1989;
Director, Harbour Group, 1986 to
present; Director, CPA 10 Real Estate
Inv. Trust, 1990 to present; Director,
CIP 11 Real Estate Inv. Trust, 1991 to
present; Chairman of the Board and
Director, Rapid Rock Industries, Inc.,
1986 to present; Director, Selectide
Corporation, Member of the Executive
Committee, 1992 to present; Director
and Chairman of the Board, Del
Industries, 1990 to present; Trustee,
Jones Foundation (Los Angeles), 1978
to present; Director, Allied Healthcare
Products, Inc., 1992 to present; Director,
Sugen, Inc., 1992 to present; Director
and Chairman of the Board, Greenfield
Industries, Inc., 1993 to present; Director
and Chairman of the Board, Flair Corp.,
1993 to present; Director, DT Industries,
1992 to present.
</TABLE>
B-93
<PAGE>
<TABLE>
<CAPTION>
PRINCIPAL OCCUPATION(S)
NAME, ADDRESS AND AGE POSITION(S) WITH TRUST DURING PAST 5 YEARS
- -------------------------------- ---------------------- --------------------------------------------
<S> <C> <C>
Richard S. Trutanic Trustee Managing Director, The Somerset Group
1155 Connecticut Ave. (financial advisory firm), 1993 to present;
N.W., Suite 400 President, TR Capital Corporation
Washington, DC 20036 (financial advisory firm), 1990 to present;
Age: 44 Senior Vice President, Washington
National Investment Corporation
(financial advisory firm), 1985 to 1990;
and Director and Member of Executive
Committee, Southern Net, Inc., 1986 to
1990.
<CAPTION>
- -----------------------------------------------------------------------------------------------------
OFFICERS (OTHER THAN TRUSTEES)
- -----------------------------------------------------------------------------------------------------
PRINCIPAL OCCUPATION(S)
NAME, ADDRESS AND AGE POSITION(S) WITH TRUST DURING PAST 5 YEARS
- -------------------------------- ---------------------- --------------------------------------------
<S> <C> <C>
Jefferson C. Boyce Senior Vice President Senior Vice President, MainStay
51 Madison Avenue Institutional Funds Inc., 1995 to present;
New York, NY 10010 Senior Vice President, New York Life
Age: 38 Insurance Company, 1994 to present;
Director, NYLIFE Distributors Inc.,
1993 to present; Chief Administrative
Officer, Pension, Mutual Funds,
Structured Finance, Corporate Quality,
Human Resources and Employees'
Health Departments, New York Life
Insurance Company, 1992 to 1994; and
Vice President, Pension Department,
New York Life Insurance Company,
1989 to 1992.
Anthony W. Polis Vice President and Vice President, New York Life Insurance
51 Madison Avenue Chief Financial Company, 1988 to present; Director,
New York, NY 10010 Officer Vice President and Chief Financial
Age: 52 Officer, NYLIFE Securities Inc., 1988 to
present; Vice President and Chief
Financial Officer, NYLIFE Distributors
Inc., 1993 to present; Treasurer,
MainStay Institutional Funds Inc., 1990
to present; Treasurer, New York Life
MFA Series Fund, Inc., 1993 to present;
Assistant Treasurer, New York Life
MFA Series Fund, Inc., 1992 to 1993;
Vice President and Treasurer, Eclipse
Financial Asset Trust, 1992 to present;
Vice President and Chief Financial
Officer, Eagle Strategies Corp. (broker-
dealer and registered investment
adviser), 1993 to present.
</TABLE>
B-94
<PAGE>
<TABLE>
<CAPTION>
PRINCIPAL OCCUPATION(S)
NAME, ADDRESS AND AGE POSITION(S) WITH TRUST DURING PAST 5 YEARS
- -------------------------------- ---------------------- --------------------------------------------
<S> <C> <C>
Richard Zuccaro Tax Vice President Vice President, New York Life Insurance
51 Madison Avenue Company, 1995 to present; Vice
New York, NY 10010 President -- Tax, New York Life
Age: 46 Insurance Company, 1986 to 1995; Tax
Vice President, NYLIFE Securities Inc.,
1987 to present; Tax Vice President,
NAFCO, Inc., 1990 to present; Tax Vice
President, NYLIFE Depositary Inc., 1990
to present; Tax Vice President, NYLIFE
Inc., 1990 to present; Tax Vice President,
NYLIFE Insurance Company of
Arizona, 1990 to present; Tax Vice
President, NYLIFE Realty Inc., 1991 to
present; Tax Vice President, NYLICO
Inc., 1991 to present; Tax Vice President,
New York Life Fund Inc., 1991 to
present; Tax Vice President, New York
Life International Investment, Inc., 1991
to present; Tax Vice President, NYLIFE
Equity Inc., 1991 to present; Tax Vice
President, NYLIFE Funding Inc., 1991
to present; Tax Vice President, NYLCO
Inc., 1991 to present; Tax Vice President,
New York Life MFA Series Fund, 1991
to present; Tax Vice President, CNP
Realty, 1991 to present; Tax Vice
President, New York Life Worldwide
Holding Inc., 1992 to present; Tax Vice
President, NYLIFE Structured Asset
Management Co. Ltd., 1992 to present;
Tax Vice President, MainStay
Institutional Funds Inc., 1992 to present;
Tax Vice President, Eagle Strategies
Corp. (broker-dealer and registered
investment adviser), 1993 to present; Tax
Vice President, NYLIFE Distributors
Inc., 1993 to present; Vice President &
Assistant Controller, New York Life
Insurance and Annuity Corp., 1995 to
present, and Assistant Controller, 1991
to present; Vice President, NYLCARE
Health Plans, Inc., 1995 to present; Vice
President - Tax, New York Life and
Health Insurance Co., 1996 to present; and
Tax Vice President, NYL Trust
Company, 1996 to present.
</TABLE>
B-95
<PAGE>
<TABLE>
<CAPTION>
PRINCIPAL OCCUPATION(S)
NAME, ADDRESS AND AGE POSITION(S) WITH TRUST DURING PAST 5 YEARS
- -------------------------------- ---------------------- --------------------------------------------
<S> <C> <C>
A. Thomas Smith III Secretary Assistant General Counsel, New York
51 Madison Avenue Life Insurance Company, 1994 to
New York, NY 10010 present; Secretary, MainStay Institutional
Age: 39 Funds Inc., New York Life MFA Series
Fund, Inc., New York Life Fund Inc.,
and Eclipse Financial Asset Trust, 1994
to present; Assistant General Counsel,
Dreyfus Corporation, 1991 to 1993;
Senior Associate, Willkie, Farr &
Gallagher, 1989 to 1991; and Staff
Attorney, Chief Counsel's Office, U.S.
Securities and Exchange Commission,
Division of Investment Management,
1986 to 1988.
</TABLE>
As indicated in the above table, certain Trustees and officers also hold
positions with MacKay-Shields, Monitor, New York Life Insurance Company, NYLIFE
Securities Inc. and/or NYLIFE Distributors Inc.
The Independent Trustees of the Trust receive from the Trust an annual
retainer of $40,000 and a fee of $1,000 for each Board of Trustees meeting and
for each Board committee meeting attended and are reimbursed for all out-of-
pocket expenses related to attendance at such meetings. Trustees who are
affiliated with New York Life Insurance Company do not receive compensation from
the Trust.
For the fiscal year ended December 31, 1995, the Trustees received the
following compensation from the Trust and from certain other investment
companies (as indicated) that have the same investment advisers as the Trust or
an investment adviser that is an affiliated person of one of the Trust's
investment advisers:
B-96
<PAGE>
<TABLE>
<CAPTION>
Total Compensation
Aggregate From Registrant
Name of Compensation and Fund Complex
Trustee from the Trust+ Paid to Trustees
- -------------------------- --------------- ------------------
<S> <C> <C>
Nancy M. Kissinger $32,500 $32,500
Terry L. Lierman $33,250 $33,250
Donald E. Nickelson $33,250 $33,250
Ralph A. Pfeiffer, Jr. $32,250 $32,250
Robert P. Rittereiser/*/ $32,500 $32,500
Richard S. Trutanic $33,250 $33,250
</TABLE>
* Mr. Rittereiser resigned from his position as Trustee of the Trust as of
November 14, 1995.
+ Reflects a change in compensation structure effective July 31, 1995.
As of April 1, 1996, the Trustees and officers of the Trust as a group
owned less than 1% of the outstanding shares of any class of beneficial interest
of each of the Funds.
THE ADVISERS, THE ADMINISTRATOR AND THE DISTRIBUTOR
INVESTMENT ADVISORY AGREEMENTS
Pursuant to the Investment Advisory Agreements for Capital Appreciation
Fund, Value Fund, Convertible Fund, High Yield Corporate Bond Fund, Government
Fund, and Money Market Fund dated May 1, 1986; the Investment Advisory Agreement
for Tax Free Bond Fund dated May 29, 1987; the Investment Advisory Agreement for
Total Return Fund dated December 28, 1987; the Investment Advisory Agreements
for California Tax Free Fund and New York Tax Free Fund dated September 6, 1991;
the Investment Advisory Agreement for Equity Index Fund dated November 5, 1990;
and the Investment Advisory Agreements for International Bond Fund and
International Equity Fund dated August 25, 1994, MacKay-Shields or Monitor, each
subject to the supervision of the Trustees of the Trust and in conformity with
the stated policies of each Fund of the Trust, manages the investment operations
of the respective Funds that it advises and the composition of each such Fund's
portfolio, including the purchase, retention, disposition and loan of
securities.
On April 27, 1987 the shareholders of Capital Appreciation Fund, Value
Fund, Convertible Fund, High Yield Corporate Bond Fund, Government Fund, and
Money Market Fund approved their respective Investment Advisory Agreements and
in connection with
B-97
<PAGE>
the reorganization of such Fund as a series of the Trust, the shareholders of
the MacKay-Shields MainStay Tax Free Bond Fund approved an Investment Advisory
Agreement with MacKay-Shields substantially identical to the Tax Free Bond
Fund's current Investment Advisory Agreement with MacKay-Shields. On April 25,
1988 the shareholders of Total Return Fund, approved its Investment Advisory
Agreement. On December 8, 1992, shareholders of California Tax Free Fund and
New York Tax Free Fund approved their respective Investment Advisory Agreements
with MacKay-Shields. On September 8, 1994, the sole initial shareholder of
International Bond Fund and International Equity Fund approved their respective
Investment Advisory Agreements with MacKay-Shields. Each Investment Advisory
Agreement will remain in effect for two years following its effective date, and
will continue in effect thereafter only if such continuance is specifically
approved at least annually by the Trustees or by vote of a majority of the
outstanding voting securities of the particular Fund (as defined in the 1940 Act
and in a rule under the Act) and, in either case, by a majority of the Trustees
who are not "interested persons" of the Trust or MacKay-Shields or Monitor (as
the term is defined in the 1940 Act). The Investment Advisory Agreements were
last approved by the Trustees, including a majority of the Trustees who are not
"interested persons" of the Trust or MacKay-Shields or Monitor (as defined in
the 1940 Act), at a meeting held on April 29, 1996.
The Investment Advisory Agreement for each Fund also provides that in the
event the expenses of a Fund (including the fees of the Fund's Adviser, but
excluding interest, taxes, organization expenses, brokerage commissions,
distribution expenses, litigation and indemnification expenses and other
extraordinary expenses) for any fiscal year exceed the limits set by a state
securities commission, the Fund's Adviser will reduce its fee payable by each
such Fund by 50% (20% in the case of the Equity Index Fund) of the amount of
such excess to the extent of that Fund's fee. The Capital Appreciation Fund,
Convertible Fund, Government Fund, High Yield Corporate Bond Fund, Money Market
Fund, Tax Free Bond Fund, Total Return Fund and Value Fund have received from
the California Department of Corporations (the state securities commission)
various forms of waivers allowing the exclusion of certain Fund expenses in the
calculation of their expense limitations as set by regulation.
For the fiscal year ended August 31, 1994, for the period September 1, 1994
through December 31, 1994 and for the fiscal year ended December 31, 1995, the
expenses of each Fund did not exceed the most restrictive state expense
limitation.
The Advisers have each authorized any of their directors, officers and
employees who have been elected or appointed as
B-98
<PAGE>
Trustees or officers of the Trust to serve in the capacities in which they have
been elected or appointed. In connection with the services it renders, the
Advisers bear the salaries and expenses of all of its personnel.
For the fiscal year ended December 31, 1995, the period September 1, 1994
through December 31, 1994 and the fiscal year ended August 31, 1994, the amount
of the advisory fee paid by each Fund to the Adviser was as follows:
<TABLE>
<CAPTION>
Year Ended September 1, 1994 Year Ended
December 31, through August 31,
1995 December 31, 1994* 1994
------------ ------------------ ----------
<S> <C> <C> <C>
California Tax Free Fund........ $ 29,964++ $ 14,030 $ 42,305
Capital Appreciation Fund....... 2,155,386 543,137 1,267,894
Convertible Fund................ 1,027,604 206,175 364,706
Equity Index Fund............... 81,072 20,578 61,926
Government Fund................. 3,056,716 1,062,816 3,526,410
High Yield Corporate Bond Fund.. 3,930,939 1,068,277 2,789,320
International Bond Fund+........ 52,534++ 10,037++ N/A
International Equity Fund+...... 166,703 27,355 N/A
Money Market Fund............... 391,304++ 93,386 212,079
New York Tax Free Fund.......... 31,482++ 14,397 43,791
Tax Free Bond Fund.............. 1,610,982 525,805 1,579,219
Total Return Fund............... 2,396,247 674,170 1,798,433
Value Fund...................... 1,932,406 518,495 1,174,157
- -------------------------
</TABLE>
* The Funds changed their fiscal year end from August 31 to December 31.
+ The International Bond Fund and International Equity Fund commenced
operations on September 13, 1994.
++ After expense reimbursement.
The Adviser and the Administrator have voluntarily agreed to limit the
expenses of the Money Market Fund, described above to the extent that such
expenses for a month would exceed on an annualized basis .70%, respectively, of
the average daily net assets of the Fund. For the fiscal year ended August 31,
1994, $426,236 would have been incurred by the Money Market Fund had such
expenses not been limited. For the period September 1, 1994 through December
31, 1994, $173,990 would have been incurred by the Money Market Fund had such
expenses not been limited. And, for the fiscal year ended December 31, 1995,
$674,279 would have been incurred by the Money Market Fund had such expenses not
been limited.
B-99
<PAGE>
The Adviser voluntarily agreed to reimburse 50% of certain expenses for the
California Tax Free Fund and the New York Tax Free Fund to the extent that
operating expenses exceed on an annualized basis .99% of the daily average net
assets of that Fund. For the year ended August 31, 1994, the expense
reimbursements to the California Tax Free Fund and the New York Tax Free Fund
were $8,734 and $8,261, respectively. For the fiscal period September 1, 1994
through December 31, 1994, the expense reimbursements to the California Tax Free
Fund and the New York Tax Free Fund totaled $5,418 and $5,167, respectively.
And, for the fiscal year ended December 31, 1995, the expense reimbursements to
the California Tax Free Fund and New York Tax Free Fund were $16,845 and
$14,242, respectively.
Regarding the International Bond Fund, the Adviser and Administrator each
agreed that a portion of its fees would not be imposed, pursuant to the
applicable contracts, until such time as the Fund reaches $50 million in net
assets. After deducting the foregoing fee waiver, the advisory fee paid by the
International Bond Fund for the period September 13, 1994 to December 31, 1994
equalled an annual rate of 0.25% and for the fiscal year ended December 31, 1995
equalled an annual rate of 0.25%.
The Investment Advisory Agreements provide that MacKay-Shields or Monitor
shall not be liable to the Funds for any error of judgment by MacKay-Shields or
Monitor or for any loss sustained by the Funds or NYLIFE Distributors Inc.
except in the case of MacKay-Shields' or Monitor's willful misfeasance, bad
faith, gross negligence or reckless disregard of duty. Each Agreement also
provides that it shall terminate automatically if assigned and that it may be
terminated without penalty by either party upon no more than 60 days' nor less
than 30 days' written notice.
ADMINISTRATION AGREEMENTS
NYLIFE Distributors Inc. ("NYLIFE Distributors" or the "Administrator")
acts as administrator for the Funds pursuant to the Administration Agreements
which are dated January 1, 1994 (August 25, 1994 in the case of the
International Bond Fund and International Equity Fund). Prior to that time,
NYLIFE Securities Inc. ("NYLIFE Securities"), an affiliated company, had acted
as administrator. The Administrator has authorized any of its directors,
officers and employees who have been elected or appointed as Trustees or
officers of the Trust to serve in the capacities in which they have been elected
or appointed. In connection with its administration of the business affairs of
the Funds, and except as indicated in the Prospectus under the heading
"Investment Advisers, Administrator and Distributor," the Administrator bears
the following expenses:
B-100
<PAGE>
(a) the salaries and expenses of all personnel of the Trust and the
Administrator, except the fees and expenses of Trustees not affiliated with the
Administrator or the Advisers; and
(b) all expenses incurred by the Administrator in connection with
administering the ordinary course of the Funds' business, other than those
assumed by the Trust.
The Administration Agreements also provide that in the event the expenses
of a Fund (including the fees of the Fund's Adviser and the Administrator, but
excluding interest, taxes, organization expenses, brokerage commissions,
distribution expenses, litigation and indemnification expenses and other
extraordinary expenses) for any fiscal year exceed the limits set by a state
securities commission, the Administrator will reduce its fees payable by each
such Fund by 50% (80% in the case of the Equity Index Fund) of the amount of
such excess to the extent of that Fund's fee.
The Administration Agreements for the Funds were approved by the Trustees,
including a majority of the Trustees who are not "interested persons" of the
Trust or NYLIFE Distributors (as the term is defined in the 1940 Act) at a
meeting held on October 25, 1993 (and at a meeting held on July 25, 1994 for the
International Bond Fund and International Equity Fund). The Administration
Agreements for each Fund were reapproved by the Trustees, including a majority
of the Trustees who are not "interested persons" of the Trust or NYLIFE
Distributors, at a meeting held on April 29, 1996.
For the fiscal year ended December 31, 1995, the fiscal period September 1,
1994 through December 31, 1994 and the fiscal year ended August 31, 1994, the
amount of the administration fee paid by each Fund was as follows:*
B-101
<PAGE>
<TABLE>
<CAPTION>
Year Ended September 1, 1994 Year Ended
December 31, through August 31,
1995 December 31, 1994** 1994
- -------------------------------------------- ------------------- ----------
<S> <C> <C> <C>
California Tax Free Fund........ $ 29,964++ $ 14,030 $ 42,305
Capital Appreciation Fund....... 2,155,386 543,137 1,267,894
Convertible Fund................ 1,027,604 206,175 364,706
Equity Index Fund............... 324,287 20,578 61,926
Government Fund................. 3,056,716 1,062,816 3,526,410
High Yield Corporate Bond Fund.. 3,930,939 1,068,277 2,789,320
International Bond Fund+........ 31,522++ 10,037++ N/A
International Equity Fund+...... 111,135 27,355 N/A
Money Market Fund............... 391,304++ 93,386 212,079
New York Tax Free Fund.......... 31,481++ 14,397 43,791
Tax Free Bond Fund.............. 1,610,982 525,805 1,579,219
Total Return Fund............... 2,396,247 674,170 1,798,433
Value Fund...................... 1,932,406 518,495 1,174,157
</TABLE>
_______________________
* For the period from September 1, 1993 through December 31, 1993, the Funds
paid administration fees to NYLIFE Securities. Since January 1, 1994, the
administration fees have been paid by the Funds to NYLIFE Distributors.
** The Funds changed their fiscal year end from August 31 to December 31.
+ The International Bond Fund and International Equity Fund commenced
operations on September 13, 1994.
++ After expense reimbursement.
For the fiscal year ended December 31, 1995, the period September 1, 1994
through December 31, 1994, and the fiscal year ended August 31, 1994, the
expenses of each Fund did not exceed the most restrictive state expense
limitation.
The Administrator and the Adviser have voluntarily agreed to assume the
expenses of the Money Market Fund described above to the extent that such
expenses for a month would exceed on an annualized basis .70% of the average
daily net assets of that Fund. For the fiscal year ended December 31, 1995, the
period September 1, 1994 through December 31, 1994, and the fiscal year ended
August 31, 1994, $674,279, $173,990 and $426,236 in expenses would have been
incurred by the Money Market Fund, respectively, had such expenses not been
limited.
The Administrator has voluntarily agreed to reimburse 50% of certain
expenses for the California Tax Free Fund and the New York Tax Free Fund to the
extent that operating expenses exceed on an annualized basis .99% of the daily
average net assets of
B-102
<PAGE>
that Fund. The expense reimbursements to the California Tax Free Fund and New
York Tax Free Fund for the fiscal year ended August 31, 1994 were $8,734 and
$8,262, respectively. For the period September 1, 1994 to December 31, 1994 the
expense reimbursements to the Funds were $5,418 and $5,167, respectively. And,
for the fiscal year ended December 31, 1995, the expense reimbursements to the
Funds were $16,845 and $14,241 respectively. NYLIFE Distributors reserves the
right to terminate or revise this limitation when the assets of a Fund reach $25
million.
Regarding the International Bond Fund, the Adviser and Administrator each
agreed that a portion of its fees would not be imposed, pursuant to the
applicable contracts, until such time as the Fund reaches $50 million in net
assets. After deducting the foregoing fee waiver, the administration fee paid
by the International Bond Fund for the period September 13, 1994 to December 31,
1994 equalled an annual rate of 0.15% and for the fiscal year ended December 31,
1995 equalled an annual rate of 0.15%.
DISTRIBUTION AGREEMENT
NYLIFE Distributors also acts as the Principal Underwriter and Distributor
of the Funds' shares pursuant to the Distribution Agreement with the Trust dated
January 1, 1994. Prior to that time, NYLIFE Securities Inc., an affiliated
company, had acted as principal underwriter. NYLIFE Securities sells shares of
the Funds pursuant to a dealer agreement with the Distributor. The Distributor
and other broker-dealers will pay commissions to salesmen as well as the cost of
printing and mailing prospectuses to potential investors and of any advertising
incurred by them in connection with their distribution of Trust shares. In
addition, the Distributor will pay for a variety of account maintenance and
personal services to shareholders after the sale.
The Distribution Agreement for the Funds was approved by the Trustees,
including a majority of the Trustees who are not "interested persons" (as the
term is defined in the 1940 Act) of the Trust nor have any direct or indirect
financial interest in the operation of the distribution plan or in any related
agreement (the "Independent Trustees") at a meeting held on October 25, 1993.
The Distribution Agreement for the International Bond Fund and the International
Equity Fund was approved by the Trustees, including a majority of the Trustees
who are not "interested persons" of the Trust (as the term is defined in the
1940 Act) at a meeting held on July 25, 1994. The Distribution Agreements were
reapproved by the Trustees, including a majority of the Independent Trustees, at
a meeting held on April 29, 1996.
B-103
<PAGE>
As disclosed in the Prospectus, each of the Funds (except the Money Market
Fund and the Equity Index Fund, which does not offer Class B shares) has adopted
separate plans of distribution pursuant to Rule 12b-1 under the 1940 Act for
each class of shares of each Fund (the "Class A Plans", the "Class B Plans" and,
collectively, the "Plans"). Under the Class A Plans, Class A shares of each
Fund pay the Distributor a monthly fee at the annual rate of 0.25% of the
average daily net assets of each Fund's Class A shares for distribution or
service activities, as designated by the Distributor. The Class A Plans for
each of the Funds other than the California Tax Free Fund, New York Tax Free
Fund and Equity Index Fund were approved by the sole initial shareholder of the
Class A of shares of each Fund on December 31, 1994. The Class A Plans were
approved by the shareholders of the California Tax Free Fund, New York Tax Free
Fund and the Equity Index Fund at a Special Meeting of Shareholders held on
December 28, 1994. Regarding the California Tax Free Fund, the New York Tax
Free Fund and the Equity Index Fund, the Trustees of the Trust, including a
majority of the Trustees who are not interested persons of the Trust and who
have no direct or indirect financial interest in the operation of such Plan (the
"Independent Trustees"), by vote cast in person at a meeting called for the
purpose of voting on such Plans, initially approved the Plan now designated as
the Class A Plans on July 25, 1994.
As noted above, the Class B shares of each Fund (except the Money Market
Fund and the Equity Index Fund, which does not offer Class B shares) also have
adopted Rule 12b-1 distribution plans. Originally, Rule 12b-1 plans of
distribution were adopted by each of the Funds (except the California Tax Free
Fund, New York Tax Free Fund and Money Market Fund) for the then sole existing
class of shares of the Funds. More specifically, Rule 12b-1 distribution plans
were approved on September 8, 1994 by the sole initial shareholder of each of
the International Bond Fund and International Equity Fund, on April 25, 1988 by
the shareholders of the Total Return Fund, on May 29, 1987 by the sole initial
shareholder of the Tax Free Bond Fund and on April 27, 1987 by the shareholders
of the Capital Appreciation Fund, Convertible Fund, Government Fund, High Yield
Corporate Bond Fund and Value Fund. The Trustees of the Trust, including a
majority of the Trustees who are not interested persons of the Trust and who
have no direct or indirect financial interest in the operation of such plans of
distribution, by vote cast in person at meetings called for the purpose of
voting on such Plans, initially approved the Plans of the Total Return Fund on
October 26, 1987, initially approved the Plans of the Tax Free Bond Fund on
April 27, 1987, and initially approved the Plans of the Capital Appreciation
Fund, Convertible Fund, Government Fund, High Yield Corporate Bond Fund and
Value Fund on April 28, 1986. In addition, on
B-104
<PAGE>
October 31, 1988, the Trustees of the Trust, including a majority of the
Trustees who are not interested persons, amended the Tax Free Bond Fund's Plan
to permanently reduce the amount of the distribution fee to be imposed
subsequent to that date. On October 26, 1992, the Trustees of the Trust,
including a majority of the Trustees who are not interested persons of the
Trust, amended each of the plans of distribution to provide that a portion of
total amount of the distribution fee as a service fee, to pay for a variety of
account maintenance and personal services to shareholders after the sale. On
October 25, 1993, the Trustees of the Trust, including a majority of the
Trustees who are not interested persons of the Trust, amended each of the plans
of distribution to reflect that NYLIFE Distributors would serve as principal
underwriter of the Funds' shares, effective January 1, 1994. Prior to the
implementation of the multi-class distribution system the distribution plans in
effect for the Funds were amended and redesignated and, now, are applicable only
to the Class B shares of each Fund. On October 30, 1995, the Trustees of the
Trust, including a majority of the Trustees who are not interested persons of
the Trust, amended the Class A Plans and the Class B Plans to clarify that the
Plans contemplate payment for expenses that may generally be characterized as
administrative.
Regarding the California Tax Free Fund and New York Tax Free Fund, the
Class B Plans were approved by the sole initial shareholder of the Class B
shares of each Fund on December 31, 1994. The Trustees of the Trust, including
a majority of the Trustees who are not interested persons of the Trust and who
have no direct or indirect financial interest in the operation of such Plans, by
vote cast in person at meetings called for the purpose of voting on such Plans,
initially approved such Plans now designated as the Class B Plans on October 24,
1994.
Regarding the International Bond Fund and International Equity Fund, the
Trustees of the Trust, including a majority of the Trustees who are not
interested persons of the Trust and who have no direct or indirect financial
interest in the operation of such Plans (the "Independent Trustees"), by vote
cast in person at meetings called for the purpose of voting on such Plans,
initially approved the distribution plans now designated as the Class B Plans on
July 25, 1994, and the Class A Plans on October 24, 1994.
Under the Class B plans, each Fund's Class B shares pay a monthly
distribution fee to the Distributor at the annual rate of 0.75% (0.25% in the
case of the California Tax Free Fund, New York Tax Free Fund and the Tax Free
Bond Fund) of the lesser of (a) the aggregate gross sales of the Fund's Class B
shares since the inception of the Funds (not including reinvestment of
B-105
<PAGE>
dividends and capital gains distributions from the Fund), less the aggregate net
asset value of the Class B shares exchanged or redeemed since the Fund's
inception upon which a contingent deferred sales charge has been imposed or upon
which such charge has been waived, or (b) the average daily net assets
attributable to the Fund's Class B shares. Pursuant to the Class B Plans, the
Class B shares of each Fund also pay a service fee to the Distributor at the
annual rate of 0.25% of the average daily net assets of the Fund's Class B
shares.
Once approved by a vote of a majority of the outstanding voting securities
of a class of shares of a Fund, each Plan shall continue in effect thereafter,
provided such continuance is approved annually by a vote of the Trustees in the
manner described above. No Plan may be amended to increase materially the
amount to be spent for the services described therein without approval of the
shareholders of the affected class of shares of a Fund, and all material
amendments of each Plan must also be approved by the Trustees in the manner
described above. Each Plan may be terminated at any time, without payment of
any penalty, by vote of a majority of the Trustees who are not interested
persons of the Trust and who have no direct or indirect financial interest in
the operations of the Plan, or by a vote of a majority of the outstanding voting
securities of the affected Fund (as defined in the 1940 Act) on not more than 30
days' written notice to any other party to the Plan. So long as any Plan is in
effect, the selection and nomination of Trustees who are not such interested
persons has been committed to those Trustees who are not such interested
persons. The Trustees have determined that, in their judgment, there is a
reasonable likelihood that each Plan will benefit the respective Fund and its
shareholders. Pursuant to both the Class A and Class B Plans, the Distributor
shall provide the Trust for review by the Trustees, and the Trustees shall
review at least quarterly, a written report of the amounts expended under each
Plan and the purpose for which such expenditures were made. In the Trustees'
quarterly review of each Plan, they will consider its continued appropriateness
and the level of compensation provided therein.
At a meeting held on April 29, 1996, the Trustees of the Trust, including a
majority of the Independent Trustees, approved the continuation of the Plans.
Pursuant to a rule of the National Association of Securities Dealers, Inc.,
the amount which a Fund may pay for distribution expenses, excluding service
fees, is limited to 6.25% of the gross sales of the Fund's shares since
inception of the Fund's Plan, plus interest at the prime rate plus 1% per annum
(less any contingent deferred sales charges paid by shareholders to the
B-106
<PAGE>
Distributor or distribution fee (other than service fees) paid by the Funds to
the Distributor).
For the fiscal year ended December 31, 1995, the Funds paid distribution
and service fees pursuant to the Class A and Class B Plans as follows:
<TABLE>
<CAPTION>
Amount of Fee Amount of Fee
Pursuant to Pursuant to
Class A Plan Class B Plan
------------- -------------
<S> <C> <C>
California Tax Free Fund........ $ 44,763 $ 4,009
Capital Appreciation Fund....... 54,644 5,241,894
Convertible Fund................ 26,747 2,425,078
Equity Index Fund............... 202,680 --
Government Fund................. 19,908 8,934,304
High Yield Corporate Bond Fund.. 54,204 11,505,308
International Bond Fund......... 27,649 94,984
International Equity Fund....... 27,480 168,012
Money Market Fund............... N/A N/A
New York Tax Free Fund.......... 44,241 2,923
Tax Free Bond Fund.............. 18,962 2,498,987
Total Return Fund............... 24,091 6,153,937
Value Fund...................... 32,185 4,929,564
</TABLE>
For the fiscal year ended December 31, 1995, the period September 1, 1994
through December 31, 1994 and the fiscal year ended August 31, 1994, NYLIFE
Distributors (or NYLIFE Securities with respect to the period September 1, 1993
to December 31, 1994) retained the following amounts in sales charges for sales
of Class A shares of the Funds, as applicable:
B-107
<PAGE>
<TABLE>
<CAPTION>
Year Ended September 1, 1994 Year Ended
December 31, through August 31,
1995 December 31, 1994* 1994
------------- ------------------ ----------
<S> <C> <C> <C>
California Tax Free Fund........... $ 57,181 $ 25,670 $259,675
Capital Appreciation Fund(1)....... 718,806 -- --
Convertible Fund(1)................ 529,361 -- --
Equity Index Fund.................. 308,486 133,857 484,877
Government Fund(1)................. 95,975 -- --
High Yield Corporate Bond Fund(1) 782,534 -- --
International Bond Fund+(1)........ 10,984 -- --
International Equity Fund+(1)...... 63,684 -- --
Money Market Fund(1)............... N/A N/A N/A
New York Tax Free Fund............. 35,722 21,343 210,642
Tax Free Bond Fund(1).............. 62,656 -- --
Total Return Fund(1)............... 233,202 -- --
Value Fund(1)...................... 413,692 -- --
- -----------------------
</TABLE>
* The Funds changed their fiscal year end from August 31 to December 31.
+ The International Bond Fund and International Equity Fund commenced
operations on September 13, 1994.
(1) The Fund began offering Class A shares on January 3, 1995.
For the fiscal year ended December 31, 1995, contingent deferred sales
charges were paid by investors on the redemption of Class B shares of each Fund,
as follows:
<TABLE>
<CAPTION>
Year Ended
December 31,
1995
------------
<S> <C>
California Tax Free Fund(2)..... $ 718
Capital Appreciation Fund....... 691,725
Convertible Fund................ 277,587
Equity Index Fund............... N/A
Government Fund................. 1,119,438
High Yield Corporate Bond Fund.. 1,183,376
International Bond Fund......... 6,472
International Equity Fund....... 22,447
Money Market Fund............... 635,470(1)
New York Tax Free Fund(2)....... 212
Tax Free Bond Fund.............. 675,151
Total Return Fund............... 725,396
Value Fund...................... 638,963
</TABLE>
B-108
<PAGE>
_______________________
* The Funds changed their fiscal year end from August 31 to December 31.
(1) The amount shown represents proceeds from contingent deferred sales charges
which were assessed on redemptions of shares which had previously been
exchanged from other Funds into the Money Market Fund.
(2) The Fund began offering Class B shares on January 3, 1995.
For the fiscal year ended December 31, 1995, it is estimated that the
following amounts were spent with respect to the Class A shares of each Fund:
California Tax Free Fund spent $44,763 on compensation to dealers; Capital
Appreciation Fund spent $54,644 on compensation to dealers; Convertible Fund
spent $26,747 on compensation to dealers; Equity Index Fund spent $202,680 on
compensation to dealers; Government Fund spent $19,908 on compensation to
dealers; High Yield Corporate Bond Fund spent $54,204 on compensation to
dealers; International Bond Fund spent $27,649 on compensation to dealers;
International Equity Fund spent $27,480 on compensation to dealers; New York Tax
Free Bond Fund spent $44,241 on compensation to dealers; Tax Free Bond Fund
spent $18,962 on compensation to dealers; Total Return Fund spent $24,091 on
compensation to dealers; and Value Fund spent $32,185 on compensation to
dealers.
For the fiscal year ended December 31, 1995, it is estimated that the
following amounts were spent for distribution-related activities with respect to
the Class B shares of each Fund:
<TABLE>
<CAPTION>
Printing And Approximate
Mailing Total Amount
Prospectuses Spent By
Sales to other Compensation Compensation NYLIFE
Material than to to Sales Distributors
and Current Distribution Sales Distribution With Respect
Advertising Shareholders Personnel Personnel Other Costs to Each Fund
----------- ------------ ------------ ------------ ---------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C> <C>
California Tax Free
Fund................... $ 3,046 $ 466 $ 13,965 $ 7,979 $ 9,034 $ 73,187 $ 107,675
Capital Appreciation
Fund................... 313,864 304,729 1,473,678 548,897 993,410 8,821,318 12,455,896
Convertible Fund........ 116,997 129,406 538,134 201,811 362,586 8,483,757 9,832,692
Government Fund......... 132,049 433,969 662,463 198,365 471,904 3,273,320 5,172,070
High Yield Corporate
Bond Fund.............. 461,306 609,594 2,197,584 759,406 1,500,461 14,746,191 20,274,542
International Bond
Fund................... 4,690 4,519 27,747 7,281 19,003 170,867 234,107
International Equity
Fund................... 12,003 7,782 73,987 21,525 51,108 396,879 563,283
New York Tax Free Fund 2,384 402 7,670 2,197 4,927 55,316 72,896
</TABLE>
B-109
<PAGE>
<TABLE>
<CAPTION>
Printing And Approximate
Mailing Total Amount
Prospectuses Spent By
Sales to other Compensation Compensation NYLIFE
Material than to to Sales Distributors
and Current Distribution Sales Distribution With Respect
Advertising Shareholders Personnel Personnel Other Costs to Each Fund
----------- ------------ ------------ ------------ ---------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Tax Free Fund........... 95,752 228,967 443,704 131,862 314,780 2,164,442 3,379,507
Total Return Fund....... 198,626 337,295 968,457 326,108 658,341 4,987,582 7,476,409
Value Fund.............. 194,747 262,672 959,090 308,136 649,550 6,169,315 8,543,510
</TABLE>
OTHER SERVICES
Pursuant to an Accounting Agreement with the Trust, dated January 1, 1994,
NYLIFE Distributors performs certain bookkeeping and pricing services for the
Funds that were previously provided by NYLIFE Securities. Each Fund will bear
an allocable portion of the cost of providing these services to the Trust.
In addition, each Fund reimbursed NYLIFE Securities and NYLIFE Distributors
for the cost of certain correspondence to shareholders and establishing
shareholder accounts.
For fiscal year ended December 31, 1995, the period September 1, 1994
through December 31, 1994 and the fiscal year ended August 31, 1994, the amount
of recordkeeping fee paid by each Fund was as follows:*
<TABLE>
<CAPTION>
September 1,
Year Ended 1994 through Year Ended
December 31, December 31, August 31,
1995 1994 ** 1994
------------ ------------- -----------
<S> <C> <C> <C>
California Tax Free Fund........ $ N/A $ N/A $ N/A
Capital Appreciation Fund....... 95,042 24,684 63,653
Convertible Fund................ 57,184 13,603 34,971
Equity Index Fund............... N/A N/A N/A
Government Fund................. 128,798 42,333 147,843
High Yield Corporate Bond Fund.. 164,329 45,331 124,644
International Bond Fund+........ 12,000 3,600 --
International Equity Fund+...... 12,668 3,600 --
Money Market Fund............... 53,064 16,047 43,522
New York Tax Free Fund.......... N/A N/A N/A
Tax Free Bond Fund.............. 79,801 24,274 81,781
Total Return Fund............... 103,032 29,600 83,984
Value Fund...................... 85,935 23,809 61,792
</TABLE>
________________
* For the period from September 1, 1993 to December 31, 1993, the Funds paid
accounting fees to NYLIFE Securities. Since January 1, 1994, the
accounting fees charged to the Funds have been paid to NYLIFE Distributors.
** The Funds changed their fiscal year end from August 31 to December 31.
B-110
<PAGE>
+ The International Bond Fund and International Equity Fund commenced
operations on September 13, 1994.
EXPENSES BORNE BY THE TRUST
Except for the expenses to be paid by the Advisers and the Administrator as
described in the Prospectus, the Trust, on behalf of each Fund, is responsible
under its Administration Agreement for the payment of expenses related to each
Fund's operations, including (i) the fees payable to the Advisers and the
Administrator, (ii) the fees and expenses of Trustees who are not affiliated
with the Advisers or the Administrator, (iii) certain fees and expenses of the
Trust's Custodian and Transfer Agent, including the cost of pricing a Fund's
shares, (iv) the charges and expenses of the Trust's legal counsel and
independent accountants, (v) brokers' commissions and any issue or transfer
taxes chargeable to the Trust, on behalf of a Fund, in connection with its
securities transactions, (vi) the fees of any trade association of which a Fund
or the Trust is a member, (vii) the cost of share certificates representing
shares of a Fund, (viii) reimbursement of a portion of the organization expenses
of a Fund and the fees and expenses involved in registering and maintaining
registration of the Trust and of its shares with the SEC and registering the
Trust as a broker or dealer and qualifying its shares under state securities
laws, including the preparation and printing of the Trust's registration
statements and prospectuses for such purposes, (ix) allocable communications
expenses with respect to investor services and all expenses of shareholders' and
Trustees' meetings and preparing, printing and mailing prospectuses and reports
to shareholders, (x) litigation and indemnification expenses and other
extraordinary expenses not incurred in the ordinary course of a Fund's business,
(xi) any expenses assumed by the Fund pursuant to its plan of distribution, and
(xii) all taxes and business fees payable by a Fund to federal, state or other
governmental agencies. Fees and expenses of legal counsel, registering shares,
holding meetings and communicating with shareholders include an allocable
portion of the cost of maintaining an internal legal and compliance department.
PORTFOLIO TRANSACTIONS AND BROKERAGE
Purchases and sales of securities on a securities exchange are effected by
brokers, and the Funds pay a brokerage commission for this service. In
transactions on stock exchanges in the United States, these commissions are
negotiated, whereas on many foreign stock exchanges these commissions are fixed.
In the over-the-counter markets, securities (i.e., Municipal Bonds and other
debt securities) are generally traded on a "net" basis with
B-111
<PAGE>
dealers acting as principal for their own accounts without a stated commission,
although the price of the security usually includes a profit to the dealer.
Transactions in certain over-the-counter securities also may be effected on an
agency basis, when the total price paid (including commission) is equal to or
better than the best total prices available from other sources. In underwritten
offerings, securities are purchased at a fixed price which includes an amount of
compensation to the underwriter, generally referred to as the underwriter's
concession or discount. On occasion, certain money market instruments may be
purchased directly from an issuer, in which case no commissions or discounts are
paid.
Regarding the California Tax Free Fund and New York Tax Free Fund, newly
issued securities normally are purchased directly from the issuer or from an
underwriter acting as principal. Other purchases and sales usually are placed
with those dealers from which it appears that the best price or execution will
be obtained; those dealers may be acting as either agents or principals. The
purchase price paid by a Fund to underwriters of newly issued securities usually
includes a concession paid by the issuer to the underwriter, and purchases of
after-market securities from dealers normally are executed at a price between
the bid and asked prices.
The primary consideration in placing portfolio security transactions with
broker-dealers for execution is to obtain and maintain the availability of
execution at the most favorable prices and in the most effective manner
possible. The Advisers attempt to achieve this result by selecting broker-
dealers to execute portfolio transactions on behalf of each Fund and their
other clients on the basis of the broker-dealers' professional capability, the
value and quality of their brokerage services and the level of their brokerage
commissions. Consistent with the foregoing primary considerations, the Rules of
Fair Practice of the NASD and such other policies as the Trustees may determine,
the Advisers may consider sales of shares of the Funds as a factor in the
selection of broker-dealers to execute the Funds' portfolio transactions.
NYLIFE Securities (the "Affiliated Broker") may act as broker for the
Trust. In order for the Affiliated Broker to effect any portfolio transactions
for the Trust, the commissions, fees or other remuneration received by the
Affiliated Broker must be reasonable and fair compared to the commissions, fees
or other remuneration paid to other brokers in connection with comparable
transactions involving similar securities being purchased or sold on an exchange
during a comparable period of time. This standard would allow the Affiliated
Broker to receive no more than the remuneration which would be expected to be
received by an
B-112
<PAGE>
unaffiliated broker in a commensurate arms-length transaction. The Trust will
not deal with the Affiliated Broker in any portfolio transaction in which the
Affiliated Broker acts as principal.
Under each Investment Advisory Agreement and as permitted by Section 28(e)
of the Securities Exchange Act of 1934 (the "1934 Act"), the Adviser may cause a
Fund to pay a broker-dealer (except the Affiliated Broker) which provides
brokerage and research services to the Adviser an amount of commission for
effecting a securities transaction for a Fund in excess of the amount other
broker-dealers would have charged for the transaction if the Adviser determines
in good faith that the greater commission is reasonable in relation to the value
of the brokerage and research services provided by the executing broker-dealer
viewed in terms of either a particular transaction or the Adviser's overall
responsibilities to the Trust or to its other clients. The term "brokerage and
research services" includes advice as to the value of securities, the
advisability of investing in, purchasing, or selling securities, and the
availability of securities or of purchasers or sellers of securities; furnishing
analyses and reports concerning issuers, industries, securities, economic
factors and trends, portfolio strategy and the performance of accounts; and
effecting securities transactions and performing functions incidental thereto
such as clearance and settlement.
Although commissions paid on every transaction will, in the judgment of the
Advisers, be reasonable in relation to the value of the brokerage services
provided, commissions exceeding those which another broker might charge may be
paid to broker-dealers (except the Affiliated Broker) who were selected to
execute transactions on behalf of the Trust and the Advisers' other clients in
part for providing advice as to the availability of securities or of purchasers
or sellers of securities and services in effecting securities transactions and
performing functions incidental thereto such as clearance and settlement.
Broker-dealers may be willing to furnish statistical, research and other
factual information or services ("Research") to the Advisers for no
consideration other than brokerage or underwriting commissions. Securities may
be bought or sold through such broker-dealers, but at present, unless otherwise
directed by the Trust, a commission higher than one charged elsewhere will not
be paid to such a firm solely because it provided Research to an Adviser.
Research provided by brokers is used for the benefit of all of the Advisers'
clients and not solely or necessarily for the benefit of the Trust. The
Advisers' investment management personnel attempt to evaluate the quality of
Research provided by brokers. Results of this effort
B-113
<PAGE>
are sometimes used by the Advisers as a consideration in the selection of
brokers to execute portfolio transactions.
In certain instances there may be securities which are suitable for a
Fund's portfolio as well as for that of another Fund or one or more of the other
clients of the Advisers. Investment decisions for a Fund and for the Advisers'
other clients are made with a view to achieving their respective investment
objectives. It may develop that a particular security is bought or sold for
only one client even though it might be held by, or bought or sold for, other
clients. Likewise, a particular security may be bought for one or more clients
when one or more other clients are selling that same security. Some
simultaneous transactions are inevitable when several clients receive investment
advice from the same investment adviser, particularly when the same security is
suitable for the investment objectives of more than one client. When two or
more clients are simultaneously engaged in the purchase or sale of the same
security, the securities are allocated among clients in a manner believed to be
equitable to each. It is recognized that in some cases this system could have a
detrimental effect on the price or volume of the security in a particular
transaction as far as a Fund is concerned. The Trust believes that over time
its ability to participate in volume transactions will produce better executions
for the Funds.
The investment advisory fee that the Trust pays on behalf of each Fund to
the Advisers will not be reduced as a consequence of the Advisers' receipt of
brokerage and research services. To the extent a Fund's portfolio transactions
are used to obtain such services, the brokerage commissions paid by the Fund
will exceed those that might otherwise be paid, by an amount which cannot be
presently determined. Such services would be useful and of value to the
Advisers in serving both the Funds and other clients and, conversely, such
services obtained by the placement of brokerage business of other clients would
be useful to the Advisers in carrying out their obligations to the Funds.
For the fiscal year ended December 31, 1995, the period September 1, 1994
through December 31, 1994* and the fiscal year ended August 31, 1994, each of
the following Funds paid brokerage commissions as follows:
B-114
<PAGE>
<TABLE>
<CAPTION>
Total Brokerage
Commissions Paid
------------------
September 1, 1994
Year ended through Year ended Year ended
Dec. 31, 1995 Dec. 31, 1994 Aug. 31, 1994 Dec. 31, 1995
----------------------- -------------------------- ---------------------------- -------------------
<S> <C> <C> <C> <C>
Capital Appreciation Fund.. $ 681,250 $ 126,845 $ 392,614 $ ---
Convertible Fund........... 674,139 151,524 254,853 ---
Equity Index Fund.......... 7,018 2,364 13,056 ---
Government Fund............ 71,818 27,123 36,978 ---
High Yield Corporate Bond
Fund...................... 1,207,587 333,548 715,132 1,970(0%)(1)
International Equity Fund+. 135,267 54,215 --- ---
Total Return Fund.......... 436,507 102,550 344,877 ---
Value Fund................. 1,055,169 246,712 792,790 5,074(0%)(1)
</TABLE>
<TABLE>
<CAPTION>
Total Brokerage Commissions
Paid to Affiliated Persons
--------------------------
September 1, 1994
through Year ended
Dec. 31, 1994 Aug. 31, 1994
---------------- ----------------
<S> <C> <C>
Capital Appreciation Fund...... $ --- $ 892(0%)(1)
Convertible Fund............... --- ---
Equity Index Fund.............. --- ---
Government Fund................ --- ---
High Yield Corporate Bond
Fund.......................... --- ---
International Equity Fund+. --- ---
Total Return Fund.............. --- 1,062(0%)(1)
Value Fund..................... 1,540(1%)(1) 1,236(0%)(1)
</TABLE>
<TABLE>
<CAPTION>
Total Brokerage
Commissions Paid
Total Amount of Transactions to Brokers that
Where Commissions Paid Provided Research
------------------------------------------------------------------------ -----------------
September 1, 1994
Year Ended through Year ended Year ended
December 31, 1995 December 31, 1994 August 31, 1994 December 31, 1995
------------------ ------------------- ---------------- ------------------
<S> <C> <C> <C> <C>
Capital Appreciation Fund.. $391,017,677(0.0%)(2) $71,345,660(0.0%)(2) $250,574,560(0.4%)(2) $ 676,767
Convertible Fund........... 395,570,645(0.0%)(2) 81,374,040(0.0%)(2) 129,691,980(0.0%)(2) 661,909
Equity Index Fund.......... 5,863,505(0.0%)(2) 1,660,008 9,997,541 7,018
Government Fund............ 712,117,650(0.0%)(2) 291,468,420(0.0%)(2) 569,582,010(0.0%)(2) 71,818
High Yield Corporate Bond
Fund...................... 1,414,045,455(0.0%)(2) 375,961,540(0.0%)(2) 1,066,188,210(0.0%)(2) 1,165,852
International Equity Fund+ 33,559,758(0.0%)(2) 12,781,223 --- 135,267
Total Return Fund.......... 604,631,476(0.0%)(2) 153,671,710(0.0%)(2) 426,700,610(0.2%)(2) 428,424
Value Fund................. 544,224,812(0.0%)(2) 141,666,160(0.1%)(2) 402,906,740(0.3%)(2) 994,081
</TABLE>
_________________________
* The Funds changed their fiscal year end from August 31 to December 31.
(1) Percent of total commissions paid.
(2) Percent of total transactions involving the payment of commissions effected
through affiliated persons.
+ The International Equity Fund commenced operations on September 13, 1994.
The California Tax Free Fund, International Bond Fund, Money Market Fund,
New York Tax Free Fund and Tax Free Bond Fund paid no brokerage commissions
during year ended December 31, 1995, the period from September 1, 1994 through
December 31, 1994, and the fiscal year ended August 31, 1994.
As of December 31, 1995, the following Funds held securities of issuers
with whose broker-dealer subsidiaries or affiliates the Funds regularly conduct
business: the Capital Appreciation Fund held common stock in Schwab (Charles)
Corp. valued at $7,697,813, commercial paper of General Electric Capital Corp.
valued at $24,331,000 and commercial paper of Prudential Funding Corp. valued at
$10,312,000; the Money Market Fund held medium-term notes of General Electric
Capital Corp. valued at $6,000,000 and commercial paper of Morgan Stanley Group
Inc. valued at
B-115
<PAGE>
$1,490,738; the Total Return Fund held long-term bonds of Smith Barney Holdings
Inc., 7.98%, due 3/1/00 valued at $1,501,094, common stock of Schwab (Charles)
Corp. valued at $7,516,687, and commercial paper of Smith Barney Inc. valued at
$6,290,000; and the Value Fund held commercial paper of American Express Credit
Corp. valued at $20,423,000, and commercial paper of General Electric Capital
Corp. valued at $21,473,000.
Investors may, subject to the approval of the Trust, NYLIFE Distributors
and the Adviser to the particular Fund, purchase shares of a Fund with liquid
securities that are eligible for purchase by that Fund and that have a value
that is readily ascertainable. These transactions will be effected only if the
Adviser intends to retain the security in the Fund as an investment. The Trust
reserves the right to amend or terminate this practice at any time.
NET ASSET VALUE
The net asset value per share of each Fund (other than the Money Market
Fund) is determined by the Trust daily as of the close of regular trading on the
New York Stock Exchange (currently 4:00 p.m., Eastern time) on each day when the
New York Stock Exchange is open for trading. The net asset value per share of
the Money Market Fund is also determined at noon on such days.
Portfolio securities of the Money Market Fund are valued at their amortized
cost, which does not take into account unrealized securities gains or losses.
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 Money Market Fund would receive if it sold the instrument. During
periods of declining interest rates, the quoted yield on shares of the Money
Market Fund 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 Money Market Fund resulted in a lower aggregate
portfolio value on a particular day, a prospective investor in the Money Market
Fund would be able to obtain a somewhat higher yield if he or she purchased
shares of the Money Market Fund on that day, than would result from investment
in a fund utilizing solely market values, and existing investors in the Money
Market Fund would receive less investment income. The converse would apply in a
period of rising interest rates.
B-116
<PAGE>
Portfolio securities of each other Fund are valued (a) by appraising common
and preferred stocks which are traded on the New York Stock Exchange at the last
sale price on that Exchange on the day as of which assets are valued or, if no
sale occurs, at the mean between the closing bid price and asked price, (b) by
appraising other common and preferred stocks as nearly as possible in the manner
described in clause (a) if traded on any other exchange, including the National
Association of Securities Dealers National Market System and foreign securities
exchanges, (c) by appraising over-the-counter common and preferred stocks quoted
on the National Association of Securities Dealers NASDAQ system (but not listed
on the National Market System) at the bid price supplied through such system,
(d) by appraising over-the-counter common and preferred stocks not quoted on the
NASDAQ system and securities listed or traded on certain foreign exchanges whose
operations are similar to the U.S over-the-counter market at prices supplied by
a pricing agent selected by the Adviser if those prices are deemed by the
Adviser to be representative of market values at the first close of business of
the New York Stock Exchange, (e) by appraising debt securities at prices
supplied by a pricing agent selected by the Adviser, which prices reflect
broker-dealer-supplied valuations and electronic data processing techniques if
those prices are deemed by the Adviser to be representative of market values at
the close of business of the New York Stock Exchange, (f) by appraising options
and futures contracts at the last posted settlement price on the market where
any such option or futures contract is principally traded and (g) by appraising
all other securities and other assets, including over-the-counter common and
preferred stocks not quoted on the NASDAQ system, securities listed or traded on
certain foreign exchanges whose operations are similar to the U.S. over-the-
counter market and debt securities for which prices are supplied by a pricing
agent but are not deemed by the Adviser to be representative of market values,
but excluding money market instruments with a remaining maturity of 60 days or
less and including restricted securities and securities for which no market
quotation is available, at fair value in accordance with procedures approved by
and determined in good faith by the Trustees, although the actual calculation
may be done by others. Money market instruments held by the Funds with a
remaining maturity of 60 days or less will be valued by the amortized cost
method unless such method does not represent fair value. Forward foreign
currency exchange contracts held by the Funds are valued at their respective
fair market values determined on the basis of the mean between the last current
bid and asked prices based on dealer or exchange quotations.
Portfolio securities traded on more than one U.S. national securities
exchange or foreign securities exchange are valued at the last sale price on the
business day as of which such value is
B-117
<PAGE>
being determined at the close of the exchange representing the principal market
for such securities. The value of all assets and liabilities expressed in
foreign currencies will be converted into U.S. dollar values at the mean between
the buying and selling rates of such currencies against U.S. dollars last quoted
by any major bank. If such quotations are not available, the rate of exchange
will be determined in accordance with policies established by the Trustees. The
Trust recognizes dividend income and other distributions on the ex-dividend
date, except that certain dividends from foreign securities are recognized as
soon as the Trust is informed after the ex-dividend date.
Trading in securities on European and Far Eastern securities exchanges and
over-the-counter markets is normally completed well before the close of business
on each business day in New York (i.e., a day on which the New York Stock
---
Exchange is open for trading). In addition, European or Far Eastern securities
trading generally in a particular country or countries may not take place on all
business days in New York. Furthermore, trading takes place in Japanese markets
on certain Saturdays and in various foreign markets on days which are not
business days in New York and on which the Funds' net asset values are not
calculated. Such calculation of net asset value does not take place
contemporaneously with the determination of the prices of the majority of the
portfolio securities used in such calculation.
Events affecting the values of portfolio securities that occur between the
time their prices are determined and the close of the New York Stock Exchange
will not be reflected in the Funds' calculation of net asset values unless the
Adviser deems that the particular event would materially affect net asset value,
in which case an adjustment will be made.
Because the Guarantee regarding the Equity Index Fund is payable to
shareholders directly (and not payable to the Equity Index Fund), and because it
represents only a contingent liability rather than an agreement to pay a
definite amount on the Guarantee Date, the Trustees believe that the Guarantee
should have no impact in determining the Equity Index Fund's net asset value.
The proceeds received by each Fund for each issue or sale of its shares,
and all net investment income, realized and unrealized gain and proceeds
thereof, subject only to the rights of creditors, will be specifically allocated
to such Fund and constitute the underlying assets of that Fund. The underlying
assets of each Fund will be segregated on the books of account, and will be
charged with the liabilities in respect to such Fund and with a share of the
general liabilities of the Trust.
B-118
<PAGE>
Expenses with respect to any two or more Funds will be allocated in proportion
to the net asset values of the respective Funds except where allocations of
direct expenses can otherwise be fairly made.
To the extent that any newly organized fund or class of shares receives, on
or before December 31, any seed capital, the net asset value of such fund(s) or
class(es) will be calculated as of December 31.
SHAREHOLDER INVESTMENT ACCOUNT
A Shareholder Investment Account is established for each investor in the
Funds, under which a record of the shares of each Fund held is maintained by the
Transfer Agent. If a share certificate is desired, it must be requested in
writing for each transaction. There is no charge to the investor for issuance
of a certificate. Whenever a transaction takes place in a Fund (other than the
Money Market Fund), the shareholder will be mailed a confirmation showing the
transaction. Shareholders will be sent a quarterly statement showing the status
of the Account. In addition, shareholders will be sent a monthly statement for
each month in which a transaction occurs.
SHAREHOLDER SERVICING AGENT
The Glass-Steagall Act prohibits national banks from engaging in the
business of underwriting, selling or distributing securities. There is
currently no precedent prohibiting banks from performing shareholder servicing
and recordkeeping functions. Changes in federal or state statutes and
regulations pertaining to the permissible activities of banks and their
affiliates or subsidiaries, as well as further judicial or administrative
decisions or interpretations of those provisions, could prevent a bank from
continuing to perform all or a part of such services. If a bank were prohibited
from so acting, the Trustees would consider what actions, if any, would be
necessary to continue to provide efficient and effective shareholder services.
It is not expected that shareholders would suffer any adverse financial
consequences as a result of any of these occurrences.
PURCHASES, REDEMPTION AND REPURCHASE
LETTER OF INTENT ("LOI")
The LOI is a non-binding obligation on the Qualified Purchaser to purchase
the full amount indicated; however, on the initial purchase, if required (or, on
subsequent purchases if necessary), 5% of the dollar amount specified in the LOI
will be
B-119
<PAGE>
held in escrow by the Transfer Agent in shares registered in the shareholder's
name in order to assure payment of the proper sales charge. If total purchases
pursuant to the LOI (less any dispositions and exclusive of any distribution on
such shares automatically reinvested) are less than the amount specified, the
investor will be requested to remit to the Distributor an amount equal to the
difference between the sales charge paid and the sales charge applicable to the
aggregate purchases actually made. If not remitted within 20 days after written
request, an appropriate number of escrowed shares will be redeemed in order to
realize the difference.
SUSPENSION OF REDEMPTIONS
The Trust may suspend the right of redemption of shares of any Fund and may
postpone payment for any period: (i) during which the New York Stock Exchange
is closed other than customary weekend and holiday closings or during which
trading on the New York Stock Exchange is restricted; (ii) when the SEC
determines that a state of emergency exists which may make payment or transfer
not reasonably practicable; (iii) as the SEC may by order permit for the
protection of the security holders of the Trust; or (iv) at any other time when
the Trust may, under applicable laws and regulations, suspend payment on the
redemption or repurchase of its shares.
TAX-SHELTERED RETIREMENT PLANS
CASH OR DEFERRED PROFIT SHARING PLANS UNDER SECTION 401(K) FOR CORPORATIONS AND
SELF-EMPLOYED INDIVIDUALS
Shares of a Fund, except the California Tax Free Fund, New York Tax Free
Fund and Tax Free Bond Fund, may also be purchased as an investment under a
specimen cash or deferred profit sharing plan intended to qualify under Section
401(k) of the Code (a "401(k) Plan") adopted by a corporation, a self-employed
individual (including sole proprietors and partnerships), or other organization.
All Funds, except the California Tax Free Fund, New York Tax Free Fund and Tax
Free Bond Fund, may be used as funding vehicles for qualified retirement plans
including 401(k) plans, which may be administered by third-party administrator
organizations. NYLIFE Distributors does not sponsor or administer such
qualified plans at this time.
INDIVIDUAL RETIREMENT ACCOUNT ("IRA")
Shares of a Fund, except the California Tax Free Fund, New York Tax Free
Fund and Tax Free Bond Fund, may also be purchased as an underlying investment
for an IRA made available by NYLIFE Distributors.
B-120
<PAGE>
An individual may contribute as much as $2,000 of his or her earned income
each year to an IRA, or an aggregate of $2,250 to IRAs for the person and the
person's spouse if the spouse is treated as having no compensation income.
Contributions may be made to a spousal IRA even if the spouse has earnings for
that year if the spouse elects to be treated as having no earnings (for IRA
contribution purposes) for the year.
An individual who has not attained age 70-1/2 may make an IRA contribution
which is deductible for federal income tax purposes only if (i) neither the
individual nor his or her spouse (unless filing separate returns and living
apart at all times during the taxable year) is an active participant in an
employer's retirement plan, or (ii) the individual (and his or her spouse, if
applicable) has an adjusted gross income below a certain level ($40,000 for
married individuals filing a joint return, with a phase-out of the deduction for
adjusted gross income between $40,000 and $50,000; $25,000 for a single
individual, with a phase-out for adjusted gross income between $25,000 and
$35,000). However, an individual not permitted to make a deductible
contribution to an IRA may nonetheless make nondeductible contributions up to
the maximum contribution limit for that year. The deductibility of IRA
contributions under state law varies from state to state.
Distributions from IRAs (to the extent they are not treated as a tax-free
return of nondeductible contributions) are taxable under federal income tax laws
as ordinary income. There are special rules for determining how withdrawals are
to be taxed if an IRA contains both deductible and nondeductible amounts. In
general, all IRAs are aggregated and treated as one IRA, all withdrawals are
treated as one withdrawal, and then a proportionate amount of the withdrawal
will be deemed to be made from nondeductible contributions; amounts treated as a
return of nondeductible contributions will not be taxable. Certain early
withdrawals are subject to an additional excise tax. There are also special
rules governing when IRA distributions must begin and the minimum amount of such
distributions; failure to comply with these rules can result in the imposition
of an excise tax.
All income and capital gains deriving from IRA investments in the Fund are
reinvested and compound tax-deferred until distributed from the IRA. The
combination of annual contributions which may be deductible and tax-deferred
compounding can lead to substantial retirement savings.
403(B)(7) TAX SHELTERED ACCOUNT
Shares of a Fund, except the California Tax Free Fund, New York Tax Free
Fund and Tax Free Bond Fund, may also be purchased
B-121
<PAGE>
as the underlying investment for tax sheltered custodial accounts made available
by NYLIFE Distributors. In general, employees of tax-exempt organizations
described in Section 501(c)(3) of the Code (such as hospitals, churches,
religious, scientific, or literary organizations and educational institutions)
or a public school system are eligible to participate in a 403(b) plan.
The custodial agreements and forms provided by the Funds' Custodian and
Transfer Agent designate State Street Bank and Trust Company as custodian for
IRAs and 403(b) plans (unless another trustee or custodian is designated by the
individual or group establishing the plan) and contain specific information
about the plans. Each plan provides that dividends and distributions will be
reinvested automatically. For further details with respect to any plan,
including fees charged by State Street Bank and Trust Company, tax consequences
and redemption information, see the specific documents for that plan.
GENERAL INFORMATION
Shares of a Fund, except the California Tax Free Fund, New York Tax Free
Fund and Tax Free Bond Fund, may also be a permitted investment under profit
sharing, pension, and other retirement plans, IRAs, and tax-deferred annuities
other than those offered by the Fund depending on the provisions of the relevant
plan. Third-party administrative services, available for some corporate plans,
may limit or delay the processing of transactions.
The federal tax laws applicable to retirement plans, IRAs and 403(b) plans
are extremely complex and change from time to time. Therefore, an investor
should consult with his or her own professional tax adviser before establishing
any of the tax-deferred retirement plans described above.
CALCULATION OF PERFORMANCE QUOTATIONS
From time to time, quotations of the Money Market Fund's "yield" and
"effective yield" may be included in advertisements or communications to
shareholders. These performance figures are calculated in the following manner:
A. Yield -- the net annualized yield based on a specified seven-
-----
calendar day period calculated at simple interest rates. Yield is
calculated by determining the net change, exclusive of capital changes, in
the value of a hypothetical preexisting account having a balance of one
share at the beginning of the period, subtracting a hypothetical charge
reflecting deductions from shareholder accounts, and dividing the
difference by the value of the
B-122
<PAGE>
account at the beginning of the base period to obtain the base period
return. The yield is annualized by multiplying the base period return by
365/7. The yield figure is stated to the nearest hundredth of one percent.
The yield of the Class A and Class B shares of the Money Market Fund for
the seven-day period ended December 31, 1995 was 5.12% and 5.12%,
respectively.
B. Effective Yield -- the net annualized yield for a specified seven-
---------------
calendar day period assuming a reinvestment of dividends (compounding).
Effective yield is calculated by the same method as yield except the yield
figure is compounded by adding one, raising the sum to a power equal to 365
divided by 7, and subtracting one from the result, according to the
following formula: Effective Yield = [(Base Period Return + 1) /365/7/] -
1. The effective yield of the Class A and Class B shares of the Money
Market Fund for the seven-day period ended December 31, 1995 was 5.25% and
5.25%, respectively.
The yield and effective yield of the Money Market Fund reflect the
reduction of certain fees otherwise payable and voluntary expense
limitations. Had there been no reduction of fees or expense limitations,
the yield and effective yield of the Money Market Fund would have been
5.05% and 5.17%, respectively, for Class A shares and 5.05% and 5.17%,
respectively, for Class B shares for the seven-day period ended December
31, 1995.
As described above, yield and effective yield are based on historical
earnings and are not intended to indicate future performance. Yield and
effective yield will vary based on changes in market conditions and the level of
expenses.
The average annual total return of each Fund is determined for a particular
period by calculating the actual dollar amount of the investment return on a
$1,000 investment in the Fund made at the maximum public offering price at the
beginning of the period, and then calculating the annual compounded rate of
return which would produce that amount. Total return for a period of one year
is equal to the actual return of the Fund during that period. This calculation
assumes a complete redemption of the investment and the deduction of the maximum
contingent deferred sales charge at the end of the period in the case of Class B
shares. In the case of Class A shares, the calculation assumes the maximum
sales charge is deducted from the initial $1,000 purchase order. It also
assumes that all dividends and distributions are reinvested at net asset value
on the reinvestment dates during the period. The performance
B-123
<PAGE>
information shown below for the period ended December 31, 1995 provides
performance figures for both Class A and Class B shares of the Funds, except in
the case of the Equity Index Fund which offers only one class of shares, Class A
shares.
In considering any average annual total return quotation, investors should
remember that the maximum initial sales charge reflected in each quotation for
Class A shares is a one-time fee which will have its greatest impact during the
early stages of an investor's investment in the Fund. The actual performance of
your investment will be affected less by this charge the longer you retain your
investment in the Fund.
Quotations of each Fund's average annual total return will be calculated
according to the following SEC formula:
P(1+T)/n /= ERV
where:
P = a hypothetical initial payment of $1,000
T = average annual total return
n = number of years
ERV = ending redeemable value of a hypothetical $1,000 payment made at the
beginning of the 1, 5 or 10-year periods at the end of the 1, 5, or
10-year periods (or fractional portion thereof)
As discussed in the Prospectus, each Fund may quote total rates of return
in addition to its average annual total return. Such quotations are computed in
the same manner as the average annual compounded rate, except that such
quotations will be based on a Fund's actual return for a specified period as
opposed to its average return over 1, 5, and 10-year periods. In considering
any total rate of return quotation, investors should remember that the maximum
initial sales charge reflected in each quotation for Class A shares is a one-
time fee which will have its greatest impact during the early stages of an
investor's investment in the Fund. The actual performance of your investment
will be affected less by this charge the longer you retain your investment in
the Fund.
The average annual total returns of the Class A shares of the following
Funds for the one-year and, as applicable, five-year periods ended December 31,
1995 and the period from inception to December 31, 1995 were as follows:*
B-124
<PAGE>
<TABLE>
<CAPTION>
Five Average
Year Years Annual
Ended Ended Total Inception
Fund 12/31/95 12/31/95 Return(a) Date
- ------------------------------ -------- -------- ------ ---------
<S> <C> <C> <C> <C>
California Tax Free Fund...... 9.99% --- 6.32% 10/01/91
Capital Appreciation Fund(b).. 28.32% 21.91% 13.56% 5/01/86
Convertible Fund(b)........... 16.91% 19.24% 9.64% 5/01/86
Equity Index Fund............. 31.83% 14.47% 14.38% 12/20/90
Government Fund(b)............ 11.14% 6.12% 6.77% 5/01/86
High Yield Corporate
Bond Fund(b)................. 14.87% 17.94% 9.74% 5/01/86
International Bond Fund(b).... 13.34% --- 10.28% 9/13/94
International Equity Fund(b).. -0.53% --- -2.18% 9/13/94
New York Tax Free Fund........ 10.76% --- 6.69% 10/01/91
Tax Free Bond Fund(b)......... 9.83% 6.50% 6.18% 5/01/86
Total Return Fund(b).......... 21.59% 13.20% 11.72% 12/29/87
Value Fund(b)................. 21.66% 18.40% 10.89% 5/01/86
- -----------------
</TABLE>
* Assumes the deduction of the maximum applicable initial sales charge.
(a) From inception to 12/31/95.
(b) Performance figures for the Fund's Class A shares, first offered to the
public on January 3, 1995, include the historical performance of the Fund's
Class B shares for the period from inception through December 31, 1994.
Performance data for the two classes after this date vary based on
differences in their expense structures.
The average annual total returns of the Class B shares of the following
Funds for the one-year and, as applicable, five-year periods ended December 31,
1995, were as follows:
<TABLE>
<CAPTION>
Five Average
Year Years Annual
Ended Ended Total Inception
Fund 12/31/95 12/31/95 Return(a) Date
------ -------- -------- ------ ---------
<S> <C> <C> <C> <C>
California Tax Free Fund(b).. 9.91% --- 7.05% 10/01/91
Capital Appreciation Fund.... 30.11% 23.00% 14.16% 5/01/86
Convertible Fund............. 18.02% 20.27% 20.27% 5/01/86
Government Fund.............. 10.69% 6.67% 7.21% 5/01/86
High Yield Corporate
Bond Fund................... 14.71% 18.72% 10.21% 5/01/86
International Bond Fund...... 12.96% --- 10.75% 9/13/94
International Equity Fund.... -0.73% --- -1.64% 9/13/94
New York Tax Free Fund(b).... 10.67% --- 7.41 10/01/91
Tax Free Bond Fund........... 9.86% 7.15% 6.67% 5/01/86
Total Return Fund............ 22.96% 14.13% 12.44% 12/29/87
Value Fund................... 23.01% 19.42% 11.47% 5/01/86
- -----------------
</TABLE>
* Assumes a complete redemption at the end of each year and the deduction of
the maximum applicable contingent deferred sales charge.
(a) From inception to 12/31/95.
(b) Performance figures for the Fund's Class B shares, first offered to the
public on January 3, 1995, include the historical performance of the Fund's
Class A shares for the period from inception through December 31, 1994.
Performance data for the two classes after this date vary based on
differences in their expense structures.
The average annual total returns of the Class A shares of the following
Funds without deducting the applicable initial sales charge is as follows:
B-125
<PAGE>
<TABLE>
<CAPTION>
Five Average
Year Years Annual
Ended Ended Total Inception
Fund 12/31/95 12/31/95 Return(a) Date
------ -------- -------- ------ ---------
<S> <C> <C> <C> <C>
California Tax Free Fund...... 15.18% --- 7.48% 10/01/91
Capital Appreciation Fund(b).. 35.79% 23.29% 14.22% 5/01/86
Convertible Fund(b)........... 23.72% 20.60% 10.28% 5/01/86
Equity Index Fund............. 35.91% 15.17% 15.08% 12/20/90
Government Fund(b)............ 16.38% 7.10% 7.28% 5/01/86
High Yield Corporate
Bond Fund(b)................. 20.28% 19.03% 10.26% 5/01/86
International Bond Fund(b).... 18.68% --- 14.26% 9/13/94
International Equity Fund(b).. 5.25% --- 2.17% 9/13/94
New York Tax Free Fund........ 15.97% --- 7.85% 10/01/91
Tax Free Bond Fund(b)......... 15.00% 7.48% 6.68% 5/01/86
Total Return Fund(b).......... 28.66% 14.49% 12.51% 12/29/87
Value Fund(b)................. 28.74% 19.75% 11.54% 5/01/86
- -----------------
</TABLE>
(a) From inception to 12/31/95.
(b) Performance figures for the Fund's Class A shares, first offered to the
public on January 3, 1995, include the historical performance of the Fund's
Class B shares for the period from inception through December 31, 1994.
Performance data for the two classes after this date vary based on
differences in their expense structures.
The average annual total returns of the Class B shares of the following
Funds without deducting the applicable contingent deferred sales charge is as
follows:
<TABLE>
<CAPTION>
Five Average
Year Years Annual
Ended Ended Total Inception
Fund 12/31/95 12/31/95 Return(a) Date
------- -------- -------- ------ ---------
<S> <C> <C> <C> <C>
California Tax Free Fund(b).. 14.91% --- 7.42% 10/01/91
Capital Appreciation Fund.... 35.11% 23.17% 14.16% 5/01/86
Convertible Fund............. 23.02% 20.47% 10.22% 5/01/86
Government Fund.............. 15.69% 6.98% 7.21% 5/01/86
High Yield Corporate
Bond Fund................... 19.71% 18.92% 10.21% 5/01/86
International Bond Fund...... 17.96% --- 13.72% 9/13/94
International Equity Fund.... 4.27% --- 1.44% 9/13/94
New York Tax Free Fund(b).... 15.67% --- 7.78% 10/01/91
Tax Free Bond Fund........... 14.86% 7.46% 6.67% 5/01/86
Total Return Fund............ 27.96% 14.37% 12.44% 12/29/87
Value Fund................... 28.01% 19.61% 11.47% 5/01/86
- -----------------
</TABLE>
(a) From inception to 12/31/95.
(b) Performance figures for the Fund's Class B shares, first offered to the
public on January 3, 1995, include the historical performance of the Fund's
Class A shares for the period from inception through December 31, 1994.
Performance data for the two classes after this date vary based on
differences in their expense structures.
The performance data quoted represents historical performance and the
investment return and principal value of an investment will fluctuate so that an
investor's shares, when redeemed, may be worth more or less than their original
cost.
B-126
<PAGE>
The yield of each Fund, except the Money Market Fund, is computed by
dividing its net investment income (determined in accordance with the following
SEC formula) earned during a recent 30-day period by the product of the average
daily number of shares outstanding and entitled to receive dividends during the
period and the maximum offering price per share on the last day of the period.
The results are compounded on a bond equivalent (semiannual) basis and then they
are annualized. Yield will be calculated using the following SEC formula:
Yield = 2[(a-b +1)/6/ -1]
---
cd
where:
a = interest earned during the period
b = expenses accrued for the period (net of reimbursements)
c = the average daily number of shares outstanding during the period that
were entitled to receive dividends
d = the maximum offering price per share on the last day of the period
This yield figure does not reflect the deduction of any contingent deferred
sales charges which are imposed upon certain redemptions at the rates set forth
under "Redemptions and Repurchases" in the Prospectus.
For the 30-day period ended December 31, 1995, the yield of each of the
following Funds was:
<TABLE>
<CAPTION>
30-Day
Period Ended
December 31,
1995
---------------
Fund Class A Class B
------ ------- -------
<S> <C> <C>
California Tax Free Fund........ 4.846% 4.77%
Government Fund................. 4.211% 3.92%
High Yield Corporate Bond Fund.. 7.621% 8.175%
International Bond Fund......... 5.099% 4.495%
New York Tax Free Fund.......... 5.008% 5.006%
Tax Free Bond Fund.............. 5.207% 5.271%
</TABLE>
B-127
<PAGE>
The Tax Free Bond Fund may publish its tax equivalent yield in
advertisements and communications to shareholders. The tax equivalent yield is
calculated by determining the rate of return that would have to be achieved on a
fully taxable investment to produce the after-tax equivalent of the Fund's
yield, assuming certain tax brackets for a Fund shareholder.
For the 30-day period ended December 31, 1995, the Federal income tax
equivalent yield for the California Tax Free Fund, New York Tax Free Fund or Tax
Free Bond Fund was as shown in the following table.*+
To Equal a 5.50% Tax
If Free Return, a Taxable
Your Federal Investment Would Have to
Marginal Tax Earn Without Fee Reduction
Rate is: or Expense Limit
------------ ---------------------------
15.00% 6.47%
28.00% 7.64%
31.00% 7.97%
36.00% 8.59%
39.60% 9.11%
____________________
* This table reflects application of the regular Federal income tax only;
other taxes may be applicable with respect to a particular shareholder.
Such taxes could change the information shown. Tax rates are subject to
change. Investors in the California and New York Tax Free Funds should in
particular note that the chart does not reflect any state and local taxes
that may be deductible in computing Federal income tax liability.
+ This table is for illustrative purposes only; investors should consult
their tax advisers with respect to the tax implications of an investment in
a Fund that invests primarily in securities, the interest on which is
exempt from regular Federal income tax.
The current dividend rate of each Fund for a particular period is
calculated by annualizing total distributions per share from net investment
income (including equalization credits, excluding realized short-term capital
gains and premiums from
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<PAGE>
writing options) during this period and dividing this amount by the maximum
offering price per share on the last day of the period. The current dividend
rate does not reflect all components of a Fund's performance including (i)
realized and unrealized capital gains and losses, which are reflected in
calculations of a Fund's total return, or (ii) the amortized discount and
premium on debt obligations in income using the current market value of the
obligations, as is currently required for yield calculations. In addition, the
current dividend rate does not take into account the imposition of any
contingent deferred sales charge on the redemption of Fund shares.
In addition, advertising for a Fund may indicate that investors may
consider diversifying their investment portfolios in order to seek protection of
the value of their assets against inflation. From time to time, advertising
materials for a Fund may refer to or discuss current or past business,
political, economic or financial conditions, including events as they relate to
those conditions, such as any U.S. monetary or fiscal policies and the current
rate of inflation. In addition, from time to time, advertising materials for a
Fund may include information concerning retirement and investing for retirement
and may refer to the approximate number of then-current Fund shareholders,
shareholder accounts and Fund assets.
From time to time, advertising and sales literature for a Fund may discuss
the investment philosophy, personnel and assets under management of the Fund's
investment adviser, and other pertinent facts relating to the management of the
Fund by the adviser.
From time to time any of the Funds may publish an indication of its past
performance as measured by independent sources such as Lipper Analytical
Services, Incorporated, Weisenberger Investment Companies Service, Donoghue's
Money Fund Report, Spot Market Prices, Barron's, BusinessWeek, Changing Times,
-------- ------------ --------------
Financial World, Forbes, Money, Morningstar, Personal Investor, Sylvia Porter's
- --------------- ------ ----- ----------- ----------------- ---------------
Personal Finance, and The Wall Street Journal.
- ---------------- -----------------------
In addition, performance information for a Fund may be compared, in
advertisements, sales literature, and reports to shareholders, to: (i)
unmanaged indexes, such as the Standard & Poor's 500 Composite Stock Price
Index, the Salomon Brothers Broad Investment Grade Bond Index, the Morgan
Stanley Capital International indexes; the Dow Jones Industrial Average,
Donoghue Money Market Institutional Averages, the Merrill Lynch 1 to 3 Year
Treasury Index, the Salomon Brothers World Government Benchmark Bond Index, the
Salomon Brothers non-U.S. Dollar World Government Bond Index, the Lehman
Brothers Municipal Bond Index and the Lehman Brothers Government Corporate
Index; (ii) other
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<PAGE>
groups of mutual funds tracked by Morningstar Inc. or Lipper Analytical
Services, widely used independent research firms which rank mutual funds by
overall performance, investment objectives and assets, or tracked by other
services, companies, publications or persons who rank mutual funds on overall
performance or other criteria; and (iii) the Consumer Price Index (measure for
inflation) and other measures of the performance of the economy to assess the
real rate of return from an investment in the Funds. Unmanaged indexes may
assume the reinvestment of dividends but generally do not reflect deductions for
administrative and management costs and expenses.
From time to time, advertisements for the Funds may include general
information about the services and products offered by the Funds, MainStay
Institutional Funds Inc. and New York Life Insurance Company and its
subsidiaries. For example, such advertisements may include statistical
information about those entities including, but not limited to, the number of
current shareholder accounts, the amount of assets under management, sales
information, the distribution channels through which the entities' products are
available, marketing efforts and statements about this information by the
entities' officers, directors and employees.
TAX STATUS
TAXATION OF THE FUNDS
Each Fund intends to be treated as a regulated investment company ("RIC")
under Subchapter M of the Code. Such qualification does not involve supervision
of management or investment practices or policies by any governmental agency or
bureau.
As a regulated investment company required under Subchapter M of the Code
to distribute at least 90% of its taxable net investment income and net short-
term capital gain in excess of net long-term capital losses (and at least 90%
of net tax-exempt interest income), each Fund generally will not be subject to
federal income or excise tax on any of its net investment income or net realized
capital gains which are timely distributed to shareholders. Provided that a
Fund qualifies as a regulated investment company, it generally will not be
subject to any excise or income taxes in Massachusetts. A Fund's investments,
if any, in REMIC residual interests (as explained previously in this SAI) or in
Passive Foreign Investment Companies, as explained below, may cause the Fund to
become liable for certain taxes. Investors that are tax-exempt organizations
should carefully consider whether distributions of a Fund's earnings will be
subject to tax in their hands.
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<PAGE>
Each Fund, other than the Equity Index Fund (which offers only one class of
shares) has received a ruling from the IRS to the effect that differing
distributions between the classes of its shares will not result in a Fund's
dividends and other distributions being regarded as "preferential dividends"
under the Code. Generally, a preferential dividend is a dividend which a Fund
cannot treat as having been distributed for purposes of (i) determining whether
the Fund qualifies as a regulated investment company for federal tax purposes,
and (ii) determining the Fund's tax liability.
CHARACTER OF DISTRIBUTIONS TO SHAREHOLDERS -- GENERAL
Assuming a Fund qualifies as a RIC, distributions of taxable net investment
income and net short-term capital gains in excess of net long-term capital
losses will be treated as ordinary income in the hands of shareholders. If a
Fund's investment income is derived exclusively from interest rather than
dividends, no portion of such distributions will be eligible for the dividends-
received deduction available to corporations. If a portion of a Fund's net
investment income is derived from dividends from domestic corporations, then a
portion of such distributions may be eligible for the corporate dividends-
received deduction. The dividends-received deduction is reduced to the extent
shares of a Fund are treated as debt-financed under the Code and is eliminated
if such shares are deemed to have been held for less than 46 days. In addition,
the entire dividend (including the deducted portion) is includable in the
corporate shareholder's alternative minimum taxable income. Finally, if such
dividends are large enough to constitute "extraordinary dividends" under Section
1059 of the Code, the shareholder's basis in its shares could be reduced by all
or a portion of the amount of the dividends that qualifies for the dividends-
received deduction.
Distributions of the excess of net long-term capital gain over net short-
term capital loss are taxable to shareholders as long-term capital gain, if such
distributions are designated as capital gain dividends, regardless of the length
of time the shares of a Fund have been held by such shareholders. Such
distributions are not eligible for the corporate dividends-received deduction.
Any loss realized upon the redemption of shares within six months from the date
of their purchase will be treated as a long-term capital loss to the extent of
any capital gain dividends received with respect to such shares during that six-
month period. A loss realized upon a redemption of shares of a Fund within 30
days before or after a purchase of shares of the same Fund (whether by
reinvestment of distributions or otherwise) may be disallowed in whole or in
part.
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If any net long-term capital gains in excess of net short-term capital
losses are retained by a Fund for reinvestment, requiring federal income taxes
to be paid thereon by that Fund, the Fund intends to elect to treat such capital
gains as having been distributed to shareholders. As a result, such amounts
will be taxable as long-term capital gains in the hands of the shareholders.
Shareholders will be able to claim their proportionate share of the federal
income taxes paid by the Fund on such gains as a credit against their own
federal income tax liabilities and will be entitled to increase the adjusted tax
basis of the relevant Fund shares by the difference between their pro-rata share
of such gains and their tax credit.
Except for distributions by the Money Market Fund, distributions by a Fund
result in a reduction in the net asset value of a Fund's shares. Should a
distribution reduce the net asset value below a shareholder's cost basis, such
distribution nevertheless would be taxable to the shareholder (except to the
extent the distribution is an exempt interest dividend as described below) as
ordinary income or capital gain as described above, even though, from an
investment standpoint, it may constitute a partial return of investment. In
particular, investors should be careful to consider the tax implications of
buying shares just prior to a distribution. The price of shares purchased at
that time includes the amount of the forthcoming distribution. Those investors
purchasing shares just prior to a distribution will then receive a partial
return of their investment upon such distribution, which may nevertheless be
taxable to them.
Distributions of taxable net investment income and net realized capital
gains will be taxable as described above, whether received in shares or in cash.
Any distributions that are not from a Fund's net investment income or net
capital gain may be characterized as a return of capital to shareholders or, in
some cases, as capital gain. Shareholders electing to receive distributions in
the form of additional shares will have a cost basis for federal income tax
purposes in each share so received equal to the net asset value of such share on
the reinvestment date.
CHARACTER OF DISTRIBUTIONS TO SHAREHOLDERS -- THE TAX-FREE FUNDS
Subchapter M permits the character of tax-exempt interest distributed by a
regulated investment company to "flow through" as tax-exempt interest to its
shareholders, provided that 50% or more of the value of its assets at the end of
each quarter of its taxable year is invested in state, municipal or other
obligations the interest on which is exempt under Section 103(a) of the Code.
Each of the California Tax Free Fund, New York Tax Free Fund and
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Tax Free Bond Fund (collectively, the "Tax Free Funds") intend to satisfy the
50% requirement in order to permit their distributions of tax-exempt interest to
be treated as such for regular Federal income tax purposes in the hands of their
shareholders. Exempt-interest dividends must be taken into account by
individual shareholders in determining whether their total incomes are large
enough to result in taxation of up to 85% of their social security benefits and
certain railroad retirement benefits. None of the income distributions of such
Fund will be eligible for the deduction for dividends received by corporations.
Although a significant portion of the distributions by the Tax Free Funds
generally is expected to be exempt from federal taxes, each of these Funds may
under certain circumstances invest in obligations the interest from which is
fully taxable, or, although exempt from the regular federal income tax, is
subject to the alternative minimum tax. Similarly, gains from the sale or
exchange of obligations the interest on which is exempt from regular Federal
income tax will constitute taxable income to those Funds. In addition, a sale
of shares in such Fund (including a redemption of such shares and an exchange of
shares between two mutual funds) will be a taxable event, and may result in a
taxable gain or loss to a shareholder. Accordingly, it is possible that a
significant portion of the distributions of these Funds will constitute taxable
rather than tax-exempt income in the hands of a shareholder. Furthermore,
investors should be aware that tax laws may change, and issuers may fail to
follow applicable laws, causing a tax-exempt item to become taxable.
Exempt-interest dividends from the Tax Free Funds; ordinary dividends from
the Tax Free Funds, if any; capital gains distributions from the Tax Free Funds
and any capital gains or losses realized from the sale or exchange of shares may
be subject to state and local taxes. However, the portion of a distribution of
the Funds' tax-exempt income that is attributable to state and municipal
securities issued within the shareholder's own state may not be subject, at
least in some states, to state or local taxes.
Distributions derived from interest on certain private activity bonds which
is exempt from regular federal income tax are treated as a tax preference item
and may subject individual or corporate shareholders to liability (or increased
liability) for the alternative minimum tax. In addition, because a portion of
the difference between adjusted current earnings, as defined in the Code, and
alternative minimum taxable income is an addition to the alternative minimum tax
base, all distributions derived from interest which is exempt from regular
federal income tax are included in adjusted current earnings and may subject
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corporate shareholders to or increase their liability for the alternative
minimum tax. In addition, a deductible "environmental tax" of 0.12% is imposed
on a corporation's modified alternative minimum taxable income in excess of $2
million. The environmental tax will be imposed even if the corporation is not
required to pay an alternative minimum tax because the corporation's regular
income tax liability exceeds its minimum tax liability. To the extent that
exempt-interest dividends paid by a Fund are included in alternative minimum
taxable income, corporate shareholders may be subject to the environmental tax.
DISCOUNT
Certain of the bonds purchased by the Funds, such as zero coupon bonds, may
be treated as bonds that were originally issued at a discount. Original issue
discount represents interest for federal income tax purposes and can generally
be defined as the difference between the price at which a security was issued
and its stated redemption price at maturity. Original issue discount, although
no cash is actually received by a Fund until the maturity of the bond, is
treated for federal income tax purposes as income earned by a Fund over the term
of the bond, and therefore is subject to the distribution requirements of the
Code. The annual amount of income earned on such a bond by a Fund generally is
determined on the basis of a constant yield to maturity which takes into account
the semiannual compounding of accrued interest.
In addition, some of the bonds may be purchased by a Fund at a discount
which exceeds the original issue discount on such bonds, if any. This
additional discount represents market discount for federal income tax purposes.
The gain realized on the disposition of any bond having market discount,
generally will be treated as taxable ordinary income to the extent it does not
exceed the accrued market discount on such bond (unless a Fund elects to include
market discount in income in tax years to which it is attributable). Realized
accrued market discount on obligations that pay tax-exempt interest is
nonetheless taxable. Generally, market discount accrues on a daily basis for
each day the bond is held by a Fund at a constant rate over the time remaining
to the bond's maturity. In the case of any debt security having a fixed
maturity date of not more than one year from date of issue, the gain realized on
disposition will be treated as short-term capital gain.
USERS OF BOND-FINANCED FACILITIES
Section 147(a) of the Code prohibits exemption from taxation of interest on
certain governmental obligations to persons who
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are "substantial users" (or persons related thereto) of facilities financed
thereby. No investigation as to the users of the facilities financed by bonds
in the portfolios of the Tax Free Funds has been made by these Funds. Persons
who may be "substantial users" (or "related persons" of substantial users) of
facilities financed by private activity bonds should consult their tax advisers
before purchasing shares of a Fund since the acquisition of shares of the Tax
Free Bond Fund, California Tax Free Fund or New York Tax Free Fund may result in
adverse tax consequences to them.
EXCISE TAX
The Funds are potentially subject to a 4% nondeductible excise tax on
amounts required to be but not distributed under a prescribed formula. The
formula generally requires payment to shareholders during a calendar year of
distributions representing at least 98% of each Fund's ordinary income for the
calendar year and at least 98% of the excess of its capital gains over capital
losses realized during the one-year period ending October 31 during such year.
The Funds have adjusted their distribution policies to minimize any adverse
impact from this tax or eliminate its application.
TAXATION OF OPTIONS, FUTURES AND SIMILAR INSTRUMENTS
Many of the options, futures contracts and forward contracts entered into
by a Fund will be classified as "Section 1256 contracts." Generally, gains or
losses on Section 1256 contracts are considered 60% long-term and 40% short-term
capital gains or losses ("60/40"). Also, certain Section 1256 contracts held by
a Fund are "marked-to-market" at the times required pursuant to the Code with
the result that unrealized gains or losses are treated as though they were
realized and the resulting gain or loss generally is treated as 60/40 gain or
loss, except for foreign currency gain or loss on such contracts, which
generally is ordinary in character.
Gains from hedging transactions generally are taxable so distributions of
such gains generally will be taxable to shareholders. Generally, the hedging
transactions and certain other transactions in options, futures and forward
contracts undertaken by a Fund may result in "straddles" for federal income tax
purposes. The straddle rules may affect the character of gains (or losses)
realized by a Fund. In addition, losses realized by a Fund on positions that
are part of a straddle may be deferred under the straddle rules rather than
being taken into account in the taxable year in which such losses are realized.
Because only a few regulations implementing the straddle rules have been
promulgated, the tax consequences of transactions in
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options, futures and forward contracts to a Fund are not entirely clear. The
hedging transactions in which a Fund engages may increase the amount of short-
term capital gain realized by a Fund which is taxed as ordinary income when
distributed to shareholders.
A Fund may make one or more of the elections available under the Code which
are applicable to straddles. If a Fund makes any of the elections, the amount,
character and timing of the recognition of gains or losses from the affected
straddle positions will be determined under rules that vary according to the
election(s) made. The rules applicable under certain of the elections operate
to accelerate the recognition of gains or losses from the affected straddle
positions.
Because application of the straddle rules may affect the character of gains
or losses, defer losses and/or accelerate the recognition of gains or losses
from the affected straddle positions, the amount which must be distributed to
shareholders and which will be taxed to shareholders as ordinary income or long-
term capital gain, may be increased or decreased substantially as compared to a
Fund that did not engage in such hedging transactions.
The 30% limit on gains from the disposition of certain assets held less
than three months and the diversification requirements applicable to a Fund's
status as a regulated investment company may limit the extent to which a Fund
will be able to engage in transactions in options, futures contracts or forward
contracts.
Regarding the Tax Free Bond Fund, the California Tax Free Fund and New York
Tax Free Fund, gains from certain transactions, including, for example,
transactions in options, futures, and other instruments, and from obligations
the interest on which is not exempt from Federal income tax, will be taxable
income to those Funds. The requirements relating to those Funds' qualification
as a regulated investment company and those Funds' investment policies may limit
the extent to which each Fund will be able to engage in transactions in options
and futures contracts.
Regarding the International Bond Fund and International Equity Fund, rules
governing the tax aspects of swap agreements are in a developing stage and are
not entirely clear in certain respects. Accordingly, while the Funds intend to
account for such transactions in a manner they deem to be appropriate, the IRS
might not accept such treatment. If it did not, the status of a Fund as a
regulated investment company might be affected. The Funds intend to monitor
developments in this area. Certain
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requirements that must be met under the Code in order for a Fund to qualify as a
regulated investment company may limit the extent to which a Fund will be able
to engage in swap agreements.
PASSIVE FOREIGN INVESTMENT COMPANIES
Certain of the Funds may invest in shares of foreign corporations which may
be classified under the Code as passive foreign investment companies ("PFICs").
In general, a foreign corporation is classified as a PFIC if at least one-half
of its assets constitute investment-type assets or 75% or more of its gross
income is investment-type income. If a Fund receives a so-called "excess
distribution" with respect to PFIC stock, the Fund itself may be subject to a
tax on a portion of the excess distribution, whether or not the corresponding
income is distributed by the Fund to Shareholders. In general, under the PFIC
rules, an excess distribution is treated as having been realized ratably over
the period during which the Fund held the PFIC shares. The Fund itself will be
subject to tax on the portion, if any, of an excess distribution that is so
allocated to prior Fund taxable years and an interest factor will be added to
the tax, as if the tax had been payable in such prior taxable years. Certain
distributions from a PFIC as well as gain from the sale of PFIC shares are
treated as excess distributions. Excess distributions are characterized as
ordinary income even though, absent application of the PFIC rules, certain
excess distributions might have been classified as capital gain.
A Fund may be eligible to elect alternative tax treatment with respect to
PFIC shares. Under an election that currently is available in some
circumstances, a Fund generally would be required to include in its gross income
its share of the earnings of a PFIC on a current basis, regardless of whether
distributions are received from the PFIC in a given year. If this election were
made, the special rules, discussed above, relating to the taxation of excess
distributions, would not apply. In addition, another election may be available
that would involve marking-to-market a Fund's PFIC shares at the end of each
taxable year (and on certain other dates prescribed in the Code), with the
result that unrealized gains are treated as though they were realized. If this
election were made, tax at the fund level under the PFIC rules would generally
be eliminated, but a Fund could, in limited circumstances, incur nondeductible
interest charges. Other elections may become available that would affect the
tax treatment of PFIC shares held by the Fund. The Fund's intention to qualify
annually as a regulated investment company may limit its elections with respect
to PFIC shares.
Because the application of the PFIC rules may affect, among other things,
the character of gains, the amount of gain or loss
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and the timing of the recognition of income with respect to PFIC shares, as well
as subject the Fund itself to tax on certain income from PFIC shares, the
amount that must be distributed to shareholders, and which will be taxed to
shareholders as ordinary income or long-term capital gain, may be increased or
decreased substantially as compared to a Fund that did not invest in PFIC
shares.
FOREIGN CURRENCY GAINS AND LOSSES
Under the Code, gains or losses attributable to fluctuations in exchange
rates which occur between the time a Fund accrues income or other receivables or
accrues expenses or other liabilities denominated in a foreign currency and the
time a Fund actually collects such receivables or pays such liabilities
generally are treated as ordinary income or ordinary loss. Similarly, on the
disposition of debt securities denominated in a foreign currency and on the
disposition of certain options, futures, forward and other contracts, gain or
loss attributable to fluctuations in the value of foreign currency between the
date of acquisition of the security or contract and the date of disposition also
are treated as ordinary gain or loss. These gains or losses, referred to under
the Code as "Section 988" gains or losses, may increase or decrease the amount
of a Fund's net investment income to be distributed to its shareholders. If
Section 988 losses exceed other investment company taxable income (which
includes, among other items, dividends, interest and the excess, if any, of net
short-term capital gains over net long-term capital losses) during the taxable
year, a Fund would not be able to make any ordinary dividend distributions, and
distributions made before the losses were realized would be recharacterized as a
return of capital to shareholders or, in some cases, as capital gain, rather
than as an ordinary dividend.
COMMODITY INVESTMENTS
A regulated investment company is required under the Code to derive at
least 90% of its gross income from certain qualifying sources and to have, at
the close of each quarter of the taxable year, at least 50% of the market value
of its assets represented by cash, U.S. government securities, the securities of
other regulated investment companies and other securities, with such other
securities of any one issuer limited for the purposes of this calculation to an
amount not greater than 5% of the value of the Fund's total assets and 10% of
the outstanding voting securities of such issuer. In addition, not more than
25% of the value of a Fund's total assets may be invested in the securities of
any one issuer (other than U.S. government securities or the securities of other
regulated investment companies). Qualifying income includes, inter alia,
----------
interest, dividends, and gain from
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the sale of stock or securities, but it does not include gain from the sale of
commodities such as gold and other precious metals.
DISPOSITIONS OF FUND SHARES
Upon redemption, sale or exchange of shares of a Fund, a shareholder will
realize a taxable gain or loss, depending on whether the gross proceeds are more
or less than the shareholder's tax basis for the shares. Such gain or loss
generally will be a capital gain or loss if the shares of a Fund were capital
assets in the hands of the shareholder, and generally will be long- or short-
term, depending on the length of time the shares of the Fund were held. A loss
realized by a shareholder on the redemption, sale or exchange of shares of a
Fund with respect to which capital gain dividends have been paid will, to the
extent of such capital gain dividends, be treated as long-term capital loss if
such shares have been held by the shareholder for six months or less at the time
of their disposition. Furthermore, a loss realized by a shareholder on the
redemption, sale or exchange of shares of a Fund with respect to which exempt-
interest dividends have been paid will, to the extent of such exempt-interest
dividends, be disallowed if such shares have been held by the shareholder for
six months or less at the time of their disposition. A loss realized on a
redemption, sale or exchange also will be disallowed to the extent the shares
disposed of are replaced (whether through reinvestment of distributions, or
otherwise) within a period of 61 days beginning 30 days before and ending 30
days after the shares are disposed of. In such a case, the basis of the shares
acquired will be adjusted to reflect the disallowed loss.
Shareholders should be aware that redeeming shares of a Fund after tax-
exempt interest has been accrued by the Fund but before that income has been
declared as a dividend may be disadvantageous. This is because the gain, if
any, on the redemption will be taxable, even though such gains may be
attributable in part to the accrued tax-exempt interest which, if distributed to
the shareholder as a dividend rather than as redemption proceeds, might have
qualified as an exempt-interest dividend.
Under certain circumstances, the sales charge incurred in acquiring shares
of either Fund may not be taken into account in determining the gain or loss on
the disposition of those shares. This rule applies where shares of a Fund are
exchanged within 90 days after the date they were purchased and new shares are
acquired without a sales charge or at a reduced sales charge. In that case, the
gain or loss recognized on the exchange will be determined by excluding from the
tax basis of the shares exchanged all or a portion of the sales charge incurred
in
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acquiring those shares. This exclusion applies to the extent that the otherwise
applicable sales charge with respect to the newly acquired shares is reduced as
a result of having incurred a sales charge initially. The portion of the sales
charge affected by this rule will be treated as a sales charge paid for the new
shares.
TAX REPORTING REQUIREMENTS
All distributions, whether received in shares or cash, must be reported by
each shareholder on his or her federal income tax return. Shareholders are also
required to report tax-exempt interest. Dividends declared and payable to
shareholders of record on a specified date in October, November or December, if
any, will be deemed to have been received by shareholders on December 31 if paid
during January of the following year. Redemptions of shares, including
exchanges for shares of another Fund, may result in tax consequences (gain or
loss) to the shareholder and generally are also subject to these reporting
requirements. Each shareholder should consult his or her own tax adviser to
determine the tax status of a Fund distribution in his or her own state and
locality.
Under the federal income tax law, a Fund will be required to report to the
IRS all distributions of income (other than exempt-interest dividends) and
capital gains as well as gross proceeds from the redemption or exchange of Fund
shares (other than shares of the Money Market Fund), except in the case of
certain exempt shareholders. Under the backup withholding provisions of Section
3406 of the Code, all such taxable distributions and proceeds from the
redemption or exchange of a Fund's shares may be subject to withholding of
federal income tax at the rate of 31% in the case of nonexempt shareholders who
fail to furnish a Fund with their taxpayer identification number and with
required certifications regarding their status under the federal income tax law
or if the IRS or a broker notifies a Fund that the number furnished by the
shareholder is incorrect. In addition, both the Fund and the shareholder are
potentially subject to a $50 penalty imposed by the IRS if a correct, certified
taxpayer identification number is not furnished and used on required information
returns. If the withholding provisions are applicable, any such distributions
and proceeds, whether taken in cash or reinvested in shares, will be reduced by
the amounts required to be withheld. Backup withholding is not an additional
tax and any amounts withheld are creditable against the shareholder's U.S.
Federal tax liability. Investors may wish to consult their tax advisers about
the applicability of the backup withholding provisions.
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FOREIGN TAXES
Investment income and gains received by a Fund from sources outside the
United States may be subject to foreign taxes which were withheld at the
source. Since the percentage of each Fund's total assets (with the exception of
the International Bond Fund and International Equity Fund) which will be
invested in foreign stocks and securities will not be more than 50%, any foreign
tax credits or deductions associated with such foreign taxes will not be
available for use by its shareholders. The effective rate of foreign taxes to
which a Fund will be subject depends on the specific countries in which each
Fund's assets will be invested and the extent of the assets invested in each
such country and, therefore, cannot be determined in advance.
The International Bond Fund and the International Equity Fund may qualify
for and make the election permitted under Section 853 of the Code so that
shareholders will be able to claim a credit or deduction on their federal income
tax returns for, and will be required to treat as part of the amounts
distributed to them, their pro rata portion of qualified taxes paid by the Fund
to foreign countries (which taxes relate primarily to investment income). The
U.S. shareholders of a Fund may claim a foreign tax credit or deduction by
reason of the Fund's election under Section 853 of the Code, provided that more
than 50% of the value of the total assets of the Fund at the close of the
taxable year consists of securities of foreign corporations. The foreign tax
credit and deduction available to shareholders is subject to certain limitations
imposed by the Code. Also, under Section 63 of the Code, no deduction for
foreign taxes may be claimed by shareholders who do not itemize deductions on
their federal income tax returns, although any such shareholder may claim a
credit for foreign taxes and in any event will be treated as having taxable
income in respect to the shareholder's pro rata share of foreign taxes paid by
the Fund. It should also be noted that a tax-exempt shareholder, like other
shareholders, will be required to treat as part of the amounts distributed its
pro rata portion of the income taxes paid by the Fund to foreign countries.
However, that income will generally be exempt from taxation by virtue of such
shareholder's tax-exempt status, and such a shareholder will not be entitled to
either a tax credit or a deduction with respect to such income. The foreign tax
credit generally may offset only up to 90% of the alternative minimum tax in any
given year. Foreign taxes generally are not deductible in computing alternative
minimum taxable income.
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STATE AND LOCAL TAXES - GENERAL
The state and local tax treatment of distributions received from a Fund and
any special tax considerations associated with foreign investments of a Fund
should be examined by shareholders with regard to their own tax situations.
Shareholders of the Tax Free Bond Fund, the California Tax Free Fund and
New York Tax Free Fund may be subject to state and local taxes on distributions
from the Fund, including distributions which are exempt from federal income
taxes. Some states exempt from the state personal income tax distributions from
a Fund derived from interest on obligations issued by the U.S. government or by
such state or its municipalities or political subdivisions. Each investor
should consult his or her own tax adviser to determine the tax status of
distributions from the Funds in his or her own state and locality.
Opinions relating to the validity of municipal securities and the exemption
of interest thereon from federal income tax are rendered by bond counsel to the
issuers. The Tax Free Bond Fund, California Tax Free Fund and New York Tax Free
Fund, the Adviser and its affiliates, and the Funds' counsel make no review of
proceedings relating to the issuance of state or municipal securities or the
bases of such opinions.
Due to the lack of adequate supply of certain types of tax-exempt
obligations, and other reasons, various instruments are being marketed which are
not "pure" state and local obligations, but which are thought to generate
interest excludable from taxable income under Code section 103. While a Fund
may invest in such instruments, it does not guarantee the tax-exempt status of
the income earned thereon or from any other investment. Thus, for example, were
a Fund to invest in an instrument thought to give rise to tax-exempt interest
but such interest ultimately were determined to be taxable, the Fund might have
invested more than 20% of its assets in taxable instruments. In addition, it is
possible in such circumstances that a Fund will not have met the 50% investment
threshold, described above, necessary for it to pay exempt-interest dividends.
EXPLANATION OF FUND DISTRIBUTIONS
Each distribution is accompanied by a brief explanation of the form and
character of the distribution. In January of each year, each Fund will issue to
each shareholder a statement of the federal income tax status of all
distributions, including, in the case of the Tax Free Bond Fund, the California
Tax Free Fund and New York Tax Free Fund, a statement of the percentage of the
prior calendar year's distributions which the Fund has designated
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as tax-exempt, the percentage of such tax-exempt distributions treated as a
tax-preference item for purposes of the alternative minimum tax, and in, the
case of the Tax Free Bond Fund, the source on a state-by-state basis of all
distributions.
ADDITIONAL INFORMATION REGARDING THE EQUITY INDEX FUND
Distributions of investment company taxable income generally are taxable to
shareholders as ordinary income. As a result of the Guarantee, distributions
from the Fund may not be eligible for the dividends-received deduction available
to corporations. Distributions of net capital gains, if any, designated by the
Fund as capital gain dividends are taxable to shareholders as long-term capital
gain, regardless of the length of time the Fund's shares have been held by a
shareholder, and are not eligible for the dividends-received deduction. All
distributions are taxable to the shareholder whether reinvested in additional
shares or received in cash. Shareholders will be notified annually as to the
Federal tax status of distributions.
In addition, although not considered likely, it is possible that
shareholders could be regarded for tax purposes as receiving a constructive
distribution(s) (which could be taxable) from the Fund to the extent that the
Guarantee is deemed to have value.
It is anticipated that capital gain or loss from the disposition of shares
will be eligible for treatment as long-term or short-term capital gain or loss
depending upon the shareholder's actual holding period for the shares.
Investors should be aware that, under recent IRS regulations, as a result of the
Guarantee, a shareholder's holding period for Fund shares might be deemed not to
commence until the Guarantee is paid or expires. In that event, the capital
gain or loss on the disposition of Fund shares would be short-term capital gain
or loss until such time as the shares have been held continuously by the
shareholder for the requisite long-term holding period (currently more than one
year for Federal income tax purposes) after the expiration or payment of the
Guarantee. The holding period for shares received from reinvestment of
dividends and distributions will commence no earlier than the reinvestment date
but could be delayed as described previously in this paragraph as a result of
the Guarantee. If reverse stock splits are done, a share may have a split
holding period reflecting the fact that part of the share represents a
reinvested dividend or distribution.
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ADDITIONAL INFORMATION REGARDING THE CALIFORNIA TAX FREE FUND AND NEW YORK TAX
FREE FUND
Under California law, a mutual fund which qualifies as a regulated
investment company must have at least 50% of its total assets in obligations
exempt from California personal income tax at the end of each quarter of its
taxable year in order to be eligible to pay dividends which will be exempt from
California personal income tax. Generally, shareholders who are California
residents will not incur California personal income tax on the amount of exempt-
interest dividends received by them from the California Tax Free Fund and
derived from California state and local issues, whether taken in cash or
reinvested in additional shares. However, other taxes, such as the franchise
tax may apply. Shareholders will normally be subject to California personal
income tax on dividends paid from interest income derived from taxable
securities and from securities issued by states other than California and its
subsidiaries and on distributions of capital gains.
Deductions for interest on indebtedness incurred or continued by a
shareholder to purchase or carry shares of the Fund may be disallowed in whole
or in part for California personal income tax purposes.
Exempt-interest dividends paid by the New York Tax Free Fund from interest
on qualifying New York bonds generally are exempt from New York State and New
York City personal income taxes, but not corporate franchise taxes. Dividends
and distributions of the Fund derived from taxable income and capital gains are
not exempt from New York State and New York City taxes. Deductions for interest
on indebtedness incurred or continued by a shareholder to purchase or carry
shares of the Fund may be disallowed in whole or in part for New York State or
New York City personal income tax purposes.
Dividends from the California Tax Free Fund or New York Tax Free Fund
(including exempt-interest dividends), capital gains distributions from a Fund,
and any capital gains or losses realized from the sale or exchange of shares may
be subject to state and local taxes (as well as Federal taxes). However, the
portion of a distribution of a Fund's tax-exempt income that is attributable to
state and municipal securities issued within the shareholder's own state
generally will not be subject to state or local taxes. Individuals are often
exempt from state and local personal income taxes on distributions of tax-exempt
interest income derived from obligations of issuers located in the state in
which they reside when these distributions are received directly from these
issuers, but are usually subject to such taxes on income derived from
obligations of issuers located in
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other jurisdictions. Shareholders are urged to consult their tax advisers with
specific reference to their own federal, state and local tax situations.
ANNUAL STATEMENTS
Each shareholder of the California Tax Free Fund will be sent after the
close of the calendar year an annual statement as to the federal income tax and
California state personal income tax status of his or her dividends and
distributions from the Fund for the prior calendar year. Any dividends
attributable to interest on municipal obligations that are not California
municipal securities will be taxable as ordinary dividends for California state
personal income tax purposes even if such dividends are excluded from gross
income for federal income tax purposes. These statements will also designate
the amount of exempt-interest dividends that is a specific preference item for
purposes of the federal individual and corporate alternative minimum taxes.
Each shareholder also will receive, if appropriate, various written notices
after the close of the Fund's prior taxable year as to the federal income tax
status of his or her dividends and distributions which were received from the
Fund during the Fund's prior taxable year. Shareholders should consult their
tax advisers as to any other state and local taxes that may apply to these
dividends and distributions. The dollar amount of dividends excluded or exempt
from federal income taxation or California state personal income taxation, if
any, will vary for each shareholder depending upon the size and duration of each
shareholder's investment in the Fund.
Each shareholder of the New York Tax Free Fund will be sent after the close
of the calendar year an annual statement as to the federal income tax and New
York State and New York City personal income tax status of his or her dividends
and distributions from the Fund for the prior calendar year. These statements
will also designate the amount of exempt-interest dividends that is a specified
preference item for purposes of the federal individual and corporate alternative
minimum taxes. Each shareholder also will receive, if appropriate, various
written notices after the close of the Fund's prior taxable year as to the
federal income tax status of his or her dividends and distributions which were
received from the Fund during the Fund's prior taxable year. Shareholders
should consult their tax advisers as to any other state and local taxes that may
apply to these dividends and distributions. The dollar amounts of dividends
excluded or exempt from federal income taxation or New York State and City
personal income taxation and the dollar amount subject to federal income
taxation or New York State and City personal income taxation, if any, will vary
for each
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shareholder depending upon the size and duration of each shareholder's
investment in the Fund.
GENERAL INFORMATION
The foregoing discussion generally relates to U.S. federal income tax law
as applicable to U.S. persons (i.e., U.S. citizens and residents and U.S.
domestic corporations, partnerships, trusts and estates). Each shareholder who
is not a U.S. person should consult his or her tax adviser regarding the U.S.
and non-U.S. tax consequences of ownership of shares of a Fund, including the
possibility that such a shareholder may be subject to a U.S. withholding tax at
a rate of 30% (or at a lower rate under an applicable U.S. income tax treaty) on
amounts constituting ordinary income to him or her.
This discussion of the federal income tax treatment of each Fund and its
shareholders is based on the federal income tax law in effect as of the date of
this SAI.
ORGANIZATION AND CAPITALIZATION
GENERAL
The Funds are separate series of an open-end investment company, The
MainStay Funds ("Trust"), established under the laws of The Commonwealth of
Massachusetts by a Declaration of Trust dated January 9, 1986, as amended. The
Tax Free Bond Fund was originally formed as the MacKay-Shields MainStay Tax Free
Bond Fund pursuant to a Declaration of Trust on January 9, 1986 and became a
series of the Trust pursuant to a reorganization which occurred on May 29, 1987.
The Total Return Fund commenced operations on December 29, 1987. The Equity
Index Fund commenced operations on December 20, 1990. The California Tax Free
Fund and New York Tax Free Fund commenced operations on October 1, 1991. The
International Bond Fund and International Equity Fund commenced operations on
September 13, 1994.
VOTING RIGHTS
Shares entitle their holders to one vote per share; however, separate votes
will be taken by each Fund or class on matters affecting an individual Fund or a
particular class of shares issued by a Fund. Shares have noncumulative voting
rights, which means that holders of more than 50% of the shares voting for the
election of Trustees can elect all Trustees and, in such event, the holders of
the remaining shares voting for the election of Trustees will not be able to
elect any person or persons as Trustees. Shares have no preemptive or
subscription rights and are transferable.
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SHAREHOLDER AND TRUSTEE LIABILITY
The Trust is an entity of the type commonly known as a "Massachusetts
business trust." Under Massachusetts law, shareholders of such a trust may,
under certain circumstances, be held personally liable as partners for the
obligations of the trust. The Declaration of Trust contains an express
disclaimer of shareholder liability for acts or obligations of the Trust.
Notice of such disclaimer will normally be given in each agreement, obligation
or instrument entered into or executed by the Trust or the Trustees. The
Declaration of Trust provides for indemnification by the relevant Fund for any
loss suffered by a shareholder as a result of an obligation of the Fund. The
Declaration of Trust also provides that the Trust shall, upon request, assume
the defense of any claim made against any shareholder for any act or obligation
of the Trust 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 a Fund would be unable to meet its obligations. The
Trustees believe that, in view of the above, the risk of personal liability of
shareholders is remote.
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 or she
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 or
her office.
OTHER INFORMATION
INDEPENDENT ACCOUNTANTS
Price Waterhouse LLP, 1177 Avenue of the Americas, New York, New York,
10036, has been selected as independent public accountants of the Trust. The
Funds' Annual Reports, which are incorporated by reference in this SAI (included
in the case of the Equity Index Fund) have been so incorporated or included in
reliance on the reports of Price Waterhouse, independent public accountants,
given on the authority of said firm as experts in auditing and accounting.
LEGAL COUNSEL
Dechert Price & Rhoads, 1500 K Street, N.W., Washington, D.C. 20005, passes
upon certain legal matters in connection with the shares offered by the Trust,
and also acts as counsel to the Trust.
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SHARE OWNERSHIP OF THE FUNDS
The following table sets forth information concerning beneficial and record
ownership, as of April 1, 1996, of the Funds' shares by each person who
beneficially or of record owns more than five percent of the voting securities
of any Fund:
<TABLE>
<CAPTION>
Shares Percentage of
Name and Address Beneficially Outstanding
Name of Fund of Shareholder Owned (1) Shares Owned
- ----------------- --------------------------- ------------------- ----------------
<S> <C> <C> <C>
California NYLIFE Distributors Inc.(2) 424,485 (Class A) 21.82% (Class A)
Tax Free Fund 260 Cherry Hill Road 12 (Class B) 0.0% (Class B)
Parsippany, NJ 07054
New York Tax NYLIFE Distributors Inc.(2) 650,775 (Class A) 36.50% (Class A)
Free Fund 260 Cherry Hill Road 12 (Class B) 0.0% (Class B)
Parsippany, NJ 07054
International NYLIFE Distributors Inc.(2) 1,012,380 (Class A) 92.88% (Class A)
Bond Fund 260 Cherry Hill Road 0 (Class B) 0.0% (Class B)
Parsippany, NJ 07054
International NYLIFE Distributors Inc.(2) 1,000,010 (Class A) 71.76% (Class A)
Equity Fund 260 Cherry Hill Road 0 (Class B) 0.0% (Class B)
Parsippany, NJ 07054
</TABLE>
- ----------------------
(1) This information, not being within the knowledge of the Trust, has been
furnished by each of the above persons. Beneficial ownership is as defined
under Section 13(d) of the Securities Exchange Act of 1934. Fractional
Shares have been omitted.
(2) Mr. George Daoust, in connection with his position with NYLIFE
Distributors, has the power to vote all of the shares shown in the above
table owned by NYLIFE Distributors. Mr. Daoust disclaims beneficial
ownership of such shares.
NYLIFE Distributors Inc. is a corporation organized under the laws of
Delaware. NYLIFE Distributors Inc. is a wholly owned subsidiary of NYLIFE Inc.,
and an indirect wholly owned subsidiary of New York Life Insurance Company.
CODE OF ETHICS
The Trust has adopted a Code of Ethics governing personal trading
activities of all Trustees, officers of the Trust and persons who, in connection
with their regular functions, play a role in the recommendation of any purchase
or sale of a security by the Trust or obtain information pertaining to such
purchase or
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sale or who have the power to influence the management or policies of the Trust
or an Investment Adviser unless such power is the result of their position with
the Trust or Investment Adviser. Such persons are generally required to
preclear all security transactions with the Trust's Compliance Officer or his
designee and to report all transactions on a regular basis. The Trust has
developed procedures for administration of the Code.
FINANCIAL STATEMENTS
The financial statements of the Capital Appreciation Fund, California Tax
Free Fund, New York Tax Free Fund, Value Fund, Convertible Fund, Total Return
Fund, High Yield Corporate Bond Fund, Government Fund (formerly the Government
Plus Fund), Tax Free Bond Fund (formerly the MacKay-Shields MainStay Tax Free
Bond Fund), International Bond Fund, International Equity Fund and the Money
Market Fund, including the Portfolio of Investments as of December 31, 1995, the
Statement of Assets and Liabilities as of December 31, 1995, the Statement of
Operations for the year ended December 31, 1995, the Statement of Changes in Net
Assets for year ended December 31, 1995, the period from September 1, 1994
(September 13, in the case of the International Bond and Equity Funds) through
December 31, 1994 and the year ended August 31, 1994, the Notes to the Financial
Statements and the Reports of Independent Accountants, all of which are included
in the 1995 Annual Reports to the Shareholders are hereby incorporated by
reference into this Statement of Additional Information.
Audited financial statements for the Equity Index Fund, including the
Portfolio of Investments as of December 31, 1995, the Statement of Assets and
Liabilities as of December 31, 1995, the Statement of Operations for the year
ended December 31, 1995, the Statement of Changes in Net Assets for year ended
December 31, 1995, the period from September 1, 1994 through December 31, 1995
and the year ended August 31, 1994, the Notes to the Financial Statements and
the Report of Independent Accountants, all of which are included in the MainStay
Equity Index Fund 1995 Annual Report to the Shareholders, and audited financial
statement for NYLIFE Inc. as of December 31, 1995, are included in this
Statement of Additional Information.
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