Supplement No. 1 dated August 29, 1995
to
Statement of Additional Information dated May 1, 1995
for
STATE STREET RESEARCH NEW YORK TAX-FREE FUND
a series of State Street Research Tax-Exempt Trust
New York City and Other Localities
The third paragraph under the caption "New York Municipal Obligations
- --New York City and Other Localities" is revised in its entirety as follows:
"In 1975, S&P suspended its A rating of City bonds. This suspension
remained in effect until March 1981, at which time the City received an
investment grade rating of BBB from S&P. On July 2, 1985, S&P revised its rating
of City bonds upward to BBB+ and on November 19, 1987, to A-. On July 2, 1993,
S&P reconfirmed its A- rating of City bonds, continued its negative rating
outlook assessment and stated that maintenance of such rating depended upon the
City's making further progress towards reducing budget gaps in the outlying
years. On July 10, 1995, S&P downgraded its rating on the City's $23 billion of
outstanding general obligation bonds to BBB+, citing the City's chronic
structural budget problems and weak economic outlook. S&P stated that the City's
reliance on one-time revenue measures to close annual budget gaps, a dependence
on unrealized labor savings, overly optimistic estimates of revenues and state
and federal aid, and the City's continued high debt levels also contributed to
its decision to lower the rating. Moody's ratings of City bonds were revised in
November 1981 from B (in effect since 1977) to Ba1, in November 1983 to Baa, in
December 1985 to Baa1, in May 1988 to A and again in February 1991 to Baa1."
<PAGE>
STATE STREET RESEARCH NEW YORK TAX-FREE FUND
A Series of
STATE STREET RESEARCH TAX-EXEMPT TRUST
STATEMENT OF ADDITIONAL INFORMATION
May 1, 1995
TABLE OF CONTENTS
Page
ADDITIONAL INVESTMENT POLICIES AND RESTRICTIONS ............................ 2
NEW YORK MUNICIPAL OBLIGATIONS ............................................. 5
ADDITIONAL INFORMATION CONCERNINGCERTAIN INVESTMENT TECHNIQUES ............. 18
DEBT INSTRUMENTS AND PERMITTED CASH INVESTMENTS ............................ 27
TRUSTEES AND OFFICERS ...................................................... 32
INVESTMENT ADVISORY SERVICES ............................................... 36
PURCHASE AND REDEMPTION OF SHARES .......................................... 37
NET ASSET VALUE ............................................................ 39
PORTFOLIO TRANSACTIONS ..................................................... 41
CERTAIN TAX MATTERS ........................................................ 43
DISTRIBUTION OF SHARES OF THE FUND ......................................... 46
CALCULATION OF PERFORMANCE DATA ............................................ 50
CUSTODIAN .................................................................. 56
INDEPENDENT ACCOUNTANTS .................................................... 56
FINANCIAL STATEMENTS ....................................................... 56
APPENDIX ................................................................... A-1
The following Statement of Additional Information is not a Prospectus. It
should be read in conjunction with the Prospectus of State Street Research New
York Tax-Free Fund (the "Fund") dated May 1, 1995 which may be obtained without
charge from the offices of State Street Research Tax-Exempt Trust (the "Trust")
or State Street Research Investment Services, Inc. (the "Distributor"), One
Financial Center, Boston, Massachusetts 02111-2690.
CONTROL NUMBER: 1285M-950510(0696) SSR-LD NYTF-879D-595
<PAGE>
ADDITIONAL INVESTMENT POLICIES AND RESTRICTIONS
In addition to the investment policies set forth under "The Fund's
Investments" and "Limiting Investment Risk" in the Fund's Prospectus, the Fund
has adopted certain investment restrictions.
The following restrictions are deemed fundamental and may not be changed
except by the affirmative vote of a majority of the Fund's outstanding voting
securities as defined in the Investment Company Act of 1940 (the "1940 Act").
(Under the 1940 Act, a "vote of the majority of the outstanding voting
securities" means the vote, at the annual or a special meeting of security
holders duly called, (i) of 67% or more of the voting securities present at a
meeting if the holders of more than 50% of the outstanding voting securities are
present or represented by proxy or (ii) of more than 50% of the outstanding
voting securities, whichever is less.) Under these restrictions, it is the
Fund's policy:
(1) not to issue senior securities;
(2) not to underwrite or participate in the marketing of securities of
other issuers, except (a) the Fund may, acting alone or in
syndicates or groups, if determined by the Trust's Board of
Trustees, purchase or otherwise acquire securities of other issuers
for investment, either from the issuers or from persons in a control
relationship with the issuers or from underwriters of such
securities; and (b) to the extent that, in connection with the
disposition of the Fund's securities, the Fund may be deemed to be
an underwriter under certain federal securities laws;
(3) not to purchase or sell fee simple interests in real estate,
although the Fund may purchase and sell other interests in real
estate including securities which are secured by real estate, or
securities of companies which own or invest or deal in real estate;
(4) not to invest in commodities or commodity contracts in excess of 10%
of the Fund's total assets, except that investments in futures
contracts and options on futures contracts on securities or
securities indices shall not be deemed an investment in commodities
or commodities contracts;
(5) not to make loans, except that the Fund may lend portfolio
securities and purchase bonds, debentures, notes and similar
obligations (including repurchase agreements with respect thereto);
(6) not to invest more than 10% of its total assets in illiquid
securities, which may include, to the extent any are not readily
marketable under the circumstances, securities restricted as to
resale, repurchase agreements extending for more than seven days,
and options not listed and traded on any national securities
2
<PAGE>
exchange (as a current nonfundamental policy, restricted securities
are limited to 5% of total assets);
(7) not to conduct arbitrage transactions (provided that investments
in futures and options shall not be deemed arbitrage
transactions);
(8) not to invest in oil, gas or other mineral exploration or
development programs (provided that the Fund may invest in
securities issued by companies which invest in or sponsor such
programs and in securities indexed to the price of oil, gas or other
minerals);
(9) not to make any investment which would cause more than 25% of the
value of the Fund's total assets to be invested in securities of
issuers principally engaged in any one industry [for purposes of
this restriction, (a) utilities will be divided according to their
services so that, for example, gas, gas transmission, electric and
telephone companies will each be deemed in a separate industry, (b)
oil and oil related companies will be divided by type so that, for
example, oil production companies, oil service companies and
refining and marketing companies will each be deemed in a separate
industry, (c) finance companies will be classified according to the
industries of their parent companies, (d) securities issued or
guaranteed by the U.S. Government or its agencies or
instrumentalities (including repurchase agreements involving such
U.S. Government securities to the extent excludable under relevant
regulatory interpretations) shall be excluded; (e) industrial
development revenue bonds which are based, directly or indirectly,
on the credit of private issuers will be classified according to the
industry of the issuer, and (f) New York State and other
jurisdictions and each of their separate political subdivisions,
agencies, authorities or instrumentalities are treated as separate
issuers and are not regarded as members of any industry];
(10) not to borrow money except for borrowings from banks for
extraordinary and emergency purposes, such as permitting redemption
requests to be honored, and then not in an amount in excess of 25%
of the value of its total assets, and except insofar as reverse
repurchase agreements may be regarded as borrowing. As a matter of
current operating, but not fundamental, policy, the Fund will not
purchase additional portfolio securities at any time when it has
outstanding money borrowings in excess of 5% of the Fund's total
assets (taken at current value);
(11) not to invest in a security if the transaction would result in, with
respect to 75% of its total assets, more than 5% of the Fund's total
assets being invested in any one issuer, except this restriction
does not apply to investments in securities issued or guaranteed by
the U.S. Government or its agencies or
3
<PAGE>
instrumentalities or backed by the U.S. Government or to repurchase
agreements involving U.S. Government securities to the extent
excludable under relevant regulatory interpretations;
(12) not to invest in a security if the transaction would result in
the Fund's owning more than 10% of the outstanding voting
securities of an issuer, except that this restriction does not
apply to investments in securities issued or guaranteed by the
U.S. Government or its agencies or instrumentalities or backed by
the U.S. Government or to repurchase agreements involving U.S.
Government securities to the extent excludable under relevant
regulatory interpretations;
(13) not to invest in a security if the transaction would result in more
than 5% of the Fund's total assets being invested in securities of
issuers (including predecessors) with less than three years of
continuous operations except in the case of debt securities rated
BBB or higher by Standard & Poor's Corporation ("S&P") or Ba or
higher by Moody's Investors Service, Inc. ("Moody's"), and except
this restriction does not apply to investments in securities issued
or guaranteed by the U.S. Government or its agencies and
instrumentalities, or backed by the U.S. Government or to repurchase
agreements involving U.S. Government securities to the extent
excludable under relevant regulatory interpretations; and
(14) not to invest in a security if the transaction would result in more
than 25% of the Fund's total assets being invested in industrial
revenue bonds which are based directly or indirectly on the credit
of private issuers in any one industry, except that this restriction
does not apply to investments in securities issued or guaranteed by
the U.S. Government or its agencies or instrumentalities or backed
by the U.S. Government or to repurchase agreements involving such
U.S. Government securities to the extent excludable under relevant
regulatory interpretations.
The following investment restrictions may be changed by a vote of a
majority of the Trustees. Under these restrictions, it is the Fund's policy:
(1) not to engage in transactions in options except in connection with
options on securities and securities indices and options on futures
on securities and securities indices;
(2) not to purchase securities on margin or make short sales of
securities or maintain a short position except for short sales
"against the box" (as a matter of current operating, but not
fundamental policy, the Fund will not make short sales or maintain a
short position unless not more than 5% of the Fund's net assets
(taken at current value) is held as collateral for such sales at any
time);
4
<PAGE>
(3) not to hypothecate, mortgage or pledge any of its assets except
as may be necessary in connection with permitted borrowings (for the
purpose of this restriction, futures and options, and related escrow
or custodian receipts or letters, margin or safekeeping accounts, or
similar arrangements used in the industry in connection with the
trading of futures and options, are not deemed to involve a
hypothecation, mortgage or pledge of assets);
(4) not to purchase a security issued by another investment company if,
immediately after such purchase, the Fund would own, in the
aggregate, (i) more than 3% of the total outstanding voting stock of
such other investment company; (ii) securities issued by such other
investment company having an aggregate value in excess of 5% of the
value of the Fund's total assets; or (iii) securities issued by such
other investment company and all other investment companies (other
than treasury stock of the Fund) having an aggregate value in excess
of 10% of the value of the Fund's total assets; provided, however,
that the Fund may purchase investment company securities without
limit for the purpose of completing a merger, consolidation or other
acquisition of assets;
(5) not to purchase or retain any security of an issuer if, to the
knowledge of the Trust, those of its officers and Trustees and
officers and directors of its investment advisers who individually
own more than 1/2 of 1% of the securities of such issuer, when
combined, own more than 5% of the securities of such issuer taken at
market;
(6) not to invest in warrants more than 5% of the value of its total
assets (warrants initially attached to securities and acquired by
the Fund upon original issuance thereof shall be deemed to be
without value); and
(7) not to invest in companies for the purpose of exercising control
over their management, although the Fund may from time to time
present its views on various matters to the management of issuers in
which it holds investments.
NEW YORK MUNICIPAL OBLIGATIONS
As used in the Prospectus and this Statement, the term "New York Municipal
Obligations" refers to debt obligations, including bonds and notes, issued by
the State of New York and its political subdivisions, the interest on which was
at the time of issuance, in the opinion of bond counsel, excluded from gross
income for federal income tax purposes and exempt from New York State and New
York City personal income taxes. Like other tax-exempt bonds, New York Municipal
Obligations are issued to obtain funds for various public purposes, including
the construction of a wide range of public facilities such as airports, bridges,
highways, housing, mass transportation, roads, schools, and water and sewer
works.
5
<PAGE>
Other public purposes for which New York Municipal Obligations, like
other tax-exempt bonds, may be issued include refunding outstanding obligations,
obtaining funds for general operating expenses and obtaining funds to lend to
other public institutions and facilities. In addition, certain debt obligations
known as industrial development revenue bonds may be issued by or on behalf of
public authorities to obtain funds to provide privately-operated housing
facilities, sports facilities, conventions or trade show facilities, airport,
mass transit, port or parking facilities, air or water pollution control
facilities and certain local facilities for water supply, gas, electricity or
sewage or solid waste disposal. Such obligations are included within the term
New York Municipal Obligations if the interest paid thereon is, in the opinion
of bond counsel at the time of issuance, excluded from gross income for federal
income tax purposes and exempt from New York State and City personal income
taxes. Other industrial development bonds used to fund the construction,
equipment, repair or improvement of privately-operated industrial or commercial
facilities may also be New York Municipal Obligations, but the size of such
issues is limited under current federal tax law. The Fund may not be a desirable
investment for "substantial users" of facilities financed by industrial
development revenue bonds or for "related persons" of substantial users.
The two principal classifications for tax-exempt bonds are general
obligation bonds and limited obligation (or revenue) bonds. General obligation
bonds are obligations involving the credit of an issuer possessing taxing power
and are payable from the issuer's general unrestricted revenues and not from any
particular fund or source. The characteristics and method of enforcement of
general obligation bonds vary according to the law applicable to the particular
issuer, and payment may be dependent upon appropriation by the issuer's
legislative body. Limited obligation bonds are payable only from the revenues
derived from a particular facility or class of facilities or, in some cases,
from the proceeds of a special excise or other specific revenue source.
Tax-exempt industrial development revenue bonds generally are revenue bonds and
thus not payable from the unrestricted revenues of the issuer. The credit and
quality of industrial development revenue bonds is usually directly related to
the credit of the corporate user of the facilities. Payment of principal of and
interest on industrial development revenue bonds is the responsibility of the
corporate user (and any guarantor).
Prices and yields on New York Municipal Obligations and other tax-exempt
obligations are dependent on a variety of factors, including general money
market conditions, the financial condition of the issuer, general conditions in
the market for tax-exempt obligations, the size of a particular offering, the
maturity of the obligation and ratings of particular issues, and are subject to
change from time to time. Information about the financial condition of an issuer
of tax-exempt bonds or notes may not be as extensive as that which is made
available by corporations whose securities are publicly traded.
The ratings of S&P and Moody's represent their opinions and are not
absolute standards of quality. Tax-exempt obligations with the same maturity,
interest rate and rating may have different yields while on the other hand
tax-exempt obligations with the same maturity and interest rate but with
different ratings may have the same yield.
6
<PAGE>
Obligations of issuers of tax-exempt securities are subject to the
provisions of bankruptcy, insolvency and other laws, such as the Federal
Bankruptcy Reform Act of 1978, affecting the rights and remedies of creditors.
Congress or state legislatures may seek to extend the time for payment of
principal or interest, or both, or to impose other constraints upon enforcement
of such obligations. There is also the possibility that, as a result of
litigation or other conditions, the power or ability of issuers to meet their
obligations to pay interest on and principal of their tax-exempt securities may
be materially impaired or their obligations may be found to be invalid or
unenforceable. Such litigation or conditions may from time to time have the
effect of introducing uncertainties in the market for tax-exempt obligations or
certain segments thereof, or may materially affect the credit risk with respect
to particular bonds or notes. Adverse economic, business, legal or political
developments might affect all or a substantial portion of the Fund's tax-exempt
bonds or notes in the same manner.
From time to time, proposals have been introduced before Congress to
restrict or eliminate the federal income tax exemption for interest on debt
obligations issued by states and their political subdivisions, and similar
proposals may well be introduced in the future. If such a proposal were enacted,
the availability of New York Municipal Obligations for investment by the Fund
and the value of the Fund's portfolio could be materially affected, in which
event the Fund would reevaluate its investment objective and policies and
consider changes in the structure of the Fund or dissolution.
Special Considerations Relating to New York Municipal Obligations
Some of the significant financial considerations relating to the Fund's
investment in New York Municipal Obligations are summarized below. This summary
information is not intended to be a complete description and is principally
derived from official statements relating to issues of New York Municipal
Obligations that were available prior to the date of this Statement of
Additional Information. The accuracy and completeness of the information
contained in those official statements have not been independently verified.
State Economy. New York (the "State") is the third most populous state in
the nation and has a relatively high level of personal wealth. The State's
economy is diverse with a comparatively large share of the nation's finance,
insurance, transportation, communications and services employment, and a very
small share of the nation's farming and mining activity. The State has a
declining proportion of its workforce engaged in manufacturing, and an
increasing proportion engaged in service industries. New York City (the "City"),
which is the most populous city in the State and nation and is the center of the
nation's largest metropolitan area, accounts for a large portion of the State's
population and personal income.
The State has historically been one of the wealthiest states in the
nation. For decades, however, the State has grown more slowly than the nation as
a whole, gradually eroding its relative economic position. The recession has
been more severe in the State, owing to a significant retrenchment in the
financial services industry, cutbacks in defense spending, and
7
<PAGE>
an overbuilt real estate market. There can be no assurance that the State
economy will not experience worse-than-predicted results in the 1994-95 fiscal
year, with corresponding material and adverse effects on the State's
projections of receipts and disbursements.
The unemployment rate in the State dipped below the national rate in the
second half of 1981 and remained lower until 1991. It stood at 7.7% in 1993. The
total employment growth rate in the State has been below the national average
since 1984 and is expected to slow to less than 0.50% in 1995. State per capita
personal income remains above the national average. State per capita income for
1993 was $24,623, which is 18.3% above the 1993 national average of $20,817.
During the past 10 years, total personal income in the State rose slightly
faster than the national average only in 1986 through 1989.
State Budget. The State Constitution requires the Governor to submit to
the Legislature a balanced Executive Budget which contains a complete plan of
expenditures for the ensuing fiscal year and all moneys and revenues estimated
to be available therefor, accompanied by bills containing all proposed
appropriations or reappropriations and any new or modified revenue measures to
be enacted in connection with the Executive Budget. The entire plan constitutes
the proposed State financial plan for that fiscal year. The Governor is required
to submit to the Legislature quarterly budget updates which include a revised
cash-basis state financial plan, and an explanation of any changes from the
previous state financial plan.
The State's budget for the 1994-95 fiscal year was enacted by the
Legislature on June 7, 1994, 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 1994-95 fiscal year was formulated on June 16, 1994 and
is based upon the State's budget as enacted by the Legislature and signed into
law by the Governor (the "1994-95 State Financial Plan"). This delay in the
enactment of the State's 1995-95 fiscal year budget may reduce the effectiveness
of several of the actions proposed.
The State issued its third quarterly update to the cash basis 1994-95
State Financial Plan on February 1, 1995. The update projects a potential
deficit of $259 million for the 1994-95 fiscal year. The Governor has proposed
to close this deficit through a hiring freeze, a review of pending contracts and
spending cuts in certain programs that were started or expanded in the 1994-95
budget.
The 1994-95 State Financial Plan is based on a number of assumptions and
projections. Because it is not possible to predict accurately the occurrence of
all factors that may affect the 1994-95 State Financial Plan, actual results may
differ and have differed materially in recent years, from projections made at
the outset of a fiscal year. There can be no assurance that the State will not
face substantial potential budget gaps in future years resulting from a
significant disparity between tax revenues projected from a lower recurring
receipts base and the spending
8
<PAGE>
required to maintain State programs at current levels. To address any potential
budgetary imbalance, the State may need to take significant actions to align
recurring receipts and disbursements in future fiscal years.
On February 1, 1995, the Governor presented his 1995-96 Executive Budget
(the "Executive Budget") to the Legislature, as required by the State
Constitution. It proposes actual reductions in the year-over-year dollar levels
of State spending from the General Fund with a proposed cut of 3.4%. Proposed
spending on State operations is projected to drop even more sharply, by 7.7%.
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 projections set forth above. In addition, there is no assurance that
the tax and spending cuts proposed in the Executive Budget will be enacted, or
if enacted, will be upheld in the face of potential legal challenges. The
comptroller has indicated his intention to challenge the proposed use of certain
pension reserves in the Executive Budget.
Recent Financial Results. The General Fund is the general operating fund
of the State and is used to account for all financial transactions, except those
required to be accounted for in another fund. It is the State's largest fund and
receives almost all State taxes and other resources not dedicated to particular
purposes. In the State's 1994-95 fiscal year, the General Fund is expected to
account for approximately 52% of total governmental-fund receipts and 51% of
total governmental-fund disbursements.
The General Fund is projected to be balanced on a cash basis for the
1994-95 fiscal year. Total receipts are projected to be $34.321 billion, an
increase of $2.092 billion over total receipts in the prior fiscal year. Total
General Fund disbursements are projected to be $34.248 billion, an increase of
$2.351 billion over the total amount disbursed and transferred in the prior
fiscal year.
The State's financial position on a GAAP (generally accepted accounting
principles) basis as of March 31, 1993 included an 1991-92 accumulated deficit
in its combined governmental funds of $681 million. Liabilities totalled $12.864
billion and assets of $12.183 billion were available to liquidate these
liabilities.
The State's financial operations have improved during recent fiscal years.
During the period 1989-90 through 1991-92, the State incurred General Fund
operating deficits that were closed with receipts from the issuance of tax and
revenue anticipation notes. The national recession and then the lingering
economic slowdown in the New York and regional economy resulted in repeated
shortfall in receipts and three budget deficits. For its 1992-93 and 1993-94
fiscal years, however, the State recorded balanced budgets on a cash basis, with
substantial fund balances in each year.
Debt Limits and Outstanding Debt. There are a number of methods by which
the State of New York may incur debt. Under the State Constitution, the State
may not, with limited
9
<PAGE>
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. The total amount of long-term State general obligation
debt authorized but not issued as of December 31, 1993 was approximately $2.273
billion.
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 of New York's
authorities and public benefit corporations ("Authorities"). Payments of debt
service on New York State general obligation and New York State-guaranteed bonds
and notes are legally enforceable obligations of the State.
The State also employs additional long-term financing mechanisms,
lease-purchase and contractual-obligation financings, which involve obligations
of public authorities or municipalities that are State-supported but are not
general obligations of the State. Under these financing arrangements, certain
public authorities and municipalities have issued obligations to finance the
construction and rehabilitation of facilities or the acquisition of equipment,
and expect to meet their debt service requirements through the receipt of rental
or other contractual payments made by the State. Although these financing
arrangements involve a contractual agreement by the State to make payments to a
public authority, municipality or other entity, the State's obligation to make
such payments is generally expressly made subject to appropriation by the
Legislature and the actual availability of money to the State for making the
payments. The State has also entered into a contractual-obligation financing
arrangement with the Local Government Assistance Corporation ("LGAC") in an
effort to restructure the way the State makes certain local aid payments.
In 1990, as part of a State fiscal reform program, legislation was enacted
creating 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. The legislation empowered LGAC to
issue its bonds and notes in an amount not in excess of $4.7 billion (exclusive
of certain refunding bonds) plus certain other amounts. Over a period of years,
the issuance of these long-term obligations, which will be amortized over no
more than 30 years, was expected to eliminate the need for continuing 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. The
legislation also 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
provided a schedule for reducing it to the cap. If borrowing above the cap is
thus permitted in
10
<PAGE>
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
December, 1994, LGAC had issued bonds to provide net proceeds of $3.856 billion
and has been authorized to issue bonds to provide net proceeds of up to an
additional $315 million during the State's 1994-95 fiscal year. The impact of
this borrowing, together with the availability of certain cash reserves, is
that, for the first time in nearly 35 years, the 1994-95 Financial Plan includes
no short-term seasonal borrowing.
In April 1993, legislation was enacted proposing significant
constitutional changes in the long-term financing practices of the State and the
Authorities.
The Legislature passed a proposed constitutional amendment that 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 amendment would require that State debt be incurred only for capital
projects included in a multi-year capital financing plan and would prohibit,
after its effective date, lease-purchase and contractual-obligation financing
mechanisms for State facilities. Public hearings were held on the proposed
constitutional amendment during 1993. Following these hearings, in February
1994, the Governor and the State Comptroller recommended a revised
constitutional amendment which would further tighten the ban on lease-purchase
and contractual-obligation financing, incorporate existing lease-purchase and
contractual-obligation debt under the proposed revenue bond cap while
simultaneously reducing the size of the cap. After considering these
recommendations, the Legislature passed a revised constitutional amendment which
tightens the ban, and provides for a phase-in to a lower cap. Before the
approved constitutional amendment or any revised amendment enacted in 1994 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 the presentation to the voters at the
earliest in November 1995. The amendment could not become effective before
January 1, 1996.
On January 13, 1992, S&P reduced its ratings on the State's general
obligation bonds to "A-" from "A" and, in addition, reduced its ratings on the
State's moral obligation, lease purchase, guaranteed and contractual obligation
debt. S&P also continued its negative rating outlook assessment on State general
obligation debt. On April 26, 1993, S&P revised the rating outlook assessment to
stable. On February 14, 1994, S&P raised its outlook to positive and, on
February 28, 1994, confirmed its A- rating. On January 6, 1992, Moody's reduced
its ratings on outstanding limited-liability State lease purchase and
contractual obligations from A to Baa1. On February 28, 1994, Moody's
reconfirmed its A rating on the State's general obligation long-term
indebtedness.
The State anticipates that its capital programs will be financed, in part,
by State and public authorities borrowings in 1994-95. The State expects to
issue $374 million in general obligation bonds (including $140 million for
purposes of redeeming outstanding bond
11
<PAGE>
anticipation notes) and $140 million in general obligation commercial paper.
The Legislature has also authorized the issuance of up to $69 million in
certificates of participation during the State's 1994-95 fiscal year for
equipment purchases. The projection of the State regarding its borrowings for
the 1994-95 fiscal year may change if circumstances require.
Principal and interest payments on general obligation bonds and interest
payments on bond anticipation notes and on tax and revenue anticipation notes
were $782.5 million for the 1993-94 fiscal year, and are estimated to be $786.3
million for the 1994-95 fiscal year. These figures do not include interest
payable on State General Obligation Refunding Bonds issued in July 1992
("Refunding Bonds") to the extent that such interest was paid from an escrow
fund established with the proceeds of such Refunding Bonds. Principal and
interest payments on fixed rate and variable rate bonds issued by LGAC were
$239.4 million for the 1993-94 fiscal year, and are estimated to be $289.9
million for 1994-95. State lease-purchase rental and contractual obligation
payments for 1993-94, including State installment payments relating to
certificates of participation, were $1.258 billion and are estimated to be
$1.495 billion in 1994-95.
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.
Litigation. Certain litigation pending against the State or its officers
or employees could have a substantial or long-term adverse effect on the State
finances. Among the more significant of these cases are those that involve (1)
the validity of agreements and treaties by which various Indian tribes
transferred title to the State of certain land in central and upstate New York;
(2) certain aspects of the State's Medicaid policies, including its rates,
regulations and procedures; (3) contamination in the Love Canal area of Niagara
Falls; (4) action against the State and the City officials alleging inadequate
shelter allowances to maintain proper housing; (5) challenges to the practice of
reimbursing certain Office of Mental Health patient care expenses from the
client's Social Security benefits; (6) alleged responsibility of the State
officials to assist in remedying racial segregation in the City of Yonkers; (7)
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; (8) challenges by
commercial insurers, employee welfare benefit plans, and health maintenance
organizations to Section 2807-c of the Public Health Law, which imposes 13%, 11%
and 9% surcharges on inpatient hospital bills and a bad debt and charity care
allowance on all hospital bills and hospital bills paid by such entities, (9)
challenge by a long distance carrier to the constitutionality of Tax Law
ss.186-a(2-a) which restricted certain deduction of local access service fees,
(10) challenges to certain aspects of petroleum business taxes, and (11) action
alleging damages resulting from the failure by the State's Department of
Environmental Conservation to timely provide certain data.
12
<PAGE>
A number of cases have also been instituted against the State challenging
the constitutionality of various public authority financing programs.
In a proceeding commenced on August 6, 1991 (Schulz, et al. v. State of
New York, et al., Supreme Court, Albany County), petitioners challenge the
constitutionality of two bonding programs of the New York State Thruway
Authority authorized by Chapters 166 and 410 of the Laws of 1991. In addition,
petitioners challenge the fiscal year 1991-92 judiciary budget as having been
enacted in violation of Sections 1 and 2 of Article VII of the State
Constitution. The defendants' motion to dismiss the action on procedural grounds
was denied by order of the Supreme Court dated January 2, 1992. By order dated
November 5, 1992, the Appellate Division, Third Department, reversed the order
of the Supreme Court and granted defendants' motion to dismiss on grounds of
standing and mootness. By order dated September 16, 1993, on motion to
reconsider, the Appellate Division, Third Department, ruled that plaintiffs have
standing to challenge the bonding program authorized by Chapter 166 of the laws
of 1991. The proceeding is presently pending in Supreme Court, Albany County.
In Schulz, et al. v. State of New York, et al., commenced May 24, 1993,
Supreme Court, Albany County, petitioners challenge, among other things, the
constitutionality of, and seek to enjoin certain highway, bridge and mass
transportation bonding programs of the New York State Thruway Authority and the
Metropolitan Transportation Authority authorized by Chapter 56 of the Laws of
1993. Petitioners contend that the application of State tax receipts held in
dedicated transportation funds to pay debt service on bonds of the Thruway
Authority and of the Metropolitan Transportation Authority violates Sections 8
and 11 of Article VII and Section 5 of Article X of the State Constitution and
due process provisions of the State and Federal Constitutions. By order dated
July 27, 1993, the Supreme Court granted defendants' motions for summary
judgment, dismissed the complaint, and vacated the temporary restraining order
previously issued. By decision dated October 21, 1993, the Appellate Division,
Third Department, affirmed the judgment of the Supreme Court. On June 30, 1994,
the Court of Appeals unanimously affirmed the ruling of the trial court and the
Appellate Division in favor of the State.
Several actions challenging the constitutionality of legislation enacted
during the 1990 legislative session which changed actuarial funding methods for
determining state and local contributions to state employee retirement systems
have been decided against the State. As a result, the State's Comptroller has
developed a plan to restore the State's retirement systems to prior funding
levels. Such funding is expected to exceed prior levels by $30 million in fiscal
1994-95, $63 million in fiscal 1995-96, $116 million in fiscal 1996-97, $193
million in fiscal 1997-98, peaking at $241 million in fiscal 1998-99. Beginning
in fiscal 2001-02, State contributions required under the Comptroller's plan are
projected to be less than that required under the prior funding method. As a
result of the United States Supreme Court decision in the case of State of
Delaware v. State of New York, on January 21, 1994, the State entered into a
settlement agreement with various parties. Pursuant to all agreements executed
in connection with the action, the State is required to make aggregate payments
of $351.4
13
<PAGE>
million, of which $90.3 million have been made. Annual payments to the
various parties will continue through the State's 2002-03 fiscal year in amounts
which will not exceed $48.4 million in any fiscal year subsequent to the State's
1994-95 fiscal year.
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 in the 1994-95
fiscal year or thereafter. Adverse developments in these proceedings or the
initiation of new proceedings could affect the ability of the State to maintain
a balanced 1994-95 State Financial Plan. An adverse decision in any of these
proceedings could exceed the amount of the 1994-95 State Financial Plan reserve
for the payment of judgments and, therefore, could affect the ability of the
State to maintain a balanced 1994-95 State Financial Plan. In its audited
financial statements for the fiscal year ended March 31, 1994, the State
reported its estimated liability for awarded and anticipated unfavorable
judgments to be $675 million.
Although other litigation is pending against the State, except as
described above, no current litigation involves the State's authority, as a
matter of law, to contract indebtedness, issue its obligations, or pay such
indebtedness when it matures, or affects the State's power or ability, as a
matter of law, to impose or collect significant amounts of taxes and revenues.
Authorities. The fiscal stability of the State is related, in part, to the
fiscal stability of its Authorities, which generally have responsibility for
financing, constructing and operating revenue- producing public benefit
facilities. Authorities are not subject to the constitutional restrictions on
the incurrence of debt which apply to the State itself, and may issue bonds and
notes within the amounts of, and as otherwise restricted by, their legislative
authorization. The State's access to the public credit markets could be
impaired, and the market price of its outstanding debt may be materially and
adversely affected, if any of the Authorities were to default on their
respective obligations, particularly with respect to debt that are
State-supported or State-related. As of September 30, 1993, date of the latest
data available, there were 18 Authorities that had outstanding debt of $100
million or more. The aggregate outstanding debt, including refunding bonds, of
these 18 Authorities was $63.5 billion. As of March 31, 1994, aggregate public
authority debt outstanding as State-supported debt was $21.1 billion and as
State-related debt was $29.4 billion.
Authorities are generally supported by revenues generated by the projects
financed or operated, such as fares, user fees on bridges, highway tolls and
rentals for dormitory rooms and housing. In recent years, however, 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. This operating assistance is expected to
continue to be required in future years.
14
<PAGE>
In addition, certain statutory arrangements provide for State local
assistance payments otherwise payable to localities to be made under certain
circumstances to certain Authorities. The State has no obligation to provide
additional assistance to localities whose local assistance payments have been
paid to Authorities under these arrangements. However, in the event that such
local assistance payments are so diverted, the affected localities could seek
additional State funds.
New York City and Other Localities. The fiscal health of the State may
also be impacted by 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. The City's independently audited operating
results for each of its 1981 through 1993 fiscal years, which end on June 30,
show a General Fund surplus reported in accordance with GAAP. In addition, the
City's financial statements for the 1993 fiscal year received an unqualified
opinion from the City's independent auditors, the eleventh consecutive year the
City has received such an opinion.
In 1975, the City suffered a fiscal crisis that impaired the borrowing
ability of both the City and New York State. In that year the City lost access
to public credit markets. The City was not able to sell short-term notes to the
public again until 1979.
In 1975, S&P suspended its A rating of City bonds. This suspension
remained in effect until March 1981, at which time the City received an
investment grade rating of BBB from S&P. On July 2, 1985 S&P revised its rating
of City bonds upward to BBB+ and on November 19, 1987, to A-. On July 2, 1993,
S&P reconfirmed its A- rating of City bonds, continued its negative rating
outlook assessment and stated that maintenance of such rating depended upon the
City's making further progress towards reducing budget gaps in the outlying
years. Moody's ratings of City bonds were revised in November 1981 from B (in
effect since 1977) to Ba1, in November 1983 to Baa, in December 1985 to Baa1, in
May 1988 to A and again in February 1991 to Baa1. On January 17, 1995, S&P
placed the City's general obligation bonds on its CreditWatch list which may
portend a rating downgrade from the agency in the outcoming months.
The City is heavily dependent on the State and federal assistance to cover
insufficiencies in its revenues. There can be no assurance that in the future
federal and State assistance will enable the City to make up its budget
deficits. To help alleviate the City's financial difficulties, the Legislature
created the Municipal Assistance Corporation ("MAC") in 1975. MAC is authorized
to issue bonds and notes payable from certain stock transfer tax revenues, from
the City's portion of the State sales tax derived in the City and from State per
capita aid otherwise payable by the State to the City. Failure by the State to
continue the imposition of such taxes, the reduction of the rate of such taxes
to rates less than those in effect on July 2, 1975, failure by the State to pay
such aid revenues and the reduction of such aid revenues below a specified level
are included among the events of default in the resolutions authorizing MAC's
long-term debt. The occurrence of an event of default may result in the
15
<PAGE>
acceleration of the maturity of all or a portion of MAC's debt. As of December
31, 1993, MAC had outstanding an aggregate of approximately $5.204 billion of
its bonds. MAC bonds and notes constitute general obligations of MAC and do not
constitute an enforceable obligation or debt of either the State or the City.
Under its enabling legislation, MAC's authority to issue bonds and notes (other
than refunding bonds and notes) expired on December 31, 1984. Legislation has
been passed by the legislature which would, under certain conditions, permit MAC
to issue up to $1.465 billion of additional bonds, which are not subject to a
moral obligation provision.
Since 1975, the City's financial condition has been subject to oversight
and review by the New York State Financial Control Board (the "Control Board")
and since 1978 the City's financial statements have been audited by independent
accounting firms. To be eligible for guarantees and assistance, the City is
required during a "control period" to submit annually for Control Board
approval, and when a control period is not in effect for Control Board review, a
financial plan for the next four fiscal years covering the City and certain
agencies showing balanced budgets determined in accordance with GAAP. New York
State also established the Office of the State Deputy Comptroller for New York
City ("OSDC") to assist the Control Board in exercising its powers and
responsibilities. On June 30, 1986, the City satisfied the statutory
requirements for termination of the control period. This means that the Control
Board's powers of approval are suspended, but the Board continues to have
oversight responsibilities.
The staffs of OSDC and the Control Board issued 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
(i.e., those which receive or may receive monies from the City directly,
indirectly or contingently). OSDC staff reports issued during the mid-1980's
noted that the City's budgets benefited 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 examined
the 1987 stock market crash and the 1989-92 recession, which effected the City's
region more severely than the nation, and attributed an erosion of City revenues
and increasing strain on City expenditures to that recession. According to a
recent OSDC staff report, the City's economy is now slowly recovering, but the
scope of that recovery is uncertain and unlikely, in the foreseeable future, to
match the expansion of the mid-1980's. Also, staff reports of OSDC and the
Control Board have indicated that the City's recent balanced budgets have been
accomplished, in part, through the use of non-recurring resources, tax increases
and additional State assistance; that the City has not yet brought its long-term
expenditures in line with recurring revenues; and that the City is therefore
likely to continue to face future projected budget gaps requiring the City to
increase revenues and/or reduce expenditures. According to the most recent staff
reports of OSDC and the Control Board, 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
16
<PAGE>
of its municipal labor unions, Covered Organizations and City Council, as well
as the state and federal governments, among others.
On February 14, 1995, the Mayor released the preliminary budget for the
City's 1996 fiscal year, which addresses a projected $2.7 billion budget gap.
Most of the gap-closing initiatives may be implemented only with the cooperation
of the City's municipal unions, or the State or Federal governments.
Although the City has balanced its budget since 1981, estimates of the
City's revenues and expenditures, which are based on numerous assumptions, 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 New York State.
The City requires certain amounts of financing for seasonal and capital
spending purposes. The City has issued $1.75 billion of notes for seasonal
financing purposes during fiscal year 1994. The City's capital financing program
projects long-term financing requirements of approximately $17 billion for the
City's fiscal years 1995 through 1998. The major capital requirements include
expenditures for the City's water supply and sewage disposal systems, roads,
bridges, mass transit, schools, hospitals and housing. In addition to financing
for new purposes, the City and the New York City Municipal Water Finance
Authority have issued refunding bonds totaling $1.8 billion in fiscal year 1994.
Certain localities, in addition to the City, could have financial problems
leading to requests for additional State assistance during the State's 1994-95
fiscal year and thereafter. The potential impact on the State of such requests
by localities is not included in the projections of the State receipts and
disbursements in the State's 1994-95 fiscal year.
Fiscal difficulties experienced by the City of Yonkers ("Yonkers")
resulted in the creation of the Financial Control Board for the City of Yonkers
(the "Yonkers Board") by New York State in 1984. The Yonkers Board is charged
with oversight of the fiscal affairs of Yonkers. Future actions taken by the
Governor or the Legislature 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. In 1992, the total indebtedness of all localities in
the State was approximately $35.2 billion, of which $19.5 billion was debt of
the City (excluding $5.9 billion in MAC debt); a small portion (approximately
$71.6 million) of the $35.2 billion of indebtedness
17
<PAGE>
represented borrowing to finance budgetary deficits and was issued pursuant to
enabling State legislation. State law requires the comptroller to review and
make recommendations concerning the budgets of those local government units
other than the City authorized by State law to issue debt to finance deficits
during the period that such deficit financing is outstanding. Seventeen
localities had outstanding indebtedness for deficit financing at the close of
their fiscal year ending in 1992.
From time to time, federal expenditure reductions could reduce, or in some
cases eliminate, federal funding of some local programs and accordingly might
impose substantial increased expenditure requirements on affected localities. If
the State, the City or any of the Authorities were to suffer serious financial
difficulties jeopardizing their respective access to the public credit markets,
the marketability of notes and bonds issued by localities within the State could
be adversely affected. Localities also face anticipated and potential problems
resulting from certain pending litigation, judicial decisions and long-range
economic trends. The longer-range problems of declining urban population,
increasing expenditures and other economic trends could adversely affect
localities and require increasing the State assistance in the future.
ADDITIONAL INFORMATION CONCERNING
CERTAIN INVESTMENT TECHNIQUES
Among other investments described below, the Fund may buy and sell
options, futures contracts, and options on futures contracts with respect to
securities and securities indices and may enter into closing transactions with
respect to each of the foregoing, and invest in other derivatives, under
circumstances in which the use of such techniques is expected by State Street
Research & Management Company (the "Investment Manager") to aid in achieving the
investment objective of the Fund. The Fund on occasion may also purchase
instruments with characteristics of both futures and securities (e.g., debt
instruments with interest and principal payments determined by reference to the
value of a commodity at a future time) and which, therefore, possess the risks
of both futures and securities investments.
Futures Contracts
Futures contracts are publicly traded contracts to buy or sell underlying
assets, such as certain securities or an index of securities, at a future time
at a specified price. A contract to buy establishes a "long" position while a
contract to sell establishes a "short" position.
The purchase of a futures contract on securities or an index of securities
normally enables a buyer to participate in the market movement of the underlying
asset or index after paying a transaction charge and posting margin in an amount
equal to a small percentage of the value of the underlying asset or index. This
characteristic makes futures useful for hedging purposes.
18
<PAGE>
The Fund will initially be required to deposit with the Trust's custodian
or the broker effecting the transaction an amount of "initial margin" in cash or
U.S. Treasury obligations.
Initial margin in futures transactions is different from margin in
securities transactions in that the former does not involve the borrowing of
funds by the customer to finance the transaction. Rather, the initial margin is
like a performance bond or good faith deposit on the contract. Subsequent
payments (called "maintenance margin") to and from the broker will be made on a
daily basis as the price of the underlying asset fluctuates. This process is
known as "marking to market." For example, when the Fund has taken a long
position in a futures contract and the value of the underlying asset has risen,
that position will have increased in value and the Fund will receive from the
broker a maintenance margin payment equal to the increase in value of the
underlying asset. Conversely, when the Fund has taken a long position in a
futures contract and the value of the underlying asset has declined, the
position would be less valuable, and the Fund would be required to make a
maintenance margin payment to the broker.
At any time prior to expiration of the futures contract, the Fund may
elect to close the position by taking an opposite position which will terminate
its position in the futures contract. A final determination of maintenance
margin is then made, additional cash is required to be paid by or released to
the Fund, and the Fund realizes a loss or a gain. While futures contracts with
respect to securities do provide for the delivery and acceptance of such
securities, such delivery and acceptance are seldom made.
Futures contracts will be executed primarily (a) to establish a short
position, and thus protect the Fund from experiencing the full impact of an
expected decline in market value of portfolio holdings without requiring the
sale of holdings, or (b) to establish a long position, and thus to participate
in an expected rise in market value of securities which the Fund intends to
purchase. Subject to the limitations described below, the Fund may also enter
into futures contracts for purposes of enhancing return. In transactions
establishing a long position in a futures contract, money market instruments
equal to the face value of the futures contract will be identified by the Fund
to the Trust's custodian for maintenance in a separate account to insure that
the use of such futures contracts is unleveraged. Similarly, a representative
portfolio of securities having a value equal to the aggregate face value of the
futures contract will be identified with respect to each short position. The
Fund will employ any other appropriate method of cover which is consistent with
applicable regulatory and exchange requirements.
Options on Securities
The Fund may use options on securities to implement its investment
strategy. A call option on a security, for example, gives the purchaser of the
option the right to buy, and the writer the obligation to sell, the underlying
asset at the exercise price during the option period.
19
<PAGE>
Conversely, a put option on a security gives the purchaser the right to sell,
and the writer the obligation to buy, the underlying asset at the exercise price
during the option period.
Purchased options have defined risk, i.e., the premium paid for the
option, no matter how adversely the price of the underlying asset moves, while
affording an opportunity for gain corresponding to the increase or decrease in
the value of the optioned asset.
Written options have varying degrees of risk. An uncovered written call
option theoretically carries unlimited risk, as the market price of the
underlying asset could rise far above the exercise price before its expiration.
This risk is tempered when the call option is covered, i.e., when the option
writer owns the underlying asset. In this case, the writer runs the risk of the
lost opportunity to participate in the appreciation in value of the asset rather
than the risk of an out-of-pocket loss. A written put option has defined risk,
i.e., the difference between the agreed upon price that the Fund must pay to the
buyer upon exercise of the put and the value, which could be zero, of the asset
at the time of exercise.
The obligation of the writer of an option continues until the writer
effects a closing purchase transaction or until the option expires. To secure
his obligation to deliver the underlying asset in the case of a call option, or
to pay for the underlying asset in the case of a put option, a covered writer is
required to deposit in escrow the underlying security or other assets in
accordance with the rules of the applicable clearing corporation and exchanges.
Options on Securities Indices
The Fund may engage in transactions in call and put options on securities
indices. For example, the Fund may purchase put options on indices of fixed
income securities in anticipation of or during a market decline to attempt to
offset the decrease in market value of its securities that might otherwise
result.
Put options on indices of securities are similar to put options on the
securities themselves except that the delivery requirements are different.
Instead of giving the right to make delivery of a security at a specified price,
a put option on an index of securities gives the holder the right to receive an
amount of cash upon exercise of the option if the value of the underlying index
has fallen below the exercise price. The amount of cash received will be equal
to the difference between the closing price of the index and the exercise price
of the option expressed in dollars times a specified multiple. Gain or loss to
the Fund on transactions in index options will depend on price movements in the
relevant securities market generally (or in a particular industry or segment of
the market) rather than price movements of individual securities. As with
options on equity or fixed income securities, futures contracts or commodities,
the Fund may offset its position in index options prior to expiration by
entering into a closing transaction on an exchange or it may let the option
expire unexercised.
20
<PAGE>
A securities index assigns relative values to the securities included in
the index and the index options are based on a broad market index. Although
there are at present few available options on indices of fixed income
securities, other than tax-exempt securities, or futures and related options
based on such indices, such instruments may become available in the future. When
available, the Fund might employ such devices to hedge its positions in fixed
income securities in the same manner that it currently uses futures and related
options or, subject to receiving any necessary regulatory approval, to seek a
higher level of return. In connection with the use of such options, the Fund may
cover its position by identifying a representative portfolio of securities
having a value equal to the aggregate face value of the option position taken.
However, the Fund may employ any appropriate method to cover its positions that
is consistent with applicable regulatory and exchange requirements.
Options on Futures Contracts
An option on a futures contract gives the purchaser the right, in return
for the premium paid, to assume a position in a futures contract (a long
position if the option is a call and a short position if the option is a put) at
a specified exercise price at any time during the period of the option.
Options Strategy
A basic option strategy for protecting the Fund against a decline in
securities prices could involve (a) the purchase of a put -- thus "locking in"
the selling price of the underlying securities or securities indices -- or (b)
the writing of a call on securities or securities indices held by the Fund --
thereby generating income (the premium paid by the buyer) by giving the holder
of such call the option to buy the underlying asset at a fixed price. The
premium will offset, in whole or in part, a decline in portfolio value; however,
if prices of the relevant securities or securities indices rose instead of
falling, the call might be exercised, thereby resulting in a potential loss of
appreciation in the underlying securities or securities indices.
A basic option strategy when a rise in securities prices is anticipated is
the purchase of a call -- thus "locking in" the purchase price of the underlying
security or other asset. In transactions involving the purchase of call options
by the Fund, money market instruments equal to the aggregate exercise price of
the options will be identified by the Fund to the Trust's custodian to insure
that the use of such investments is unleveraged.
The Fund may write options in connection with buy-and-write transactions;
that is, the Fund may purchase a security and concurrently write a call option
against that security. If the call option is exercised in such a transaction,
the Fund's maximum gain will be the premium received by it for writing the
option, adjusted upward or downward by the difference between the Fund's
purchase price of the security and the exercise price of the option. If the
option is not exercised and the price of the underlying security declines, the
amount of such decline will be offset in part, or entirely, by the premium
received.
21
<PAGE>
The writing of covered put options is similar in terms of risk/return
characteristics to buy-and-write transactions. If the market price of the
underlying security rises or otherwise is above the exercise price, the put
option will expire worthless and the Fund's gain will be limited to the premium
received. If the market price of the underlying security declines or otherwise
is below the exercise price, the Fund's return will be the premium received from
writing the put option minus the amount by which the market price of the
security is below the exercise price.
Limitations and Risks of Options and Futures Activity
The Fund will engage in transactions in futures contracts or options only
as a hedge against changes resulting from market conditions which produce
changes in the values of their securities or the securities which it intends to
purchase (e.g., to replace portfolio securities which will mature in the near
future) and, subject to the limitations described below, to enhance return. The
Fund will not purchase any futures contract or purchase any call option if,
immediately thereafter, more than one-third of the Fund's net assets would be
represented by long futures contracts or call options. The Fund will not write a
covered call or put option if, immediately thereafter, the aggregate value of
the assets (securities in the case of written calls and cash or cash equivalents
in the case of written puts) underlying all such options, determined as of the
dates such options were written, would exceed 25% of the Fund's net assets. In
addition, the Fund may not establish a position in a commodity futures contract
or purchase or sell a commodity option contract for other than bona fide hedging
purposes if immediately thereafter the sum of the amount of initial margin
deposits and premiums required to establish such positions for such nonhedging
purposes would exceed 5% of the market value of the Fund's net assets.
Although effective hedging can generally capture the bulk of a desired
risk adjustment, no hedge is completely effective. Moreover, the use of options,
futures and options on futures may involve risks not associated with the other
types of instruments which the Fund intends to purchase. Most of the hedging
anticipated for the Fund will be against the risk characteristics of its
portfolio and not against the risk characteristics of specific debt securities.
The Fund's ability to hedge effectively through transactions in futures or
options depends on the degree to which price movements in its holdings correlate
with price movements of the futures and options. The prices of the assets being
hedged may not move in the same amount as the hedging instrument, or there may
be a negative correlation which would result in an ineffective hedge and a loss
to the Fund.
Some positions in futures and options may be closed out only on an
exchange which provides a secondary market therefor. There can be no assurance
that a liquid secondary market will exist for any particular futures contract or
option at any specific time. Thus, it may not be possible to close such an
option or futures position prior to maturity. The inability to close options and
futures positions also could have an adverse impact on the Fund's ability
effectively to hedge its securities and might in some cases require the Fund to
deposit cash to
22
<PAGE>
meet applicable margin requirements. The Fund will enter into an
option or futures position only if it appears to be a liquid investment.
When-Issued Securities
The Fund may purchase "when-issued" securities, which are traded on a
price or yield basis prior to actual issuance. Such purchases will be made only
to achieve the Fund's investment objective and not for leverage. The when-issued
trading period generally lasts from a few days to up to a month or more; during
this period dividends or interest on the securities are not payable. A frequent
form of when-issued trading occurs in the U.S. Treasury market when dealers
begin to trade a new issue of bonds or notes shortly after a Treasury financing
is announced, but prior to the actual sale of the securities. Similarly,
securities to be created by a merger of companies may also be traded prior to
the actual consummation of the merger. Such transactions may involve a risk of
loss if the value of the securities falls below the price committed to prior to
actual issuance. The Trust's custodian will establish a segregated account when
the Fund purchases securities on a when-issued basis consisting of cash or
liquid securities equal to the amount of the when-issued commitments.
Repurchase Agreements
The Fund may enter into repurchase agreements. Repurchase agreements occur
when the Fund acquires a security and the seller which may be either (i) a
primary dealer in U.S. Government securities or (ii) an FDIC-insured bank having
gross assets in excess of $500 million, simultaneously commits to repurchase it
at an agreed-upon price on an agreed-upon date within a specified number of days
(usually not more than seven) from the date of purchase. The repurchase price
reflects the purchase price plus an agreed-upon market rate of interest which is
unrelated to the coupon rate or maturity of the acquired security. The Fund will
only enter into repurchase agreements involving U.S. Government securities.
Repurchase agreements could involve certain risks in the event of default or
insolvency of the other party, including possible delays or restrictions upon
the Fund's ability to dispose of the underlying securities. Repurchase
agreements will be limited to 30% of the Fund's total assets, except that
repurchase agreements extending for more than seven days when combined with any
other illiquid assets held by the Fund will be limited to 10% of the Fund's
total assets.
Reverse Repurchase Agreements
The Fund may enter into reverse repurchase agreements. In a reverse
repurchase agreement the Fund transfers possession of a portfolio instrument to
another person, such as a financial institution, broker or dealer, in return for
a percentage of the instrument's market value in cash, and agrees that on a
stipulated date in the future the Fund will repurchase the portfolio instrument
by remitting the original consideration plus interest at an agreed-upon rate.
The ability to use reverse repurchase agreements may enable, but does not ensure
the
23
<PAGE>
ability of, the Fund to avoid selling portfolio instruments at a time when a
sale may be deemed to be disadvantageous.
When effecting reverse repurchase agreements, assets of the Fund in a
dollar amount sufficient to make payment of the obligations to be purchased
are segregated on the Fund's records at the trade date and maintained until
the transaction is settled.
Securities Lending
The Fund may lend portfolio securities with a value of up to 33 1/3% of
its total assets. The Fund will receive cash or cash equivalents (e.g., U.S.
Government obligations) as collateral in an amount equal to at least 100% of the
current market value of the loaned securities plus accrued interest. Collateral
received by the Fund will generally be held in the form tendered, although cash
may be invested in securities issued or guaranteed by the U.S. Government or its
agencies or instrumentalities, irrevocable stand-by letters of credit issued by
a bank, or any combination thereof. The investing of cash collateral received
from loaning portfolio securities involves leverage which magnifies the
potential for gain or loss on monies invested and, therefore, results in an
increase in the volatility of the Fund's outstanding securities. Such loans may
be terminated at any time. The Fund will retain most rights of ownership of the
loaned securities including rights to dividends, interests or other
distributions on the loaned securities. Voting rights pass with the landing,
although the Fund may call loans to vote proxies if desired. Should the borrower
of the securities fail financially, there is a risk of delay in recovery of the
securities or loss of rights in the collateral. Loans are made only to borrowers
which are deemed by the Investment Manager to be of good financial standing.
Short Sales Against the Box
The Fund may effect short sales, but only if such transactions are short
sale transactions known as short sales "against the box." A short sale is a
transaction in which the Fund sells a security it does not own by borrowing it
from a broker, and consequently becomes obligated to replace that security. A
short sale against the box is a short sale where the Fund owns the security sold
short or has an immediate and unconditional right to acquire that security
without additional cash consideration upon conversion, exercise or exchange of
options with respect to securities held in its portfolio. The effect of selling
a security short against the box is to insulate that security against any future
gain or loss.
High Yield Securities
Lower rated "high yield" securities (i.e., bonds rated BB or lower by S&P
or Ba or lower by Moody's) commonly known as "junk bonds," of the type in which
the Fund may invest generally involve more credit risk than higher rated
securities and are considered by S&P and Moody's to be predominantly speculative
with respect to capacity to pay interest and
24
<PAGE>
repay principal in accordance with the terms of the obligation. Such securities
may also be subject to greater market price fluctuations than lower yielding,
higher rated debt securities; credit ratings do not reflect this market risk.
In addition, these ratings may not reflect the effect of recent developments on
an issuer's ability to make interest and principal payments.
Additional risks of "high yield" securities include (i) limited liquidity
and secondary market support, particularly in the case of securities that are
not rated or subject to restrictions on resale, which may limit the availability
of securities for purchase by the Fund, limit the ability of the Fund to sell
portfolio securities either to meet redemption requests or in response to
changes in the economy or the financial markets, heighten the effect of adverse
publicity and investor perceptions, and make selection and valuation of
portfolio securities more subjective and dependent upon the Investment Manager's
credit analysis; (ii) substantial market price volatility and/or the potential
for the insolvency of issuers during periods of changing interest rates and
economic difficulty, particularly with respect to high yield securities that do
not pay interest currently in cash; (iii) subordination to the prior claims of
banks and other senior lenders; and (iv) the possibility that revenues or
earnings of the issuer may be insufficient to meet its debt service. Growth in
the market for "high yield" securities has paralleled a general expansion in
certain sectors in the U.S. economy, and the effects of adverse economic changes
(including a recession) are unclear. For further information concerning the
ratings of debt securities, see the Appendix.
In the event the rating of a security is downgraded, the Investment
Manager will determine whether the security should be retained or sold depending
on an assessment of all facts and circumstances at that time.
Rule 144A Securities
Subject to the limitations on illiquid and restricted securities noted
above, the Fund may buy or sell restricted securities in accordance with Rule
144A under the Securities Act of 1933 ("Rule 144A Securities"). Securities may
be resold pursuant to Rule 144A under certain circumstances only to qualified
institutional buyers as defined in the rule, and the markets and trading
practices for such securities are relatively new and still developing; depending
on the development of such markets, such Rule 144A Securities may be deemed to
be liquid as determined by or in accordance with methods adopted by the
Trustees. Under such methods the following factors are considered, among others:
the frequency of trades and quotes for the security, the number of dealers and
potential purchasers in the market, marketmaking activity, and the nature of the
security and marketplace trades. Investments in Rule 144A Securities could have
the effect of increasing the level of the Fund's illiquidity to the extent that
qualified institutional buyers become, for a time, uninterested in purchasing
such securities. Also, the Fund may be adversely impacted by the subjective
valuation of such securities in the absence of an active market for them.
25
<PAGE>
Other Derivative Securities
The Fund may invest in tax-exempt derivative products such as stripped
tax-exempt bonds, synthetic floating rate tax-exempt bonds, tax-exempt asset
backed securities including interests in trusts holding tax-exempt lease
receivables, and may enter into various interest rate transactions such as
swaps, caps, floors or collars as described below. Many of these derivative
products are new and are still being developed. Some of these products may
generate taxable income or income which is believed to be non-taxable which may
later be determined to be taxable. In making investments in any tax-exempt
derivative, the Fund will take into consideration the impact on the Fund of the
potential taxable nature of any income or gains, the effect of such taxable
income or gains on the taxable and non-taxable status of dividends and
distributions by the Fund to its shareholders, and the speculative nature of the
products given their development nature. Other risks which may arise with
tax-exempt derivative products include possible illiquidity because the market
for such instruments is still developing. The Fund will attempt to invest in
products which appear to have reasonable liquidity and to reduce the risks of
nonperformance by counterparties by dealing only with established and reputable
institutions.
Swap Arrangements
The Fund may enter into various forms of swap arrangements with
counterparties with respect to interest rates or indices, including purchase of
caps, floors and collars as described below. In an interest rate swap, the Fund
could agree for a specified period to pay a bank or investment banker the
floating rate of interest on a so-called notional principal amount (i.e. an
assumed figure selected by the parties for this purpose) in exchange for
agreement by the bank or investment banker to pay the Fund a fixed rate of
interest on the notional principal amount. In an index swap, the Fund would
agree to exchange cash flows on a notional amount based on changes in the values
of the selected indices. Purchase of a cap entitles the purchaser to receive
payments from the seller on a notional amount to the extent that the selected
index exceeds an agreed upon interest rate or amount whereas purchase of a floor
entitles the purchaser to receive such payments to the extent the selected index
falls below an agreed-upon interest rate or amount. A collar combines a cap and
a floor.
Most swaps entered into by the Fund will be on a net basis; for example,
in an interest rate swap, amounts generated by application of the fixed rate and
the floating rate to the notional principal amount would first offset one
another, with the Fund either receiving or paying the difference between such
amounts. In order to be in a position to meet any obligations resulting from
swaps, the Fund will set up a segregated custodial account to hold appropriate
liquid assets, including cash; for swaps entered into on a net basis, assets
will be segregated having a daily net asset value equal to any excess of the
Fund's accrued obligations over the accrued obligations of the other party,
while for swaps on other than a net basis assets will be segregated having a
value equal to the total amount of the Fund's obligations.
26
<PAGE>
These arrangements will be made primarily for hedging purposes, to
preserve the return on an investment or on a part of the Fund's portfolio.
However, the Fund may enter into such arrangements for income purposes to the
extent permitted by the Commodity Futures Trading Commission for entities which
are not commodity pool operators, such as the Fund. In entering a swap
arrangement, the Fund is dependent upon the creditworthiness and good faith of
the counterparty. The Fund attempts to reduce the risks of nonperformance by the
counterparty by dealing only with established, reputable institutions. The swap
market is still relatively new and emerging; positions in swap arrangements may
become illiquid to the extent that non-standard arrangements with one
counterparty are not readily transferable to another counterparty or if a market
for the transfer of swap positions does not develop. The use of interest rate
swaps is a highly specialized activity which involves investment techniques and
risks different from those associated with ordinary portfolio securities
transactions. If the Investment Manager is incorrect in its forecast of market
values, interest rates and other applicable factors, the investment performance
of the Fund would diminish compared with what it would have been if these
investment techniques were not used. Moreover, even if the Investment Manager is
correct in its forecast, there is a risk that the swap position may correlate
imperfectly with the price of the asset or liability being hedged.
DEBT INSTRUMENTS AND PERMITTED CASH INVESTMENTS
As indicated in the Fund's Prospectus, the Fund may invest in long-term
and short-term debt securities. The Fund may invest in cash and short-term
securities for temporary defensive purposes when, in the opinion of the
Investment Manager, such investments are more likely to provide protection
against unfavorable market conditions than adherence to other investment
policies. Certain debt securities and money market instruments in which the Fund
may invest are described below.
The Fund intends that short-term securities acquired for temporary
defensive purposes will be exempt from federal income taxes and New York State
and New York City personal income taxes. However, if such suitable short-term
tax-exempt securities are not available or if such securities are available only
on a when-issued basis, the Fund may invest up to 100% of its total assets in
short-term securities the interest on which is not exempt from federal income
taxes or New York State or New York City personal income taxes.
U.S. Government and Related Securities. U.S. Government securities are
securities which are issued or guaranteed as to principal or interest by the
U.S. Government, a U.S. Government agency or instrumentality, or certain
mixed-ownership Government corporations as described herein. The U.S.
Government securities in which the Fund invests include, among others:
27
<PAGE>
o direct obligations of the U.S. Treasury, i.e., Treasury
bills, notes, certificates and bonds;
o obligations of U.S. Government agencies or
instrumentalities such as the Federal Home Loan Banks, the
Farmers Home Administration, the Federal Farm Credit Banks, the
Federal National Mortgage Association, the Government National
Mortgage Association and the Federal Home Loan Mortgage
Corporation; and
o obligations of mixed-ownership Government corporations
such as Resolution Funding Corporation.
U.S. Government securities which the Fund may buy are backed in a variety
of ways by the U.S. Government, its agencies or instrumentalities. Some of these
obligations, such as Government National Mortgage Association mortgage-backed
securities and obligations of the Farmers Home Administration, are backed by the
full faith and credit of the U.S. Treasury. Other obligations, such as those of
the Federal National Mortgage Association, are backed by the discretionary
authority of the U.S. Government to purchase certain obligations of agencies or
instrumentalities, although the U.S. Government has no legal obligation to do
so. Obligations such as those of the Federal Home Loan Banks, the Farmers Home
Administration, the Federal Farm Credit Banks, the Federal National Mortgage
Association and the Federal Home Loan Mortgage Corporation are backed by the
credit of the agency or instrumentality issuing the obligations. Certain
obligations of Resolution Funding Corporation, a mixed-ownership Government
corporation, are backed with respect to interest payments by the U.S. Treasury,
and with respect to principal payments by U.S. Treasury obligations held in a
segregated account with a Federal Reserve Bank. Except for certain
mortgage-backed securities, the Fund will only invest in obligations issued by
mixed-ownership Government corporations where such securities are guaranteed as
to payment of principal or interest by the U.S. Government or a U.S. Government
agency or instrumentality, and any unguaranteed principal or interest is
otherwise supported by U.S. Government obligations held in a segregated account.
U.S. Government securities may be acquired by the Fund in the form of
separately traded principal and interest components of securities issued or
guaranteed by the U.S. Treasury. The principal and interest components of
selected securities are traded independently under the Separate Trading of
Registered Interest and Principal of Securities ("STRIPS") program. Under the
STRIPS program, the principal and interest components are individually numbered
and separately issued by the U.S. Treasury at the request of depository
financial institutions, which then trade the component parts independently.
Obligations of Resolution Funding Corporation are similarly divided into
principal and interest components and maintained as such on the book entry
records of the Federal Reserve Banks.
28
<PAGE>
In addition, the Fund may invest in custodial receipts that evidence
ownership of future interest payments, principal payments or both on certain
U.S. Treasury notes or bonds in connection with programs sponsored by banks and
brokerage firms. Such notes and bonds are held in custody by a bank on behalf of
the owners of the receipts. These custodial receipts are known by various names,
including "Treasury Receipts" ("TRs"), "Treasury Investment Growth Receipts"
("TIGRs") and "Certificates of Accrual on Treasury Securities" ("CATS"), and may
not be deemed U.S. Government securities.
The Fund may also invest from time to time in collective investment
vehicles, the assets of which consist principally of U.S. Government securities
or other assets substantially collateralized or supported by such securities,
such as Government trust certificates.
Bank Money Investments. Bank money investments include but are not limited
to certificates of deposit, bankers' acceptances and time deposits. Certificates
of deposit are generally short-term (i.e., less than one year), interest-bearing
negotiable certificates issued by commercial banks or savings and loan
associations against funds deposited in the issuing institution. A banker's
acceptance is a time draft drawn on a commercial bank by a borrower, usually in
connection with an international commercial transaction (to finance the import,
export, transfer or storage of goods). A banker's acceptance may be obtained
from a domestic or foreign bank including a U.S. branch or agency of a foreign
bank. The borrower is liable for payment as well as the bank, which
unconditionally guarantees to pay the draft at its face amount on the maturity
date. Most acceptances have maturities of six months or less and are traded in
secondary markets prior to maturity. Time deposits are nonnegotiable deposits
for a fixed period of time at a stated interest rate. The Fund will not invest
in any such bank money investment unless the investment is issued by a U.S. bank
that is a member of the Federal Deposit Insurance Corporation ("FDIC"),
including any foreign branch thereof, a U.S. branch or agency of a foreign bank,
a foreign branch of a foreign bank, or a savings bank or savings and loan
association that is a member of the FDIC and which at the date of investment has
capital, surplus and undivided profits (as of the date of its most recently
published financial statements) in excess of $50 million. The Fund will not
invest in time deposits maturing in more than seven days and will not invest
more than 10% of its total assets in time deposits maturing in two to seven
days.
U.S. branches and agencies of foreign banks are offices of foreign
banks and are not separately incorporated entities. They are chartered and
regulated either federally or under state law. U.S. federal branches or
agencies of foreign banks are chartered and regulated by the Comptroller of
the Currency, while state branches and agencies are chartered and regulated
by authorities of the respective states or the District of Columbia. U.S.
branches of foreign banks may accept deposits and thus are eligible for FDIC
insurance; however, not all such branches elect FDIC insurance. Unlike U.S.
branches of foreign banks, U.S. agencies of foreign banks may not accept
deposits and thus are not eligible for FDIC insurance. Both branches and
agencies can maintain credit balances, which are funds received by the office
29
<PAGE>
incidental to or arising out of the exercise of their banking powers and can
exercise other commercial functions, such as lending activities.
Short-Term Corporate Debt Instruments. Short-term corporate debt
instruments include commercial paper to finance short-term credit needs (i.e.,
short-term, unsecured promissory notes) issued by corporations including but not
limited to (a) domestic or foreign bank holding companies or (b) their
subsidiaries or affiliates where the debt instrument is guaranteed by the bank
holding company or an affiliated bank or where the bank holding company or the
affiliated bank is unconditionally liable for the debt instrument. Commercial
paper is usually sold on a discounted basis and has a maturity at the time of
issuance not exceeding nine months.
Commercial Paper Ratings. Commercial paper investments at the time of
purchase will be rated A by S&P or Prime by Moody's, or, if not rated, issued by
companies having an outstanding long-term unsecured debt issue rated at least A
by S&P or by Moody's. The money market investments in corporate bonds and
debentures (which must have maturities at the date of settlement of one year or
less) must be rated at the time of purchase at least A by S&P or by Moody's.
Commercial paper rated A (highest quality) by S&P is issued by entities
which have liquidity ratios which are adequate to meet cash requirements.
Long-term senior debt is rated A or better, although in some cases BBB credits
may be allowed. The issuer has access to at least two additional channels of
borrowing. Basic earnings and cash flow have an upward trend with allowance made
for unusual circumstances. Typically, the issuer's industry is well established
and the issuer has a strong position within the industry. The reliability and
quality of management are unquestioned. The relative strength or weakness of the
above factors determines whether the issuer's commercial paper is rated A-1, A-2
or A-3. (Those A-1 issues determined to possess overwhelming safety
characteristics are denoted with a plus (+) sign: A-1+.)
The rating Prime is the highest commercial paper rating assigned by
Moody's. Among the factors considered by Moody's in assigning ratings are the
following: evaluation of the management of the issuer; economic evaluation of
the issuer's industry or industries and an appraisal of speculative-type risks
which may be inherent in certain areas; evaluation of the issuer's products in
relation to competition and customer acceptance; liquidity; amount and quality
of long-term debt; trend of earnings over a period of 10 years; financial
management of obligations which may be present or may arise as a result of
public interest questions and preparations to meet such obligations. These
factors are all considered in determining whether the commercial paper is rated
Prime-1, Prime-2 or Prime-3.
Information concerning the ratings of S&P and Moody's for municipal debt
appears in the Appendix hereto. In the event applicable rating agencies lower
the ratings of debt instruments held by the Fund, resulting in a material
decline in the overall quality of the
30
<PAGE>
Fund's portfolio, the situation will be reviewed and necessary action, if any,
will be taken, including changes in the composition of the portfolio.
31
<PAGE>
TRUSTEES AND OFFICERS
The Trustees and officers of the Trust, their addresses, and their
principal occupations and positions with certain affiliates of the Investment
Manager are set forth below.
*Paul J. Clifford, Jr., One Financial Center, Boston, MA 02111, serves as
Vice President of the Trust. He is 32. His principal occupation is Vice
President of State Street Research & Management Company. During the past five
years, he has also served as a securities analyst for State Street Research &
Management Company.
*Susan W. Drake, One Financial Center, Boston, MA 02111, serves as Vice
President of the Trust. She is 42. Her principal occupation is Vice
President of State Street Research & Management Company. During the past
five years she has also served as a securities analyst for State Street
Research & Management Company.
*+Constantine Hutchins, Jr., One Financial Center, Boston, MA 02111,
serves as Secretary and General Counsel of the Trust. He is 66. His principal
occupation during the past five years has been Senior Vice President, Secretary
and General Counsel of State Street Research & Management Company. Mr.
Hutchins's other principal business affiliations include Senior Vice President,
Clerk and General Counsel, State Street Research Investment Services, Inc.
*+John H. Kallis, One Financial Center, Boston, MA 02111 serves as Vice
President of the Trust. He is 54. Mr. Kallis's principal occupation is Senior
Vice President of State Street Research & Management Company. During the past
five years he has also served as portfolio manager for State Street Research &
Management Company.
+Edward M. Lamont, Box 1234, Moores Hill Road, Syosset, NY 11791,
serves as Trustee of the Trust. He is 68. He is engaged principally in
private investments and civic affairs. Previously, he was with Morgan
Guaranty Trust Company of New York.
+Robert A. Lawrence, Saltonstall & Co., 50 Congress Street, Boston, MA
02109, serves as Trustee of the Trust. He is 68. His principal occupation during
the past five years has been Partner, Saltonstall & Co., a private investment
firm.
*+Gerard P. Maus, One Financial Center, Boston, MA 02111, serves as
Treasurer of the Trust. He is 44. His principal occupation is Executive Vice
President, Treasurer and Director of State Street Research & Management Company.
During the past five years he also served as Executive Vice President and Chief
Financial Officer of New England Investment Companies and as Senior Vice
President and Vice President of New England Mutual Life Insurance Company. Mr.
Maus's other principal business affiliations include Executive Vice
______________
* or + See footnotes on page 35.
32
<PAGE>
President, Treasurer, Chief Financial Officer and Director of State Street
Research Investment Services, Inc.
+Dean O. Morton, 3200 Hillview Avenue, Palo Alto, CA 94304, serves as
Trustee of the Trust. He is 63. He is retired, having served during the past
five years, until October 1992, as Executive Vice President, Chief Operating
Officer and Director of Hewlett-Packard Company.
+Thomas L. Phillips, 141 Spring Street, Lexington, MA 02173 serves as
Trustee of the Trust. He is 70. He is retired and was formerly Chairman of the
Board and Chief Executive Officer of Raytheon Company, of which he remains a
Director.
+Toby Rosenblatt, 3409 Pacific Avenue, San Francisco, CA 94118, serves as
Trustee of the Trust. He is 56. His principal occupations during the past five
years have been President of The Glen Ellen Company, a private investment
company, and Vice President of Founders Investment Ltd.
+Michael S. Scott Morton, Massachusetts Institute of Technology,
77 Massachusetts Avenue, Cambridge, MA 02139, serves as Trustee of the
Trust. He is 57. His principal occupation during the past five years has
been Jay W. Forrester Professor of Management at Sloan School of Management,
Massachusetts Institute of Technology.
*Thomas A. Shively, One Financial Center, Boston, MA 02111, serves as Vice
President of the Trust. He is 40. His principal occupation is Senior Vice
President and Director of State Street Research & Management Company. During the
past five years he has also served as Vice President of State Street Research &
Management Company. Mr. Shively's other principal business affiliations include
Director of State Street Research Investment Services, Inc.
*+Ralph F. Verni, One Financial Center, Boston, MA 02111, serves as
Chairman of the Board, President, Chief Executive Officer and Trustee of the
Trust. He is 52. His principal occupation is Chairman of the Board, President,
Chief Executive Officer and Director of State Street Research & Management
Company. During the past five years he also served as President and Chief
Executive Officer of New England Investment Companies and as Chief Investment
Officer and Director of New England Mutual Life Insurance Company. Mr. Verni's
other principal business affiliations include Chairman of the Board, President,
Chief Executive Officer and Director of State Street Research Investment
Services, Inc.
+Jeptha H. Wade, 251 Old Billerica Road, Bedford, MA 01730, serves as
Trustee of the Trust. He is 70. He is retired and was formerly Of Counsel for
the law firm Choate, Hall & Stewart. He was a partner of that firm from 1960 to
1987.
__________
* or + See footnotes on page 35.
33
<PAGE>
As of March 31, 1995, the Trustees and officers of the Trust owned no
shares of the Fund.
As of March 31, 1995, Metropolitan Life Insurance Company ("Metropolitan")
a New York corporation having its principal offices at One Madison Avenue, New
York, NY 10010, was the record and/or beneficial owner, directly or indirectly
through its subsidiaries or affiliates, of the amounts of the outstanding shares
of the Fund as set forth below:
Class D 59.5%
Ownership of 25% or more of a voting security is deemed "control" as
defined in the 1940 Act. So long as 25% of a class of shares is so owned, such
owners will be presumed to be in control of such class of shares for purposes of
voting on certain matters submitted to a vote of shareholders, such as any
Distribution Plan for a given class.
As of March 31, 1995, Merrill Lynch, Pierce, Fenner & Smith, Inc.
("Merrill Lynch"), One Liberty Plaza, 165 Broadway, New York, NY 10080, was the
record owner of 20.5% of the Fund's outstanding Class D shares. The Fund
believes that Merrill Lynch does not have beneficial ownership of such shares.
As of March 31, 1995, Bear Stearns Securities Corp. ("Bear Stearns"), One
Metrotech Center North, Brooklyn, NY 11201, was the record owner of 18.0% of the
Fund's outstanding Class D shares. The Fund believes that Bear Stearns does not
have beneficial ownership of such shares.
During the last fiscal year of the Fund, the Trustees were compensated as
follows:
Total
Compensation
Aggregate From Trust and
Name of Compensation Complex Paid
Trustee From Trust(a) to Trustees(b)
------- ------------- --------------
________________________________________________________________________
Edward M. Lamont $ 9,825 $ 49,326
Robert A. Lawrence $ 9,325 $ 72,475
Dean O. Morton $ 11,325 $ 87,925
Thomas L. Phillips $ 9,625 $ 56,825
Toby Rosenblatt $ 9,825 $ 49,326
Michael S. Scott Morton $ 11,325 $ 83,925
Ralph F. Verni $ 0 $ 0
Jeptha H. Wade $ 10,125 $ 58,525
34
<PAGE>
(a) Includes compensation from multiple series of the Trust. See
"Distribution of Shares" for a listing of series.
(b) Includes compensation from Metropolitan Series Fund, Inc., for which the
Investment Manager serves as sub-adviser, State Street Research
Portfolios, Inc., for which State Street Research Investment Services,
Inc. serves as distributor, and all investment companies for which the
Investment Manager serves as primary investment adviser, comprising a
total of 30 series. The Trust does not provide any pension or retirement
benefits for the Trustees.
__________
* These Trustees and/or officers are or may be deemed to be "interested
persons" of the Trust under the 1940 Act because of their affiliations
with the Fund's investment adviser.
+ Serves as a Trustee and/or officer of one or more of the following
investment companies, each of which has an advisory or distribution
relationship with the Investment Manager or its affiliates:
MetLife - State Street Equity Trust, MetLife - State Street Financial
Trust, MetLife - State Street Income Trust, MetLife - State Street
Money Market Trust, State Street Research Tax-Exempt Trust, State
Street Research Capital Trust, State Street Research Exchange Trust,
State Street Research Growth Trust, State Street Research Master
Investment Trust, State Street Research Securities Trust, State Street
Research Portfolios, Inc. and Metropolitan Series Fund, Inc.
35
<PAGE>
INVESTMENT ADVISORY SERVICES
State Street Research & Management Company, the Investment Manager, a
Delaware corporation, with offices at One Financial Center, Boston,
Massachusetts 02111-2690, acts as investment adviser to the Fund. The Advisory
Agreement provides that the Investment Manager shall furnish the Fund with an
investment program, office facilities and such investment advisory, research and
administrative services as may be required from time to time. The Investment
Manager compensates all executive and clerical personnel and Trustees of the
Trust if such persons are employees of the Investment Manager or its affiliates.
The Investment Manager is an indirect wholly-owned subsidiary of Metropolitan.
State Street Research & Management Company assumed responsibility as Investment
Manager effective as of July 1, 1992; previously, it served as a sub-adviser and
the Distributor acted as investment manager.
The advisory fee payable monthly by the Fund to the Investment Manager is
computed as a percentage of the average of the value of the net assets of the
Fund as determined at the close of the New York Stock Exchange (the "NYSE") on
each day the NYSE is open for trading, at the annual rate of 0.55% of the net
assets of the Fund. The Fund has been advised that the Distributor and its
affiliates may from time to time and in varying amounts voluntarily assume some
portion of fees or expenses relating to the Fund. For the fiscal years ended
December 31, 1992, 1993 and 1994, the Fund's investment advisory fees prior to
the assumption of fees or expenses were $171,406, $339,919 and $426,269,
respectively. For the same periods, the voluntary reduction of fees or
assumption of expenses amounted to $93,952, $114,140 and $249,199 respectively.
Further, to the extent required under applicable state regulatory
requirements, the Investment Manager will reduce its management fee up to the
amount of any expenses (excluding permissible items, such as brokerage
commissions, Rule 12b-1 payments, interest, taxes and litigation expenses) paid
or incurred by the Fund in any fiscal year which exceed specified percentages of
the average daily net assets of the Fund for such fiscal year. The most
restrictive of such percentage limitations is currently 2.5% of the first $30
million of average net assets, 2.0% of the next $70 million of average net
assets and 1.5% of the remaining average net assets. These commitments may be
amended or rescinded in response to changes in the requirements of the various
states by the Trustees without shareholder approval.
The Advisory Agreement provides that it shall continue in effect with
respect to the Fund from year to year as long as it is approved at least
annually both (i) by a vote of a majority of the outstanding voting securities
of the Fund (as defined in the 1940 Act) or by the Trustees of the Trust, and
(ii) in either event by a vote of a majority of the Trustees who are not parties
to the Advisory Agreement or "interested persons" of any party thereto, cast in
person at a meeting called for the purpose of voting on such approval. The
Advisory Agreement may be terminated on 60 days written notice by either party
and will terminate
36
<PAGE>
automatically in the event of its assignment, as defined
under the 1940 Act and regulations thereunder. Such regulations provide that a
transaction which does not result in a change of actual control or management of
an adviser is not deemed an assignment.
Under a Funds Administration Agreement between the Investment Manager and
the Distributor, the Distributor provides assistance to the Investment Manager
in performing certain fund administrative services for the Trust, such as
assistance in determining the daily net asset value of shares of series of the
Trust and in preparing various reports required by regulations.
Under a Shareholders' Administrative Services Agreement between the Trust
and the Distributor, the Distributor provides shareholders' administrative
services, such as responding to inquiries and instructions from investors
respecting the purchase and redemption of shares of the Fund, and is entitled to
reimbursements of its costs for providing such services. Under certain
arrangements for Metropolitan to provide subadministration services,
Metropolitan may receive a fee for the maintenance of certain share ownership
records for participants in sponsored arrangements, employee benefit plans, and
similar programs and plans, through or under which the Fund's shares may be
purchased.
Under the Code of Ethics of the Investment Manager, its employees are only
permitted to engage in personal securities transactions which do not involve
securities which the Investment Manager has recommended for purchase or sale, or
purchased or sold, on behalf of its clients. All employees must report their
personal securities transactions quarterly and supply broker confirmations of
such transactions to the Investment Manager.
PURCHASE AND REDEMPTION OF SHARES
Shares of the Fund are distributed by the Distributor. The Fund offers
four classes of shares which may be purchased at the next determined net asset
value per share plus, in the case of all classes except Class C shares, a sales
charge which, at the election of the investor, may be imposed (i) at the time of
purchase (the Class A shares) or (ii) on a deferred basis (the Class B and Class
D shares). General information on how to buy shares of the Fund, as well as
sales charges involved, is set forth under "Purchase of Shares" in the
Prospectus. The following supplements that information.
Public Offering Price. The public offering price for each class of shares
of the Fund is based on their net asset value determined as of the close of NYSE
on the day the purchase order is received by State Street Research Shareholder
Services provided that the order is received prior to the close of the NYSE on
that day; otherwise the net asset value used is that determined as of the close
of the NYSE on the next day it is open for unrestricted trading. When a purchase
order is placed through a dealer, that dealer is responsible for transmitting
the order promptly to State Street Research Shareholder Services in order to
permit the
37
<PAGE>
investor to obtain the current price. Any loss suffered by an
investor which results from a dealer's failure to transmit an order promptly is
a matter for settlement between the investor and the dealer.
Reduced Sales Charges. For purposes of determining whether a purchase of
Class A shares qualifies for reduced sales charges, the term "person" includes:
(i) an individual, or an individual combining with his or her spouse and their
children and purchasing for his, her or their own account; (ii) a "company" as
defined in Section 2(a)(8) of the 1940 Act; (iii) a trustee or other fiduciary
purchasing for a single trust estate or single fiduciary account (including a
pension, profit sharing or other employee benefit trust created pursuant to a
plan qualified under Section 401 of the Internal Revenue Code); (iv) a
tax-exempt organization under Section 501(c)(3) or (13) of the Internal Revenue
Code; and (v) an employee benefit plan of a single employer or of affiliated
employers.
Investors may purchase Class A shares of the Fund at reduced sales charges
by executing a Letter of Intent to purchase no less than an aggregate of
$100,000 of the Fund or any combination of Class A shares of "Eligible Funds" as
designated by the Distributor within a 13-month period. The sales charge
applicable to each purchase made pursuant to a Letter of Intent will be that
which would apply if the total dollar amount set forth in the Letter of Intent
were being bought in a single transaction. Purchases made within a 90-day period
prior to the execution of a Letter of Intent may be included therein; in such
case the date of the earliest of such purchases marks the commencement of the
13-month period.
An investor may include toward completion of a Letter of Intent the value
(at the current public offering price) of all of his or her Class A shares of
the Fund and of any of the other Class A shares of Eligible Funds held of record
as of the date of his or her Letter of Intent, plus the value (at the current
offering price) as of such date of all of such shares held by any "person"
described herein as eligible to join with the investor in a single purchase.
Class B, Class C and Class D shares may also be included in the combination
under certain circumstances
A Letter of Intent does not bind the investor to purchase the specified
amount. Shares equivalent to 5% of the specified amount will, however, be taken
from the initial purchase (or, if necessary, subsequent purchases) and held in
escrow in the investor's account as collateral against the higher sales charge
which would apply if the total purchase is not completed within the allotted
time. The escrowed shares will be released when the Letter of Intent is
completed or, if it is not completed, when the balance of the higher sales
charge is, upon notice, remitted by the investor. All dividends and capital
gains distributions with respect to the escrowed shares will be credited to the
investor's account.
Investors may purchase Class A shares of the Fund or a combination of
Eligible Funds at reduced sales charges pursuant to a Right of Accumulation. The
applicable sales charge under this right is determined on the amount arrived at
by combining the dollar amount of the
38
<PAGE>
purchase with the value (at the current public offering price) of all Class A
shares of the other Eligible Funds owned as of the purchase date by the
investor plus the value (at the current public offering price) of all such
shares owned as of such date by any "person" described herein as eligible to
join with the investor in a single purchase. Class B, Class C and Class D
shares may also be included in the combination under certain circumstances.
Investors must submit to the Distributor sufficient information to show that
they qualify for this Right of Accumulation.
Class C Shares. Class C shares are currently available to (i) benefit
plans such as qualified retirement plans, other than individual retirement
accounts and self-employed retirement plans, which meet certain criteria
relating to minimum assets, minimum participants, service agreements, or similar
factors; (ii) tax-exempt retirement plans of the Investment Manager and its
affiliates, including the retirement plans of the Investment Manager's
affiliated brokers; (iii) unit investment trusts sponsored by the Investment
Manager or its affiliates; (iv) banks and insurance companies purchasing for
their own accounts; (v) investment companies not affiliated with the Investment
Manager; and (vi) endowment funds of nonprofit organizations with substantial
minimum assets. The entities included in categories (i), (iv) and (vi) may not
be affiliates of the Investment Manager.
Reorganizations. In the event of mergers or reorganizations with other
public or private collective investment entities, including investment companies
as defined in the 1940 Act, as amended, the Fund may issue its shares at net
asset value (or more) to such entities or to their security holders.
Redemptions. The Fund reserves the right to pay redemptions in kind with
portfolio securities in lieu of cash. In accordance with its election pursuant
to Rule 18f-1 under the 1940 Act, the Fund may limit the amount of redemption
proceeds paid in cash. Although it has no present intention to do so, the Fund
may, under unusual circumstances, limit redemptions in cash with respect to each
shareholder during any ninety-day period to the lesser of (i) $250,000, or (ii)
1% of the net asset value of the Fund at the beginning of such period. In
connection with any redemptions paid in kind with portfolio securities,
brokerage and other costs may be incurred by the redeeming shareholder in the
sale of the securities received.
NET ASSET VALUE
The net asset value of the shares of the Fund is determined once daily as
of the close of the NYSE, ordinarily 4 P.M. New York City time, Monday through
Friday, on each day during which the NYSE is open for unrestricted trading. The
NYSE is currently closed on New Year's Day, Presidents Day, Good Friday,
Memorial Day, Independence Day, Labor Day, Thanksgiving Day and Christmas Day.
39
<PAGE>
The net asset value per share of the Fund is computed by dividing the sum
of the value of the securities held by the Fund plus any cash or other assets
minus all liabilities by the total number of outstanding shares of the Fund at
such time. Any expenses, except for extraordinary or nonrecurring expenses,
borne by the Fund, including the investment management fee payable to the
Investment Manager, are accrued daily.
In determining the values of portfolio assets, the Trustees utilize one or
more pricing services to value debt securities for which market quotations are
not readily available on a daily basis. Most debt securities are valued on the
basis of data provided by such pricing services. Since the Fund is comprised
substantially of debt securities under normal circumstances, most of the Fund's
assets are therefore valued on the basis of such data from the pricing services.
The pricing services may provide prices determined as of times prior to the
close of the NYSE.
In general, securities are valued as follows. Securities which are listed
or traded on the NYSE or the American Stock Exchange are valued at the price of
the last quoted sale on the respective exchange for that day. Securities which
are listed or traded on a national securities exchange or exchanges, but not on
the NYSE or the American Stock Exchange, are valued at the price of the last
quoted sale on the exchange for that day prior to the close of the NYSE.
Securities not listed on any national securities exchange which are traded "over
the counter" and for which quotations are available on the National Association
of Securities Dealers' NASDAQ System, or other system, are valued at the closing
price supplied through such system for that day at the close of the NYSE. Other
securities are, in general, valued at the mean of the bid and asked quotations
last quoted prior to the close of the NYSE if there are market quotations
readily available, or in the absence of such market quotations, then at the fair
value thereof as determined by or under authority of the Trustees of the Trust
utilizing such pricing services as may be deemed appropriate as described above.
Securities deemed restricted as to resale are valued at the fair value thereof
as determined by or in accordance with methods adopted by the Trustees of the
Trust.
Short-term debt instruments issued with a maturity of one year or less
which have a remaining maturity of 60 days or less are valued using the
amortized cost method, provided that during any period in which more than 25% of
the Fund's total assets is invested in short-term debt securities the current
market value of such securities will be used in calculating net asset value per
share in lieu of the amortized cost method. The amortized cost method is used
when the value obtained is fair value. Under the amortized cost method of
valuation, the security is initially valued at cost on the date of purchase (or
in the case of short-term debt instruments purchased with more than 60 days
remaining to maturity, the market value on the 61st day prior to maturity), and
thereafter a constant amortization to maturity of any discount or premium is
assumed regardless of the impact of fluctuating interest rates on the market
value of the security.
40
<PAGE>
PORTFOLIO TRANSACTIONS
Portfolio Turnover
The Fund's portfolio turnover rate is determined by dividing the lesser of
securities purchases or sales for a year by the monthly average value of
securities held by the Fund (excluding, for purposes of this determination,
securities the maturities of which as of the time of their acquisition were one
year or less). The portfolio turnover rates for the fiscal years ended December
31, 1993 and 1994 were 33.11% and 64.80%, respectively. The Investment Manager
believes the portfolio turnover rate for the fiscal year ended December 31, 1994
was significantly higher than that for the previous fiscal year because of the
dramatic rise in interest rates during the year, which increased incentive to
shorten the duration and become more defensive in portfolio holdings. The rise
in interest rates also led the Investment Manager to book losses for tax
purposes to improve the Fund's dividend position. Additionally, lesser quality
securities underperformed through out the year, leading the Investment to sell
such securities.
Brokerage Allocation
The Fund and the Investment Manager seek the best overall execution of
purchase or sale orders and the most favorable net price in securities
transactions consistent with their judgment as to the business qualifications of
the various broker or dealer firms with which the Fund may do business.
Decisions with respect to the market in which the transaction is to be
completed, and to the allocation of orders among brokers or dealers, are made in
accordance with this policy. In selecting brokers or dealers to effect portfolio
transactions, consideration is given to the performance, integrity and financial
responsibility of the various firms as well as to their demonstrated execution
experience and capability generally and in regard to particular markets or
securities and, in agency transactions, to the competitiveness of the commission
rates (or in principal transactions of the net prices) they charge. The
Investment Manager keeps current as to the range of rates or prices charged by
various firms and against this background evaluates the reasonableness of a
commission or price charged with respect to a particular transaction by
considering such factors as difficulty of execution or security positioning by
the executing firm.
When it appears that a number of firms can satisfy the required standards
in respect of a particular transaction, consideration may also be given to
services other than execution services which such firms have provided in the
past or may provide in the future. Among such other services are the supplying
of supplemental investment research, general economic and political information,
analytical and statistical data, relevant market information and daily market
quotations for computation of net asset value. In this connection it should be
noted that a substantial portion of brokerage commissions paid, or principal
transactions entered, by the Fund may be with brokers and investment banking
firms which, in the normal course of business, publish statistical, research and
other material which is received by the Investment
41
<PAGE>
Manager and which may or may not prove useful to the Investment Manager, the
Fund, or other clients of the Investment Manager.
Neither the Fund nor the Investment Manager has any definite agreements
with any firm as to the amount of business which that firm may expect to receive
for services supplied or otherwise. There may be, however, understandings with
certain firms that in order for such firms to be able to continuously supply
certain services, they need to receive allocation of a specified amount of
business. These understandings are honored to the extent possible in accordance
with the policy set forth above. Neither the Fund nor the Investment Manager
intends to pay a firm in excess of that which another would charge for handling
the same transaction in recognition of services (other than execution services)
provided. However, the Fund and the Investment Manager are aware that this is an
area where differences of opinion as to fact and circumstances may exist, and in
such circumstances, if any, rely on the provisions of Section 28(e) of the
Securities Exchange Act of 1934, to the extent applicable. For the fiscal years
ended December 31, 1992, 1993 and 1994, the Fund paid no brokerage commissions.
During and at the end of its most recent fiscal year, the Fund held in its
portfolio no securities of any entity that might be deemed to be a regular
broker dealer of the Fund as defined under the 1940 Act.
Occasions may arise when the Investment Manager determines that an
investment in a particular security, or the disposition of a particular
security, is simultaneously a proper investment decision for the Fund as well as
for the portfolio of one or more of its other clients. In this event, a purchase
or sale, as the case may be, of any such security on any given day will be
normally averaged as to price and allocated as to amount among the several
clients in a manner deemed equitable to each client.
On occasions when the Investment Manager deems the purchase or sale of a
security to be in the best interests of the Fund, as well as other clients of
the Investment Manager, the Investment Manager, to the extent permitted by
applicable laws and regulations, may aggregate such securities to be sold or
purchased for the Fund with those to be sold or purchased for other customers in
order to obtain best execution and lower brokerage commissions, if any. In such
event, allocation of the securities so purchased or sold, as well as the
expenses incurred in the transaction, will be made by the Investment Manager in
the manner it considers to be most equitable and consistent with its fiduciary
obligations to all such customers, including the Fund. In some instances, this
procedure may affect the price and size of the positions obtainable for the
Fund.
42
<PAGE>
CERTAIN TAX MATTERS
Federal Income Taxation of the Fund -- In General
The Fund intends to qualify and elect to be treated each taxable year as a
"regulated investment company" under Subchapter M of the Internal Revenue Code
of 1986, as amended (the "Code"), although it cannot give complete assurance
that it will do so. Accordingly, the Fund must, among other things, (a) derive
at least 90% of its gross income in each taxable year from dividends, interest,
payments with respect to securities loans, gains from the sale or other
disposition of stock, securities or foreign currencies, or other income
(including, but not limited to, gains from options, futures, or forward
contracts) derived with respect to its business of investing in such stock,
securities or currencies (the "90% test"); (b) derive less than 30% of its gross
income in each taxable year from the sale or other disposition of any of the
following held for less than three months (the "30% test"): (i) stocks or
securities; (ii) options, futures, or forward contracts (other than options,
futures, or forward contracts on foreign currencies); or (iii) foreign
currencies (or options, futures, or forward contracts on foreign currencies),
but only if such currencies (or options, futures, or forward contracts) are not
directly related to the Fund's principal business of investing in stocks or
securities (or options and futures with respect to stocks or securities); and
(c) satisfy certain diversification requirements. Furthermore, in order to be
entitled to pay tax-exempt interest income dividends to its shareholders, the
Fund must satisfy the requirement that, at the close of each quarter of its
taxable year, at least 50% of the value of its total assets consist of
obligations the interest of which is exempt from federal income tax under Code
section 103(a).
The 30% test will limit the extent to which the Fund may sell securities
held for less than three months, write options which expire in less than three
months and effect closing transactions with respect to call or put options that
have been written or purchased within the preceding three months. (If the Fund
purchases a put option for the purpose of hedging an underlying portfolio
security, the acquisition of the option is treated as a short sale of the
underlying security unless, for purposes only of the 30% test, the option and
the security are acquired on the same date.) Finally, as discussed below, this
requirement may also limit investments by the Fund in options on stock indices,
listed options on nonconvertible debt securities, futures contracts, options on
interest rate futures contracts and certain foreign currency contracts.
If the Fund should fail to qualify as a regulated investment company in
any year, it would lose the beneficial tax treatment accorded regulated
investment companies under Subchapter M of the Code and all of its taxable
income would be subject to tax at regular corporate rates without any deduction
for distributions to shareholders, and such distributions will be taxable to
shareholders as ordinary income to the extent of the Fund's current accumulated
earnings and profits. Also, the shareholders, if they received a distribution in
excess of current or accumulated earnings and profits, would receive a return of
capital that would reduce the basis of their shares of the Fund.
43
<PAGE>
The Fund will be liable for a nondeductible 4% excise tax on amounts not
distributed on a timely basis in accordance with a calendar year distribution
requirement. To avoid the tax, during each calendar year the Fund must
distribute an amount equal to at least 98% of the sum of its ordinary income
(not taking into account any capital gains or losses) for the calendar year, and
its capital gain net income for the 12-month period ending on October 31, in
addition to any undistributed portion of the respective balances from the prior
year. Because the excise tax is based upon undistributed taxable income, it will
not apply to tax-exempt income received by the Fund. The Fund intends to make
sufficient distributions to avoid this 4% excise tax.
Federal Income Taxation of the Fund's Investments
Original Issue Discount. For federal income tax purposes, debt securities
purchased by the Fund may be treated as having original issue discount. Original
issue discount represents interest for federal income tax purposes and can
generally be defined as the excess of the stated redemption price at maturity of
a debt obligation over the issue price. Original issue discount is treated for
federal income tax purposes as earned by the Fund, whether or not any income is
actually received, and therefore is subject to the distribution requirements of
the Code. Generally, the amount of original issue discount is determined on the
basis of a constant yield to maturity which takes into account the compounding
of accrued interest. Under section 1286 of the Code, an investment in a stripped
bond or stripped coupon will result in original issue discount.
Debt securities may be purchased by the Fund at a discount that exceeds
the original issue discount plus previously accrued original issue discount
remaining on the securities, if any, at the time the Fund purchases the
securities. This additional discount represents market discount for income tax
purposes. In the case of any debt security (other than a tax-exempt obligation)
issued after July 18, 1984, having a fixed maturity date of more than one year
from the date of issue and having market discount, the gain realized on
disposition will be treated as interest income to the extent it does not exceed
the accrued market discount on the security (unless the Fund elects to include
such accrued market discount in income in the tax year to which it is
attributable). Generally, market discount is accrued on a daily basis. The Fund
may be required to capitalize, rather than deduct currently, part or all of any
direct interest expense incurred to purchase or carry any debt security having
market discount, unless the Fund makes the election to include market discount
currently. Because the Fund must take into account all original issue discount
for purposes of satisfying various requirements to qualify as a regulated
investment company under Subchapter M of the Code, it will be more difficult for
the Fund to make the distributions required for the Fund to maintain such status
and, with respect to debt securities that are not tax-exempt, to avoid the 4%
excise tax described above.
Options and Futures Transactions. Certain of the Fund's investments may be
subject to provisions of the Code that (i) require inclusion of unrealized gains
or losses in the Fund's
44
<PAGE>
income for purposes of the 90% test, the 30% test, the excise tax and the
distribution requirements applicable to regulated investment companies; (ii)
defer recognition of realized losses; and (iii) characterize both realized and
unrealized gain or loss as short-term or long-term gain or loss. Such
provisions generally apply to, among other investments, options on debt
securities, indices on securities and futures contracts.
Federal Income Taxation of Shareholders
Distributions generally are taxable to shareholders at the time made
unless tax-exempt. However, dividends declared by the Fund in October, November
or December and made payable to shareholders of record on a specified date in
such a month are treated as received by such shareholders on December 31,
provided that the Fund pays the dividend during January of the following year.
It is expected that none of the Fund's distributions will qualify for the
corporate dividends-received deduction.
Distributions by the Fund can result in a reduction in the fair market
value of the Fund's shares. Should a distribution reduce the fair market value
below a shareholder's cost basis, such distribution nevertheless may be taxable
to the shareholder, to the extent that it is derived from other than tax-exempt
interest, as ordinary income or long-term capital gain, even though, from an
investment standpoint, it may constitute a partial return of capital. 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 any forthcoming distribution. Those investors
purchasing shares just prior to a distribution will then receive a return of
investment upon distribution which will nevertheless be taxable to them.
To the extent that the Fund's dividends are derived from interest income
exempt from federal income tax and are designated as "exempt-interest dividends"
by the Fund, they will be excludable from a shareholder's gross income for
federal income tax purposes. "Exempt-interest dividends," however, must be taken
into account by shareholders in determining whether their total incomes are
large enough to result in taxation of up to one-half of their Social Security
benefit. Interest on indebtedness incurred or continued by a shareholder to
purchase or carry shares of the Fund is not deductible.
A shareholder should be aware that a redemption of shares (including any
exchange into another Eligible Fund) is a taxable event and, accordingly,
capital gain or loss may be recognized. A loss realized by a shareholder on the
redemption or exchange of shares of the Fund with respect to which
exempt-interest dividends have been paid will be disallowed to the extent of
such dividends if the shares have not been held by the shareholder for more than
six months. Similarly, if a shareholder receives a distribution taxable as
long-term capital gain and redeems or exchanges shares before he has held them
for more than six months, any loss on the redemption or exchange (not otherwise
disallowed as attributable to an exempt-interest
45
<PAGE>
dividend) will be treated as long-term capital loss to the extent of such
capital gains distribution.
Opinions relating to the validity of tax-exempt securities and the
exemption of interest thereon from federal income tax are rendered by bond
counsel to the issuers. Neither the Investment Manager's nor the Fund's counsel
makes any review of proceedings relating to the issuance of tax-exempt
securities or the bases of such opinions.
Interest on "private activity" bonds issued after August 7, 1986 is
subject to the federal alternative minimum tax, although the interest continues
to be excludable from gross income for other purposes. The alternative minimum
tax, or AMT, is a supplemental tax designed to ensure that taxpayers pay at
least a minimum amount of tax on their income, even if they make substantial use
of certain tax deductions and exclusions. Interest from private activity bonds
is a "tax preference" item that is added into income from other sources for the
purpose of determining whether a taxpayer is subject to the AMT and the amount
of any tax to be paid. Corporate investors should note that for purposes of the
corporate AMT there is an upward adjustment equal to 75% of the amount by which
adjusted current earnings exceeds alternative minimum taxable income.
Prospective investors should consult their own tax advisors with respect to the
possible application of the AMT to their tax situation.
The exemption of interest income for federal income tax purposes does not
necessarily result in exemption under the income or other tax laws of any state
or local taxing authority. Shareholders of the Fund may be exempt from state and
local taxes on distributions of tax-exempt interest income derived from
obligations of the state and/or municipalities of the state in which they are
resident, but taxable generally on income derived from obligations of other
jurisdictions. Shareholders should consult their tax advisers about the status
of distributions from the Fund in their own states and localities.
DISTRIBUTION OF SHARES OF THE FUND
State Street Research Tax-Exempt Trust (formerly MetLife - State Street
Tax-Exempt Trust) is currently comprised of the following series: State Street
Research Tax-Exempt Fund (formerly MetLife - State Street Tax-Exempt Fund),
State Street Research New York Tax-Free Fund, State Street Research California
Tax-Free Fund, State Street Research Florida Tax-Free Fund and State Street
Research Pennsylvania Tax-Free Fund. The Trustees have authorized shares of the
Fund to be issued in four classes: Class A, Class B, Class C and Class D shares.
The Trustees of the Trust have authority to issue an unlimited number of shares
of beneficial interest of separate series, $.001 par value per share. A "series"
is a separate pool of assets of the Trust which is separately managed and has a
different investment objective and different investment policies from those of
another series. The Trustees have authority, without the necessity of a
shareholder vote, to create any number of new series or classes or to commence
the public offering of shares of any previously established series or class.
46
<PAGE>
The Trust has entered into a Distribution Agreement with State Street
Research Investment Services, Inc., as Distributor, whereby the Distributor acts
as agent to sell and distribute shares of the Fund. Shares of the Fund are sold
through dealers who have entered into sales agreements with the Distributor. The
Distributor distributes shares of the Fund on a continuous basis at an offering
price which is based on the net asset value per share of the Fund plus (subject
to certain exceptions) a sales charge which, at the election of the investor,
may be imposed (i) at the time of purchase (the Class A shares) or (ii) on a
deferred basis (Class B and Class D shares). The Distributor may reallow all or
portions of such sales charges as concessions to dealers. For the fiscal years
ended December 31, 1992 total sales charges amounted to approximately $987,000.
For the same period, approximately $117,000 was retained by the Distributor
after reallowance of concessions to dealers. Prior to the adoption of multiple
classes of shares during the fiscal year ended December 31, 1993, sales charges
amounted to approximately $444,000 for the period January 1, 1993 through June
4, 1993, of which approximately $53,000 was retained by the Distributor after
reallowance of concessions to dealers. Following the adoption of multiple
classes of shares, total sales charges on Class A shares paid to the Distributor
for the period June 5, 1993 through December 31, 1993 and for the fiscal year
ended December 31, 1994, amounted to approximately $531,000 and $257,000,
respectively, of which approximately $35,000 and $31,000, respectively, was
retained by the Distributor after reallowance of concessions to dealers.
The differences in the price at which the Fund's Class A shares are
offered due to scheduled variations in sales charges, as described in the Fund's
Prospectus, result from cost savings inherent in economies of scale. Management
believes that the cost of sales efforts of the Distributor and broker-dealers
tends to decrease as the size of purchases increases, or does not involve any
incremental sales expenses as in the case of, for example, exchanges,
reinvestments or dividend investments at net asset value. Similarly, no
significant sales effort is necessary for sales of shares at net asset value to
certain Directors, Trustees, officers, employees, their relatives and other
persons directly or indirectly related to the Fund or associated entities. Where
shares of the Fund are offered at a reduced sales charge or without a sales
charge pursuant to sponsored arrangements, the amount of the sales charge
reduction will similarly reflect the anticipated reduction in sales expenses
associated with such sponsored arrangements. The reductions in sales expenses,
and therefore the reduction in sales charge, will vary depending on factors such
as the size and stability of the organization, the term of the organization's
existence and certain characteristics of its members. The Fund reserves the
right to make variations in, or eliminate, sales charges at any time or to
revise the terms of or to suspend or discontinue sales pursuant to sponsored
arrangements at any time.
On any sale of Class A shares to a single investor in the amount of
$1,000,000 or more, the Distributor will pay the authorized securities dealer
making such sale a commission on the shares sold. Such commission also is
payable to authorized securities dealers upon sales of Class A shares made
pursuant to a Letter of Intent to purchase shares having a net asset value of
$1,000,000 or more. Shares sold with such commissions payable are subject to
47
<PAGE>
a one-year contingent deferred sales charge of 1.00% on any portion of such
shares redeemed within one year following their sale. After a particular
purchase of Class A shares is made under the Letter of Intent, the commission
will be paid only in respect of that particular purchase of shares. If the
Letter of Intent is not completed, the commission paid will be deducted from
any discounts or commissions otherwise payable to such dealer in respect of
shares actually sold. If an investor is eligible to purchase shares at net
asset value on account of the Right of Accumulation, the commission will be
paid only in respect of the incremental purchase at net asset value.
For the periods shown below, the Distributor received contingent deferred
sales charges upon redemption of Class B and Class D shares of the Fund and paid
initial commissions to securities dealers for sales of Class B and Class D
shares as follows:
June 4, 1993
(Commencement of
Fiscal Year share class designations)
Ended December 31, 1994 to December 31, 1993
Contingent Commissions Contingent Commissions
Deferred Paid to Deferred Paid to
Sales Charges Dealers Sales Charges Dealers
Class B $47,848 $247,699 $4,974 $284,191
Class D $ 0 $ 1,194 $ 0 $ 3,002
The Fund has adopted a "Plan of Distribution Pursuant to Rule 12b-1" (the
"Distribution Plan") under which the Fund may engage, directly or indirectly, in
financing any activities primarily intended to result in the sale of Class A,
Class B and Class D shares, including, but not limited to, (1) the payment of
commissions and/or reimbursement to underwriters, securities dealers and others
engaged in the sale of shares, including payments to the Distributor to be used
to pay commissions and/or reimbursement to securities dealers (which securities
dealers may be affiliates of the Distributor) engaged in the distribution and
marketing of shares and furnishing ongoing assistance to investors, (2)
reimbursement of direct out-of-pocket expenditures incurred by the Distributor
in connection with the distribution and marketing of shares and the servicing of
investor accounts including special promotional fees and cash and noncash
incentives based upon sales by securities dealers, expenses relating to the
formulation and implementation of marketing strategies and promotional
activities such as direct mail promotions and television, radio, newspaper,
magazine and other mass media advertising, the preparation, printing and
distribution of Prospectuses of the Fund and reports for recipients other than
existing shareholders of the Fund, and obtaining such information, analyses and
reports with respect to marketing and promotional activities and investor
accounts as the Fund may, from time to time, deem advisable, and (3)
reimbursement of expenses incurred by the Distributor in connection with
48
<PAGE>
the servicing of shareholder accounts including payments to securities dealers
and others in consideration of the provision of personal services to investors
and/or the maintenance of shareholder accounts and expenses associated with the
provision of personal services by the Distributor directly to investors. In
addition, the Distribution Plan is deemed to authorize the Distributor and the
Investment Manager to make payments out of general profits, revenues or other
sources to underwriters, securities dealers and others in connection with sales
of shares, to the extent, if any, that such payments may be deemed to be within
the scope of Rule 12b-1 under the 1940 Act.
The expenditures to be made pursuant to the Distribution Plan may not
exceed (i) with respect to Class A shares, an annual rate of 0.25% of the
average daily value of net assets represented by such Class A shares, and (ii)
with respect to Class B and Class D shares, an annual rate of 0.75% of the
average daily value of the net assets represented by such Class B or Class D
shares (as the case may be) to finance sales or promotion expenses and an annual
rate of 0.25% of the average daily value of the net assets represented by such
Class B or Class D shares (as the case may be) to make payments for personal
services and/or the maintenance of shareholder accounts. Proceeds from the
service fee will be used by the Distributor to compensate securities dealers and
others selling shares of the Fund for rendering service to shareholders on an
ongoing basis. Such amounts are based on the net asset value of shares of the
Fund held by such dealers as nominee for their customers or which are owned
directly by such customers for so long as such shares are outstanding and the
Distribution Plan remains in effect with respect to the Fund. Any amounts
received by the Distributor and not so allocated may be applied by the
Distributor as reimbursement for expenses incurred in connection with the
servicing of investor accounts. The distribution and servicing expenses of a
particular class will be borne solely by that class.
49
<PAGE>
During the fiscal year ended December 31, 1994, the Fund paid the
Distributor fees under the Distribution Plan and the Distributor used all of
such payments for expenses incurred on behalf of the Fund as follows:
Class A Class B Class D
Advertising $ 0 $ 0 $2,101
Printing and mailing of prospectuses
to other than current shareholders 0 0 522
Compensation to dealers 45,080 104,613 786
Compensation to sales personnel 0 0 3,280
Interest 0 0 0
Carrying or other financing charges 0 0 0
Other expenses 0 0 1,608
Total Fees $45,080 $104,613 $8,297
The Distributor may have also used additional resources of its own for further
expenses on behalf of the Trust.
No interested person of the Fund or independent Trustee of the Trust has
any direct or indirect financial interest in the operation of the Distribution
Plan or any related agreements thereunder. The Distributor's interest in the
Distribution Plan is described above.
To the extent that the Glass-Steagall Act may be interpreted as
prohibiting banks and other depository institutions from being paid for
performing services under the Distribution Plan, the Fund will make alternative
arrangements for such services for shareholders who acquired shares through such
institutions.
CALCULATION OF PERFORMANCE DATA
The average annual total return ("standard total return") and yield of the
Class A, Class B, Class C and Class D shares of the Fund will be calculated as
set forth below. Total return and yield are computed separately for each class
of shares of the Fund. Performance data for a specified class includes periods
prior to the adoption of class designations. Shares
50
<PAGE>
of the Fund had no class designations until June 5, 1993 when designations were
assigned based on the pricing and 12b-1 fees applicable to shares sold
thereafter.
All calculations of performance data in this section reflect the voluntary
measures by the Fund's affiliates to reduce fees or expenses relating to the
Fund; see "Accrued Expenses" later in this section.
The performance data reflects Rule 12b-1 fees and sales charges as set
forth below:
Rule 12b-1 Fees Sales Charges
----------------------------- -----------------------------------
Current
Class Amount Period
- ----- ------- ------
A 0.25% June 5, 1993 to present; fee will Maximum 4.5% sales
reduce performance for periods charge reflected
after June 5, 1993
B 1.00% June 5, 1993 to present; fee will 1- and 5-year periods
reduce performance for periods reflect a 5% and a
after June 5, 1993 2% contingent deferred
sales charge, respectively
C None Since commencement of None
operations to present
D 1.00% June 5, 1993 to present; fee will 1-year period reflects
reduce performance for periods a 1% contingent deferred
after June 5, 1993 sales charge
Total Return
- ------------
The Fund's average annual total return ("standard total return") of each
class of shares was as follows:
Commencement of
Operations Five Years One Year
(July 5, 1989) Ended Ended
Fund to December 31, 1994 December 31, 1994 December 31, 1994
- ---- -------------------- ----------------- -----------------
With Without With Without With Without
Subsidy Subsidy Subsidy Subsidy Subsidy Subsidy
------- ------- ------- ------- ------- -------
Class A 5.26% 4.66% 5.44% 4.94% -10.26% -10.49%
Class B 5.92% 5.31% 5.85% 5.35% -11.40% -11.62%
Class C 6.25% 5.65% 6.52% 6.04% -5.79% -6.03%
Class D 5.92% 5.31% 6.16% 5.66% -7.79% -8.02%
51
<PAGE>
Standard total return is computed by determining the average annual
compounded rates of return over the designated periods that, if applied to the
initial amount invested would produce the ending redeemable value, according to
the following 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 at the end of the
designated period assuming a hypothetical $1,000
payment made at the beginning of the designated
period
The calculation is based on the further assumptions that the maximum
initial or contingent deferred sales charge applicable to the investment is
deducted, and that all dividends and distributions by the Fund are reinvested at
net asset value on the reinvestment dates during the periods. All accrued
expenses and recurring charges are also taken into account as described later
herein.
Yield
- -----
The annualized yield of each class of shares of the Fund based on the
month of December 1994 was as follows:
With Subsidy Without Subsidy
------------ ---------------
Class A 5.35% 4.96%
Class B 4.85% 4.45%
Class C 5.84% 5.44%
Class D 4.88% 4.48%
Yield for each of the Fund's Class A, Class B, Class C and Class D shares
is computed by dividing the net investment income per share earned during a
recent month or other specified 30-day period by the applicable maximum offering
price per share on the last day of the period and annualizing the result,
according to the following formula:
YIELD = 2[( a-b + 1)6 -1]
--- cd
Where: a = dividends and interest earned during the period
52
<PAGE>
b = expenses accrued for the period (net of voluntary expense
reductions by the Investment Manager)
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
To calculate interest earned (for the purpose of "a" above) on debt
obligations, the Fund computes the yield to maturity of each obligation held by
the Fund based on the market value of the obligation (including actual accrued
interest) at the close of the last business day of the preceding period, or,
with respect to obligations purchased during the period, the purchase price
(plus actual accrued interest). The yield to maturity is then divided by 360 and
the quotient is multiplied by the market value of the obligation (including
actual accrued interest) to determine the interest income on the obligation for
each day of the period that the obligation is in the portfolio. Dividend income
is recognized daily based on published rates.
In the case of a tax-exempt obligation issued without original issue
discount and having a current market discount, the coupon rate of interest is
used in lieu of the yield to maturity. Where, in the case of a tax-exempt
obligation with original issue discount, the discount based on the current
market value exceeds the then-remaining portion of original issue discount
(market discount), the yield to maturity is the imputed rate based on the
original issue discount calculation. Where, in the case of a tax-exempt
obligation with original issue discount, the discount based on the current
market value is less than the then-remaining portion of original issue discount
(market premium), the yield to maturity is based on the market value. Dividend
income is recognized daily based on published rates.
With respect to the treatment of discount and premium on mortgage or other
receivables-backed obligations which are expected to be subject to monthly
payments of principal and interest ("paydowns"), the Fund accounts for gain or
loss attributable to actual monthly paydowns as a realized capital gain or loss
during the period. The Fund has elected not to amortize discount or premium on
such securities.
Undeclared earned income, computed in accordance with generally accepted
accounting principles, may be subtracted from the maximum offering price.
Undeclared earned income is the net investment income which, at the end of the
base period, has not been declared as a dividend, but is reasonably expected to
be declared as a dividend shortly thereafter. The maximum offering price
includes a maximum sales charge of 4.5% with respect to the Class A shares.
All accrued expenses are taken into account as described later herein.
53
<PAGE>
Yield information is useful in reviewing the Fund's performance, but
because yields fluctuate, such information cannot necessarily be used to compare
an investment in the Fund's shares with bank deposits, savings accounts and
similar investment alternatives which are insured and/or often provide an agreed
or guaranteed fixed yield for a stated period of time. Shareholders should
remember that yield is a function of the kind and quality of the instruments in
the Fund's portfolio, portfolio maturity and operating expenses and market
conditions.
Tax Equivalent Yield
- --------------------
The tax equivalent yield of each class of shares of the Fund for the month
ended December 31, 1994, assuming a combined federal and state maximum effective
marginal income tax rate of 46.88% was as follows:
With Subsidy Without Subsidy
------------ ---------------
Class A 10.07% 9.34%
Class B 9.13% 8.38%
Class C 10.99% 10.24%
Class D 9.19% 8.43%
The Fund's tax equivalent yield is computed by dividing that portion of
the Fund's yield (computed as described under "Yield" above) which is
tax-exempt, by the complement of the combined federal and state maximum
effective marginal income tax rate of 46.88% (or other relevant rate) and adding
the result to that portion, if any, of the yield of the Fund that is not
tax-exempt. The complement, for example, of a tax rate of 46.88% is 53.12%, that
is [1.00 - .4688 = .5312].
Accrued Expenses
- ----------------
Accrued expenses include all recurring expenses that are charged to all
shareholder accounts in proportion to the length of the base period. The
standard total return and yield results take sales charges, if applicable, into
account, although the results do not take into account recurring and
nonrecurring charges for optional services which only certain shareholders elect
and which involve nominal fees, such as the $7.50 fee for wire orders.
Accrued expenses do not include the subsidization, if any, by affiliates
of fees or expenses during the subject period. In the absence of such
subsidization, the performance of the Fund would have been lower.
54
<PAGE>
Nonstandardized Total Return
- ----------------------------
The Fund may provide the above described standard total return results for
Class A, Class B, Class C and Class D shares for periods which end no earlier
than the most recent calendar quarter end and which begin twelve months before
and at the time of commencement of the Fund's operations. In addition, the Fund
may provide nonstandardized total return results for differing periods, such as
for the most recent six months, and/or without taking sales charges into
account. Such nonstandardized total return is computed as otherwise described
under "Total Return" except that the result may or may not be annualized, and as
noted any applicable sales charge, if any, may not be taken into account and
therefore not deducted from the hypothetical initial payment of $1,000. For
example, the Fund's nonstandardized total return for the six months ended
December 31, 1994, without taking sales charges into account were as follows:
With Subsidy Without Subsidy
------------ ---------------
Class A -1.37% -1.56%
Class B -1.74% -1.93%
Class C -1.24% -1.43%
Class D -1.87% -2.06%
Distribution Rates
- ------------------
The Fund may also quote its distribution rate for each class of shares.
The distribution rate is calculated by annualizing the latest per-share
distribution from ordinary income and dividing the result by the maximum
offering price per share as of the end of the period. A distribution can include
gross investment income from debt obligations purchased at a premium and in
effect include a portion of the premium paid. A distribution can also include
nonrecurring, gross short-term capital gains without recognition of any
unrealized capital losses. Further, a distribution can include income from the
sale of options by the Fund even though such option income is not considered
investment income under generally accepted accounting principles.
Because a distribution can include such premiums, capital gains and option
income, the amount of the distribution may be susceptible to control by the
Investment Manager through transactions designed to increase the amount of such
items. Also, because the distribution rate is calculated in part by dividing the
latest distribution by the offering price, which is based on net asset value
plus any applicable sales charge, the distribution rate will increase as the net
asset value declines. A distribution rate can be greater than the yield rate
calculated as described above.
55
<PAGE>
The distribution rates of the Fund, based on the month of December 1994
were as follows:
Class A 5.24%
Class B 4.72%
Class C 5.73%
Class D 4.72%
CUSTODIAN
State Street Bank and Trust Company, 225 Franklin Street, Boston,
Massachusetts 02110, is the Trust's custodian. As custodian, State Street Bank
and Trust Company is responsible for, among other things, safeguarding and
controlling the Fund's cash and securities, handling the receipt and delivery of
securities and collecting interest and dividends on the Fund's investments.
State Street Bank and Trust Company is not an affiliate of the Investment
Manager or its affiliates.
INDEPENDENT ACCOUNTANTS
Price Waterhouse LLP, 160 Federal Street, Boston, Massachusetts 02110,
serves as the Trust's independent accountants, providing professional services
including (1) an audit of the Fund's annual financial statements, (2) assistance
and consultation in connection with Securities and Exchange Commission filings
and (3) review of the annual income tax returns filed on behalf of the Fund.
FINANCIAL STATEMENTS
In addition to the reports provided to holders of record on a semiannual
basis, other supplementary reports may be made available and holders of record
may request a copy of a current supplementary report, if any, by calling State
Street Research Shareholder Services.
The following financial statements are for the Fund's fiscal year ended
December 31, 1994:
56
<PAGE>
State Street Research New York Tax-Free Fund
Investment Portfolio
December 31, 1994
<TABLE>
<CAPTION>
Principal Amount Maturity Date Value (Note 1)
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Municipal Bonds 98.4%
General $ 500,000 The City of New York, General Obligation
Obligation Bonds, Fiscal 1992 Series H, 7.00% 2/01/2005 $ 508,000
21.9% 900,000 County of Ontario, New York, General
Obligations, Refunding Serial Bonds, Series
1993, FGIC Insured, 5.25% 8/15/2005 843,534
1,000,000 State of New York Municipal Bond Bank Agency, Special Program
Revenue Bonds (City of Rochester), 1991 Series A, 6.625% 3/15/2006 1,022,030
1,000,000 City of Niagara Falls, Niagara County, New York, Water
Treatment Plant Bonds, 1994 (AMT), MBIA Insured, 8.50% 11/01/2006 1,173,150
2,000,000 County of Onondaga, New York, General Improvement (Serial)
Bonds, 1992, 5.70% 4/01/2007 1,911,640
285,000 Riverhead, New York, General Obligation Unlimited
Tax Bonds, Series B, AMBAC Insured, 4.75% 6/15/2007 247,072
280,000 Riverhead, New York, General Obligation Unlimited
Tax Bonds, Series B, AMBAC Insured, 4.75% 6/15/2008 238,543
1,000,000 City of Syracuse, Onondaga County, New York, Public Improvement
Refunding Bonds, Series
1993 A, 5.125% 2/15/2009 886,920
1,500,000 County of Albany, New York, General Obligation Serial Bonds,
Series 1994, FGIC Insured, 5.75% 6/01/2009 1,401,030
900,000 Town of New Castle, Westchester County, New York, Public
Improvement Refunding, 4.75% 6/01/2009 757,854
500,000 City of Buffalo, New York, Refunding Serial Bonds-1991, FGIC
Insured, 6.25% 2/01/2010 487,610
250,000 Town of New Castle, Westchester County, New York, Public
Improvement Refunding, 4.75% 6/01/2010 207,818
250,000 Town of New Castle, Westchester County, New York, Public
Improvement Refunding, 4.75% 6/01/2011 205,162
990,000 The City of New York, General Obligation Bonds, Fiscal 1991
Series B, 7.75% 2/01/2012 1,034,411
2,000,000 Puerto Rico Municipal Finance Agency, 1994 Series A Bonds, FSA
Insured, 6.00% 7/01/2014 1,881,960
3,000,000 The City of New York, General Obligation Bonds, Fiscal 1995
Series B, 7.00% 8/15/2016 2,953,800
---------------
15,760,534
---------------
The accompanying notes are an integral part of the financial statements.
57
<PAGE>
Principal Amount Maturity Date Value (Note 1)
- -----------------------------------------------------------------------------------------------------------------------------------
Airport $2,000,000 New York City Industrial Development Agency, Special Facility
Revenue Revenue Bonds, Series 1994, (Terminal One Group Association,
4.7% L.P. Project), 6.10% 1/01/2009 $1,871,500
1,000,000 Monroe County Airport Authority, Greater Rochester
International Airport Refunding Bonds, MBIA Insured, Subject to
AMT, Series 1993, 5.50% 1/01/2013 878,490
600,000 Monroe County Airport Authority, Greater Rochester
International Airport Revenue Bonds, MBIA Insured, Subject to
AMT, Series 1989, 7.25% 1/01/2019 620,160
--------------
3,370,150
---------------
Certificates of 1,185,000 City of Syracuse, New York, (Syracuse Hancock International
Participation Airport), Certificates of Participation, Series 1992, Subject
1.7% to AMT, 6.60% 1/01/2006 1,220,514
---------------
College & 1,250,000 Dormitory Authority of the State of New York, Union College,
University Insured Revenue Bonds, Series 1992, FGIC Insured, 5.70% 7/01/2005 1,215,438
3.8% 600,000 Dormitory Authority of the State of New York, Cornell
University, Revenue Bonds, Series 1986, 6.875% 7/01/2014 612,150
1,000,000 Dormitory Authority of the State of New York, Ithaca College,
Revenue Bonds, Series 1991,
MBIA Insured, 6.25% 7/01/2021 937,510
---------------
2,765,098
---------------
Escrowed 450,000 Dormitory Authority of the State of New York, Judicial
Bonds Facilities Lease Revenue Bonds, (Suffolk County Issue) Series
0.7% 1986, 7.375% 7/01/2016 481,640
---------------
Hospital/ 1,000,000 New York City Health and Hospitals Corporation, Health System
Health Care Bonds, Series 1993 A, 6.00% 2/15/2007 911,590
1.9% 200,000 New York State Medical Care Facilities Finance Agency, Hospital
and Nursing Home, FHA-Insured, Mortgage Revenue Bonds, 1988
Series B, 8.00% 2/15/2008 215,656
230,000 New York State Medical Care Facilities Finance Agency, Mental
Health Services Facilities Improvement Revenue Bonds, 1990
Series A Refunding, 7.75% 8/15/2010 242,252
---------------
1,369,498
---------------
The accompanying notes are an integral part of the financial statements.
58
<PAGE>
Investment Portfolio (cont'd)
Principal Amount Maturity Date Value (Note 1)
- -----------------------------------------------------------------------------------------------------------------------------------
Industrial $4,000,000 Herkimer County Industrial Development Agency, Industrial
Development Development Revenue Bonds, (Burrows Paper Corporation Solid
& Pollution Waste Disposal Facility), Series 1993, Subject to AMT, 8.00% 1/01/2009 $4,233,640
Control 2,000,000 Puerto Rico Industrial, Medical and Environmental Pollution
12.2% Control Facilities Financing Authority, Revenue Bonds, Series
A, 6.25% 11/15/2013 1,924,900
400,000 New York State Energy Research and Development Authority,
Central Hudson Gas & Electric Company, FGIC Insured, Series B,
7.375% 10/01/2014 420,512
1,055,000 New York State Energy Research and Development Authority,
Brooklyn Union Gas Company, Series II, 7.00% 12/01/2020 1,060,940
1,100,000 New York State Energy Research and Development Authority, Gas
Facilities Revenue Bonds, Series 1985I, (The Brooklyn Union Gas
Company Project), 7.125% 12/01/2020 1,104,334
---------------
8,744,326
---------------
Lease 1,500,000 Dormitory Authority of the State of New York, Judicial
Revenue Facilities Lease Revenue Bonds, (Suffolk County Issue), Series
4.3% 1991A, 9.25% 4/15/2006 1,676,955
500,000 Lyons Community Health Initiatives Corp., (New York), Facility
Revenue Bonds, Series 1994, 6.55% 9/01/2009 482,190
1,000,000 Lyons Community Health Initiatives Corp., (New York), Facility
Revenue Bonds, Series 1994, 6.80% 9/01/2024 958,200
---------------
3,117,345
---------------
Life Care 1,000,000 Orange County Industrial Development Agency, (The Glen Arden
4.2% Inc. Project), Life Care Community Revenue Bonds, Series 1994,
8.25% 1/01/2002 1,001,170
600,000 Tompkins County Industrial Development Agency, Life Care
Community Revenue Bonds, 1994 (Kendal at Ithaca, Inc. Project),
7.625% 6/01/2009 591,138
1,430,000 Tompkins County Industrial Development Agency, Life Care
Community Revenue Bonds, 1994 (Kendal at Ithaca, Inc. Project),
7.70% 6/01/2011 1,397,124
---------------
2,989,432
---------------
Multi-Family 1,000,000 Herkimer Housing Authority, Multifamily Mortgage Revenue Bonds,
Housing Series 1994A (Herkimer Elderly Apartments--Section 8 Assisted
2.7% Project), 7.15% 3/01/2011 1,007,640
1,000,000 New York State Housing Finance Agency, Multi-Family Housing
Revenue Bonds, (Secured Mortgage Program), 1992 Series F,
Subject to AMT, 6.625% 8/15/2012 964,250
---------------
1,971,890
---------------
The accompanying notes are an integral part of the financial statements.
59
<PAGE>
Principal Amount Maturity Date Value (Note 1)
- -----------------------------------------------------------------------------------------------------------------------------------
Nursing $1,500,000 Dormitory Authority of the State of New York, The Miriam Osborn
Home Memorial Home Association, Revenue Bonds, 1994 B Issue,
2.1% Mandatory Put 12/5/99, 6.00% 7/01/2024 $1,510,005
---------------
Power 1,500,000 Power Authority of the State of New York, General Purpose
3.5% Bonds, Series W, 6.50% 1/01/2008 1,524,960
1,000,000 Power Authority of the State of New York, General Purpose
Bonds, Series Y, 6.75% 1/01/2018 1,004,860
---------------
2,529,820
---------------
Pre-Refunded 500,000 City of Syracuse, Onondaga County, New York, Public Improvement
Bonds Bonds, 1991, Pre-Refunded to 2/15/2001 @ 102, 6.70% 2/15/2006 529,860
9.6%
300,000 County of Nassau, New York, Combined Sewer Districts Bonds,
Series J, FGIC Insured, Pre- Refunded to 10/15/2000 @ 103, 7.375% 10/15/2009 332,442
1,000,000 Grand Central District Management Association, Inc., Grand
Central Business Improvement District, Capital Improvement
Bonds, Series 1992, Pre- Refunded to 1/01/2002 @ 102, 6.50% 1/01/2010 1,053,100
145,000 New York State Medical Care Facilities Finance Agency, Mental
Health Services Facilities Improvement Revenue Bonds, 1990
Series A Pre- Refunded to 2/15/2000 @ 102, 7.75% 8/15/2010 160,841
600,000 Dormitory Authority of the State of New York, State University
Educational Facilities, Revenue Bonds, Series 1990A,
Pre-Refunded to 5/15/2000 @ 102, 7.70% 5/15/2012 666,420
450,000 Battery Park City Authority, Revenue Bonds,
Series 1990, Pre-Refunded to 5/1/99 @ 102, 7.70% 5/01/2015 494,609
600,000 New York City Municipal Water Finance Authority, Water and
Sewer System Revenue Bonds, Fiscal 1991 Series C, FGIC Insured,
Pre-Refunded to 6/15/2001 @ 101.5, 7.00% 6/15/2016 647,754
425,000 County of Suffolk, New York, General Obligations, MBIA Insured,
1990 Series B, Pre-Refunded to 4/01/2000 @ 102, 7.10% 4/01/2018 459,863
250,000 Commonwealth of Puerto Rico, Public Improvement Bonds of 1989,
Series A, General Obligation Bonds, Pre-Refunded to 7/1/99 @ 100,
6.50% 7/01/2018 260,805
350,000 Mount Sinai Union Free School District, Unlimited Tax, Suffolk
County, New York AMBAC Insured, School District Bonds, 1989,
Pre-Refunded to 2/15/2000 @ 102, 7.25% 2/15/2019 380,565
250,000 Dormitory Authority of the State of New York, Bonds, Upstate
Community Colleges, 1990A Issue, Pre-Refunded to 5/15/2000 @ 102,
7.60% 7/01/2020 275,750
The accompanying notes are an integral part of the financial statements.
60
<PAGE>
Investment Portfolio (cont'd)
Principal Amount Maturity Date Value (Note 1)
- -----------------------------------------------------------------------------------------------------------------------------------
Pre-Refunded $ 300,000 Commonwealth of Puerto Rico, Public Improvement Bonds of 1990,
Bonds General Obligation Bonds, Pre-Refunded to 7/1/2000 @ 102, 7.70% 7/01/2020 $ 335,304
(cont'd) 400,000 Orangetown Housing Authority, (Rockland County, New York),
Housing Facilities Revenue Bonds (Orangetown Senior Housing
Center-1990 Series), Pre-Refunded to 10/1/2000 @ 102, 7.50% 10/01/2020 440,512
800,000 Town of Clifton Park Water Authority, (New York), Water System
Revenue Bonds, 1991 Series A, FGIC Insured, Pre-Refunded to
10/1/2001 @ 102, 6.375% 10/01/2026 838,520
---------------
6,876,345
---------------
Resource 500,000 Town of Hempstead Industrial Development Agency, (Hempstead,
Recovery/ Solid New York), Resource Recovery Bonds, 1985 (American REF-FUEL
Waste Company of Hempstead Project), 7.375% 12/01/2005 516,400
1.4%
480,000 New York State Environmental Facilities Corporation, Resource
Recovery Revenue Bonds, (Huntington Resource Recovery
Project-1989 Series A), Subject to AMT, 7.50% 10/01/2012 480,826
---------------
997,226
---------------
Single-Family 915,000 State of New York Mortgage Agency, Homeowner Mortgage Revenue
Housing Bonds, Series 40-A, Subject to AMT, 6.05% 4/01/2005 891,786
7.1% 1,000,000 State of New York Mortgage Agency, Homeowner Mortgage Revenue
Bonds, Series 27, 6.90% 4/01/2015 1,003,910
2,000,000 State of New York Mortgage Agency, Homeowner Mortgage Revenue
Bonds, Series 45, 7.20% 10/01/2017 2,044,400
600,000 State of New York Mortgage Agency, Homeowner Mortgage Revenue
Bonds, Series MM-I, Subject to AMT, 7.95% 10/01/2021 625,254
500,000 State of New York Mortgage Agency, Homeowner Mortgage Revenue
Bonds, Series UU, Subject to AMT, 7.75% 10/01/2023 513,645
---------------
5,078,995
---------------
Special/Sales 600,000 Municipal Assistance Corporation for the City of New York,
Tax Revenue Series 61 Bonds, 5.75% 7/01/2008 572,928
1.5% 500,000 Municipal Assistance Corporation for the City of New York,
Series 67 Bonds, 7.625% 7/01/2008 537,520
---------------
1,110,448
---------------
The accompanying notes are an integral part of the financial statements.
61
<PAGE>
Principal Amount Maturity Date Value (Note 1)
- -----------------------------------------------------------------------------------------------------------------------------------
Transit/ $ 750,000 Government of Guam, Limited Obligation Highway Bonds, 1992
Highway Series A, Capital Guaranty Insurance Co. Insured, 6.30% 5/01/2012 $ 727,642
2.4%
1,000,000 The Port Authority of New York and New Jersey, Consolidated
Bonds, Sixty-seventh Series, 6.875% 1/01/2025 1,008,490
---------------
1,736,132
---------------
Water & Sewer 2,000,000 Buffalo Municipal Water Finance Authority, Water System Revenue
11.3% Bonds, Series 1992, FSA Insured, 5.75% 7/01/2006 1,939,580
2,000,000 New York State Environmental Facilities Corporation, State
Water Pollution Control, Revolving Fund Revenue Bonds, Series
1994 D, (Pooled Loan Issue), 6.70% 11/15/2009 2,060,820
400,000 New York State Environmental Facilities Corporation, State
Water Pollution Control, Revolving Fund Revenue Bonds, Series
1990 B, (Pooled Loan Issue), 7.50% 3/15/2011 421,500
1,250,000 Monroe County Water Authority, (New York), Series 1991 A Water
System Revenue Refunding Bonds, 6.25% 8/01/2011 1,205,038
2,380,000 Albany Municipal Water Finance Authority, Water and Sewer
System Revenue Bonds, Series 1993 A, FGIC Insured, 5.75% 12/01/2011 2,214,519
250,000 Commonwealth of Puerto Rico, Aqueduct and Sewer Authority
Revenue Bonds, Series 1988 A, 7.00% 7/01/2019 250,780
---------------
8,092,237
---------------
Other 1,000,000 The Trust for Cultural Resources of the City of New York,
Revenue Revenue Refunding Bonds, Series 1993A, (The Museum of Modern
1.4% Art), AMBAC Insured, 6.625% 1/01/2011 1,006,350
---------------
Total Municipal Bonds and Investments
(Cost $70,661,877)--98.4% 70,727,985
Other Assets, Less Liabilities--1.6% 1,141,655
---------------
Net Assets--100.0% $71,869,640
===============
The accompanying notes are an integral part of the financial statements.
62
<PAGE>
Investment Portfolio (cont'd)
Federal Income Tax Information:
At December 31, 1994, the net unrealized
appreciation of investments based on
cost for Federal income tax purposes
of $70,661,877 was as follows:
Aggregate gross unrealized appreciation
for all investments in which there is an
excess of value over tax cost $ 1,461,774
Aggregate gross unrealized depreciation
for all investments in which there is an
excess of tax cost over value (1,395,666)
---------------
$ 66,108
===============
</TABLE>
The accompanying notes are an integral part of the financial statements.
63
<PAGE>
State Street Research New York Tax-Free Fund
Statement of Assets and Liabilities
December 31, 1994
<TABLE>
- -------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Assets Investments, at value (Cost $70,661,877) (Note 1) $70,727,985
Interest receivable 1,426,832
Receivable from Distributor (Note 3) 23,775
Receivable for fund shares sold 3,959
Other assets 7,451
----------
72,190,002
Liabilities Dividends payable $73,384
Accrued transfer agent and shareholder services (Note 2) 57,699
Payable for fund shares redeemed 36,073
Accrued management fee (Note 2) 33,411
Accrued trustees' fees (Note 2) 14,856
Accrued distribution fee (Note 5) 14,663
Capital gains distribution payable 8,068
Payable to custodian 5,867
Other accrued expenses 76,341 320,362
------- ------------
Net Assets $71,869,640
============
Net Assets consist of:
Undistributed net investment income $ 141,050
Unrealized appreciation of investments 66,108
Accumulated net realized loss (3,163,011)
Shares of beneficial interest 74,825,493
------------
$71,869,640
============
Net Asset Value and redemption price per share of Class A shares
($18,214,443 / 2,419,194 shares of beneficial interest) $7.53
=====
Maximum Offering Price per share of Class A shares ($7.53 / .955) $7.88
=====
Net Asset Value and offering price per share of Class B shares
($12,131,436 / 1,611,873 shares of beneficial interest)* $7.53
=====
Net Asset Value, offering price and redemption price per share of
Class C shares ($40,750,166 / 5,407,309 shares of beneficial interest) $7.54
=====
Net Asset Value and offering price per share of Class D shares
($773,595 / 102,688 shares of beneficial interest)* $7.53
=====
</TABLE>
*Redemption price per share for Class B and Class D is equal to net asset
value less any applicable contingent deferred sales charge.
The accompanying notes are an integral part of the financial statements.
64
<PAGE>
State Street Research New York Tax-Free Fund
Statement of Operations
For the year ended December 31, 1994
<TABLE>
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Investment Interest $ 4,771,548
Income
Expenses Management fee (Note 2) $ 426,269
Transfer agent and shareholder services (Note 2) 230,014
Custodian fee 102,669
Reports to shareholders 43,498
Registration fees 30,708
Audit fee 26,696
Legal fees 25,062
Trustees' fees (Note 2) 9,577
Distribution fee--Class A (Note 5) 45,080
Distribution fee--Class B (Note 5) 104,613
Distribution fee--Class D (Note 5) 8,297
Amortization of organization costs (Note 1) 4,047
Miscellaneous 9,726
--------
1,066,256
Expenses borne by the Distributor (Note 3) (249,199) 817,057
-------- ------------
Net investment income 3,954,491
------------
Realized and Net realized loss on investments (Notes 1 and 4) (3,161,667)
Unrealized Net unrealized depreciation of investments (5,773,470)
Loss on ------------
Investments Net loss on investments (8,935,137)
------------
Net decrease in net assets resulting from operations $(4,980,646)
============
</TABLE>
The accompanying notes are an integral part of the financial statements.
65
<PAGE>
State Street Research New York Tax-Free Fund
Statement of Changes in Net Assets
<TABLE>
<CAPTION>
Year ended December 31
---------------------------
1994 1993
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Increase Operations:
(Decrease) Net investment income $ 3,954,491 $ 3,100,438
in Net Assets Net realized gain (loss) on investments* (3,161,667) 391,527
Net unrealized appreciation (depreciation) of
investments (5,773,470) 3,823,310
---------- ---------
Net increase (decrease) resulting from operations (4,980,646) 7,315,275
---------- ---------
Dividends from net investment income:
Class A (895,478) (226,427)
Class B (441,657) (85,132)
Class C (2,488,395) (2,744,741)
Class D (34,740) (13,135)
---------- ----------
(3,860,270) (3,069,435)
---------- ----------
Distributions from net realized gains:
Class A (19,501) (34,199)
Class B (12,917) (16,829)
Class C (42,991) (133,873)
Class D (854) (1,939)
---------- ----------
(76,263) (186,840)
---------- ----------
Net increase from fund share transactions (Note 7) 709,765 34,459,752
---------- ----------
Total increase (decrease) in net assets (8,207,414) 38,518,752
Net Assets Beginning of period 80,077,054 41,558,302
---------- ----------
End of period (including undistributed net
investment income of $141,050 and $46,829,
respectively) $71,869,640 $80,077,054
=========== ===========
*Net realized gain (loss) for Federal income
tax purposes (Note 1) $(2,135,580) $ 391,527
=========== ===========
</TABLE>
The accompanying notes are an integral part of the financial statements.
66
<PAGE>
State Street Research New York Tax-Free Fund
Notes to Financial Statements
December 31, 1994
Note 1
State Street Research New York Tax-Free Fund (the "Fund"), is a series of
MetLife-State Street Tax-Exempt Trust (the "Trust"), which was organized as a
Massachusetts business trust in December, 1985 and is registered under the
Investment Company Act of 1940, as amended, as an open-end management
investment company. The Fund commenced operations in July, 1989. Five series
of the Trust are publicly offered: State Street Research New York Tax-Free
Fund, MetLife-State Street Tax-Exempt Fund, State Street Research California
Tax-Free Fund, State Street Research Florida Tax-Free Fund and State Street
Research Pennsylvania Tax-Free Fund.
The Fund offers four classes of shares. Class A shares are subject to an
initial sales charge of up to 4.50% and pay a service fee equal to 0.25% of
average daily net assets. Class B shares are subject to a contingent deferred
sales charge on certain redemptions made within five years of purchase and
pay annual distribution and service fees of 1.00%. Class B shares
automatically convert into Class A shares (which pay lower ongoing expenses)
at the end of eight years after the issuance of the Class B shares. Class C
shares are only offered to certain employee benefit plans and large
institutions. No sales charge is imposed at the time of purchase or
redemption of Class C shares. Class C shares do not pay any distribution or
service fees. Class D shares are subject to a contingent deferred sales
charge of 1.00% on any shares redeemed within one year of their purchase.
Class D shares also pay annual distribution and service fees of 1.00%. The
Fund's expenses are borne pro-rata by each class, except that each class
bears expenses, and has exclusive voting rights with respect to provisions of
the Plan of Distribution, related specifically to that class. The Trustees
declared separate dividends on each class of shares.
The following significant accounting policies are consistently followed by
the Fund in preparing its financial statements, and such policies are in
conformity with generally accepted accounting principles for investment
companies.
A. Investment Valuation
Tax-exempt securities are valued by a pricing service, which utilizes market
transactions, quotations from dealers, and various relationships among
securities in determining value. Short- term obligations are valued at
amortized cost. Other securities, if any, are valued at their fair value as
determined in accordance with established methods consistently applied.
B. Security Transactions
Security transactions are accounted for on the trade date (date the order to
buy or sell is executed). Realized gains or losses are reported on the basis
of identified cost of securities delivered.
C. Net Investment Income
Net investment income is determined daily and consists of interest accrued
and discount earned, less amortization of premium and the estimated daily
expenses of the Fund. Interest income is accrued daily as earned. The Fund is
charged for expenses directly attributable to it, while indirect expenses are
allocated among all funds in the Trust.
D. Dividends
Dividends are declared daily by the Fund based upon projected net investment
income and paid or reinvested monthly. Net realized capital gains, if any,
are distributed annually, unless additional distributions are required for
compliance with applicable tax regulations.
Income dividends and capital gain distributions are determined in accordance
with Federal income tax regulations which may differ from generally accepted
accounting principles.
67
<PAGE>
E. Federal Income Taxes
No provision for Federal income taxes is necessary because the Fund has
elected to qualify under Subchapter M of the Internal Revenue Code and its
policy is to distribute all of its taxable income, including net realized
capital gains, within the prescribed time periods. At December 31, 1994, the
Fund had a capital loss carryforward of $2,135,580 available, to the extent
provided in regulations, to offset future capital gains, if any, which
expires on December 31, 2002.
In order to meet certain excise tax distribution requirements under Section
4982 of the Internal Revenue Code, the Fund is required to measure and
distribute annually, if necessary, net capital gains realized during a
twelve-month period ending October 31. In this connection, the Fund is
permitted to defer into its next fiscal year any net capital losses incurred
between each November 1 and the end of its fiscal year. From November 1, 1994
through December 31, 1994 the Fund incurred net capital losses of $1,026,087
and intends to defer and treat such losses as arising in the fiscal year
ending December 31, 1995.
F. Deferred Organization Costs
Certain costs incurred in the organization and registration of the Fund were
capitalized and amortized under the straight-line method over a period of
five years.
Note 2
The Trust and State Street Research & Management Company (the "Adviser"), an
indirect wholly-owned subsidiary of Metropolitan Life Insurance Company
("Metropolitan"), have entered into an agreement under which the Adviser
earns monthly fees at an annual rate of 0.55% of the Fund's average daily net
assets. In consideration of these fees, the Adviser furnishes the Fund with
management, investment advisory, statistical and research facilities and
services. The Adviser also pays all salaries, rent and certain other expenses
of management. During the year ended December 31, 1994, the fees pursuant to
such agreement amounted to $426,269.
State Street Research Shareholder Services, a division of State Street
Research Investment Services, Inc., the Trust's principal underwriter (the
"Distributor"), an indirect wholly-owned subsidiary of Metropolitan, provides
certain shareholder services to the Fund such as responding to inquiries and
instructions from investors with respect to the purchase and redemption of
shares of the Fund. During the year ended December 31, 1994, the amount of
such expenses was $44,507.
The fees of the Trustees not currently affiliated with the Adviser amounted
to $9,577 during the year ended December 31, 1994. The Trust has an optional
deferred compensation plan for its Trustees. The Fund invests the fees of
participating Trustees in shares of a MetLife-State Street fund instead of
paying those fees in cash. Participating Trustees receive deferred amounts
equal to the market value of such shares including any reinvested income and
capital gains distributions.
Note 3
The Distributor and its affiliates may from time to time and in varying
amounts voluntarily assume some portion of fees or expenses relating to the
Fund. During the year ended December 31, 1994, the amount of such expenses
assumed by the Distributor and its affiliates was $249,199.
Note 4
For the year ended December 31, 1994, purchases and sales of securities,
exclusive of short-term obligations, aggregated $49,760,113 and $48,774,934,
respectively.
68
<PAGE>
Note 5
The Trust has adopted a Plan of Distribution Pursuant to Rule 12b-1 (the
"Plan") under the Investment Company Act of 1940, as amended. Under the Plan,
the Fund pays annual service fees to the Distributor at a rate of 0.25% of
average daily net assets for Class A, Class B and Class D shares. In
addition, the Fund pays annual distribution fees of 0.75% of average daily
net assets for Class B and Class D shares. The Distributor uses such payments
for personal services and/or the maintenance of shareholder accounts, to
reimburse securities dealers for distribution and marketing services, to
furnish ongoing assistance to investors and to defray a portion of its
distribution and marketing expenses. For the year ended December 31, 1994,
fees pursuant to such plan amounted to $45,080, $104,613 and $8,297 for Class
A, Class B and Class D, respectively.
The Fund has been informed that the Distributor and MetLife Securities, Inc.,
a wholly-owned subsidiary of Metropolitan, earned initial sales charges
aggregating $30,519 and $224,970, respectively, on sales of Class A shares of
the Fund during the year ended December 31, 1994, and that MetLife Securities,
Inc. earned commissions aggregating $230,818 on sales of Class B shares, and
that the Distributor collected contingent deferred sales charges aggregating
$41,848 on redemptions of Class B shares during the same period.
Note 6
Under normal circumstances at least 80% of the Fund's net assets will be
invested in New York Municipal Obligations. New York State and New York City
face potential economic problems due to various financial, social, economic
and political factors which could seriously affect their ability to meet
continuing obligations for principal and interest payments. Also, the Fund is
able to invest up to 25% of total assets in a single industry. Accordingly,
the Fund's investments may be subject to greater risk than those in a fund
with more restrictive concentration limits.
At December 31, 1994, investments totalling 11.7% of the Fund's net assets
were insured as to the timely payment of principal and interest by Financial
Guaranty Insurance Co. (FGIC).
69
<PAGE>
Note 7
The Trustees have the authority to issue an unlimited number of shares of
beneficial interest, $.001 par value per share. At December 31, 1994,
Metropolitan owned 61,186 Class A shares and 61,186 Class D shares and the
Distributor owned one Class C share of the Fund.
Share transactions were as follows:
<TABLE>
<CAPTION>
June 7, 1993
(Commencement of
Share Class
Year ended Designations) to
December 31, 1994 December 31, 1993
-------------------------- -------------------------
Class A Shares Amount Shares Amount
- ----------------------------------------- ---------- ------------ --------- ------------
<S> <C> <C> <C> <C>
Shares sold 1,289,154 $ 10,313,220 1,951,973 $16,298,054
Issued upon reinvestment of:
Distributions from net realized gains 2,365 17,808 3,840 32,373
Dividends from net investment income 84,420 662,001 20,410 171,170
Shares repurchased (756,289) (5,929,186) (176,679) (1,478,347)
-------- ---------- ------- ----------
Net increase 619,650 $ 5,063,843 1,799,544 $15,023,250
======== ========== ======= ==========
Class B Shares Amount Shares Amount
- ----------------------------------------- -------- ---------- ------- ----------
Shares sold 885,313 $ 7,083,969 967,843 $ 8,090,814
Issued upon reinvestment of:
Distributions from net realized gains 1,577 11,857 1,943 16,378
Dividends from net investment income 32,680 258,543 8,550 71,750
Shares repurchased (204,942) (1,640,186) (81,091) (673,621)
-------- ---------- ------- ----------
Net increase 714,628 $ 5,714,183 897,245 $ 7,505,321
======== ========== ======= ==========
Year ended
December 31, 1993
-----------------------
Class C Shares Amount Shares Amount
- ----------------------------------------- -------- ---------- ------- ----------
Shares sold 44,692 $ 369,145 2,054,942 $16,627,634
Issued upon reinvestment of:
Distributions from net realized gains 5,159 38,844 14,268 120,424
Dividends from net investment income 226,396 1,765,589 286,120 2,359,881
Shares repurchased (1,563,955) (12,288,139) (963,989) (7,979,679)
-------- ---------- ------- ----------
Net increase (decrease) (1,287,708) $(10,114,561) 1,391,341 $11,128,260
======== ========== ======= ==========
June 7, 1993
(Commencement of
Share Class
Designations) to
December 31, 1993
-----------------------
Class D Shares Amount Shares Amount
- ----------------------------------------- -------- ---------- ------- ----------
Shares sold 14,755 $ 119,504 96,912 $ 799,949
Issued upon reinvestment of:
Distributions from net realized gains 99 745 246 2,073
Dividends from net investment income 1,427 11,193 107 899
Shares repurchased (10,858) (85,142) -- --
-------- ---------- ------- ----------
Net increase 5,423 $ 46,300 97,265 $ 802,921
======== ========== ======= ==========
</TABLE>
70
<PAGE>
State Street Research New York Tax-Free Fund
Financial Highlights
For a share outstanding throughout each year.
<TABLE>
<CAPTION>
Class A Class B
--------------------------- ----------------------------
Year ended Year ended
December 31, 1994 1993** December 31, 1994 1993**
------------------------------------------------------------
<S> <C> <C> <C> <C>
Net asset value, beginning of year $8.43 $8.20 $8.43 $8.20
Net investment income* .40 .22 .34 .19
Net realized and unrealized gain (loss) on
investments (.90) .25 (.90) .25
Dividends from net investment income (.39) (.22) (.33) (.19)
Distributions from net realized gains (.01) (.02) (.01) (.02)
----- ---- ---- ----
Net asset value, end of year $7.53 $8.43 $7.53 $8.43
===== ===== ===== =====
Total return (6.04)%+ 5.79%+++ (6.74)%+ 5.35%+++
Net assets at end of year (000s) $18,214 $15,175 $12,131 $7,567
Ratio of operating expenses to average net assets* 1.10% 1.10%++ 1.85% 1.85%++
Ratio of net investment income to average net
assets* 5.07% 4.68%++ 4.34% 3.93%++
Portfolio turnover rate 64.80% 33.11% 64.80% 33.11%
* Reflects voluntary assumption of fees or expenses
per share in each year (Note 3). $.03 $.01 $.03 $.01
</TABLE>
** June 7, 1993 (commencement of share class designations) to
December 31, 1993.
++ Annualized.
+ Total return figures do not reflect any front-end or contingent deferred
sales charges. Total return would be lower if the Distributor and its
affiliates had not voluntarily assumed a portion of the Fund's expenses.
+++ Represents aggregate return for the period without annualization and does
not reflect any front-end or contingent deferred sales charges. Total
return would be lower if the Distributor and its affiliates had not
voluntarily assumed a portion of the Fund's expenses.
71
<PAGE>
<TABLE>
<CAPTION>
Class C Class D
----------------------------------------------- ----------------------------
Year ended December 31
----------------------------------------------- Year ended
1994 1993 1992 1991 1990 December 31, 1994 1993**
-------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Net asset value,
beginning of year $8.44 $7.84 $7.61 $7.11 $7.32 $8.44 $8.20
Net investment income* .42 .42 .44 .45 .45 .34 .19
Net realized and unrealized gain (loss) on
investments (.90) .62 .23 .51 (.22) (.91) .25
Dividends from net investment
income (.41) (.42) (.44) (.46) (.44) (.33) (.18)
Distributions from net
realized gains (.01) (.02) -- -- -- (.01) (.02)
---- ---- ---- ---- ---- ---- ----
Net asset value, end of year $7.54 $8.44 $7.84 $7.61 $7.11 $7.53 $8.44
===== ===== ===== ===== ===== ===== =====
Total return (5.79)%+ 13.46%+ 9.08%+ 13.88%+ 3.32%+ (6.86)%+ 5.46%+++
Net assets at end
of year (000s) $40,750 $56,515 $41,558 $21,512 $12,620 $774 $821
Ratio of operating expenses to
average net assets* 0.85% 0.85% 0.85% 0.85% 0.85% 1.85% 1.85%++
Ratio of net investment
income to average
net assets* 5.29% 5.10% 5.71% 6.21% 6.39% 4.31% 3.94%++
Portfolio turnover rate 64.80% 33.11% 29.39% 30.24% 35.54% 64.80% 33.11%
* Reflects voluntary assumption
of fees or expenses per share in each
year (Note 3). $.03 $.01 $.02 $.05 $.07 $.03 $.01
</TABLE>
** June 7, 1993 (commencement of share class designations) to
December 31, 1993.
++ Annualized.
+ Total return figures do not reflect any front-end or contingent deferred
sales charges. Total return would be lower if the Distributor and its
affiliates had not voluntarily assumed a portion of the Fund's expenses.
+++ Represents aggregate return for the period without annualization and does
not reflect any front-end or contingent deferred sales charges. Total
return would be lower if the Distributor and its affiliates had not
voluntarily assumed a portion of the Fund's expenses.
72
<PAGE>
Report of Independent Accountants
To the Trustees of MetLife-State Street
Tax-Exempt Trust and the Shareholders of
State Street Research New York Tax-Free Fund
In our opinion, the accompanying statement of assets and liabilities,
including the investment portfolio, and the related statements of operations
and of changes in net assets and the financial highlights present fairly, in
all material respects, the financial position of State Street Research New
York Tax-Free Fund (a series of MetLife-State Street Tax-Exempt Trust,
hereafter referred to as the "Trust") at December 31, 1994, and the results
of its operations, the changes in its net assets and the financial highlights
for the periods indicated, in conformity with generally accepted accounting
principles. These financial statements and financial highlights (hereafter
referred to as "financial statements") are the responsibility of the Trust's
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these financial
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts
and disclosures in the financial statements, assessing the accounting
principles used and significant estimates made by management, and evaluating
the overall financial statement presentation. We believe that our audits,
which included confirmation of securities owned at December 31, 1994 by
correspondence with the custodian, provide a reasonable basis for the opinion
expressed above.
Price Waterhouse LLP
Boston, Massachusetts
February 10, 1995
73
<PAGE>
Management's Discussion of Fund Performance
The bond market was repeatedly buffeted in 1994 by uncertainty over the
strength of the economy and the timing of the Fed's next rate increase.
We began to shorten New York Tax-Free Fund's duration and maturity in late
1993, which meant the Fund fell less than average in February, March and
April when interest rates rose and the municipal bond market dropped sharply.
After the market's sharp decline, we attempted to reduce risk further in the
portfolio by replac- ing longer-term bonds with less interest-rate-
sensitive, shorter-term bonds. In some cases we sold bonds for losses and
replaced them with higher-yielding, more defensive bonds. We also increased
our position in insured bonds, because higher-quality, more-liquid bonds tend
to perform better in weak markets.
We have targeted high-quality bonds--the bonds in the Fund's portfolio have
an average credit rating of AA, as measured by Standard & Poor's Corporation.
In general, high-quality bonds are more "liquid," which means they are easier
to buy and sell. Also, we have continued to purchase bonds from upper-state
New York, as these bonds offer quality and are usually in demand.
Comparison Of Change In Value Of A $10,000 Investment In New York Tax-Free
Fund and The Lehman Municipal Bond Index
[chart]
Class A Shares
Average Annual Total Return
1 Year 5 Years Life of Fund
-10.26%/-10.49% +5.44%/+4.94% +5.26%/+4.66%
New York Tax-Free Fund Lehman Muni Bond Index
7/89 9,550 10,000
12/89 9,714 10,391
12/90 10,036 11,148
12/91 11,428 12,502
12/92 12,465 13,604
12/93 14,108 15,275
12/94 13,526 14,485
[end chart]
[chart]
Class B Shares
Average Annual Total Return
1 Year 5 Years Life of Fund
-11.40%/-11.62% +5.85%/+5.35% +5.92%/+5.31%
New York Tax-Free Fund Lehman Muni Bond Index
7/89 10,000 10,000
12/89 10,172 10,391
12/90 10,509 11,148
12/91 11,967 12,502
12/92 13,052 13,604
12/93 14,710 15,275
12/94 13,719 14,485
[end chart]
[chart]
Class C Shares
Average Annual Total Return
1 Year 5 Years Life of Fund
-5.79%/-6.03% +6.52%/+6.04% +6.25%/+5.65%
New York Tax-Free Fund Lehman Muni Bond Index
7/89 10,000 10,000
12/89 10,172 10,391
12/90 10,509 11,148
12/91 11,967 12,502
12/92 13,052 13,604
12/93 14,810 15,275
12/94 13,952 14,485
[end chart]
[chart]
Class D Shares
Average Annual Total Return
1 Year 5 Years Life of Fund
-7.79%/-8.02% +6.16%/+5.66% +5.92%/+5.31%
New York Tax-Free Fund Lehman Muni Bond Index
7/89 10,000 10,000
12/89 10,172 10,391
12/90 11,509 11,148
12/91 11,967 12,502
12/92 13,052 13,604
12/93 14,726 15,275
12/94 13,717 14,485
[end chart]
All returns represent past performance, which is no guarantee of future
results. The investment return and principal value of an investment made in
the Fund will fluctuate and shares, when redeemed, may be worth more or less
than their original cost. All returns assume reinvestment of capital gain
distributions and income dividends. Returns reflect voluntary reduction by
the Distributor or its affiliates of fees and expenses related to the Fund.
The second number shown is what performance would have been without a
reduction of Fund fees or expenses. Shares of the Fund had no class
designations until June 7, 1993, when designations were assigned based on the
pricing and 12b-1 fees applicable to shares sold thereafter. Performance data
for a specified class include periods prior to the adoption of class
designations. "A" share returns for each of the periods reflect the maximum
4.5% sales charge. Performance prior to June 7, 1993 does not reflect annual
12b-1 fees of .25%, which will reduce subsequent performance. "B" share
returns for the 1- and 5-year periods reflect a 5% and a 2% contingent
deferred sales charge, respectively. "C" shares, offered without a sales
charge, are available only to certain employee benefit plans and large
institutions. "D" share return for the 1-year period reflects a 1% contingent
deferred sales charge. Performance for "B" and "D" shares prior to June 7,
1993, does not reflect annual 12b-1 fees of 1%, which will reduce subsequent
performance. The Lehman Muni Bond Index represents approximately 15,000 fixed
coupon, investment- grade municipal bonds. The index in unmanaged and does
not take sales charges into consideration. Direct investment in the index is
not possible; results are for illustrative purposes only.
74
<PAGE>
APPENDIX
Description of Municipal Debt Ratings
Standard & Poor's Corporation
- -----------------------------
AAA: Debt rated AAA has the highest rating assigned by S&P. Capacity
to pay interest and repay principal is extremely strong.
AA: Debt rated AA has a very strong capacity to pay interest and repay
principal and differs from the highest rated issues only in small degree.
A: Debt rated A has a strong capacity to pay interest and repay principal,
although it is more susceptible to the adverse effects of changes in
circumstances and economic conditions than debt in higher rated categories.
BBB: Debt rated BBB is regarded as having an adequate capacity to pay
interest and repay principal. Whereas it normally exhibits adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal for
debt in this category than in higher rated categories.
Debt rated BB, B, CCC, CC and C is regarded as having speculative
characteristics with respect to capacity to pay interest and repay principal. BB
indicates the least degree of speculation and C the highest. While such debt
will likely have some quality and protective characteristics, these are
outweighed by large uncertainties or major risk exposure to adverse conditions.
BB: Debt rated BB has less near-term vulnerability to default than other
speculative issues. However, it faces major ongoing uncertainties or exposure to
adverse business, financial or economic conditions which could lead to
inadequate capacity to meet timely interest and principal payments. The BB
rating category is also used for debt subordinated to senior debt that is
assigned an actual or implied BBB- rating.
B: Debt rated B has a greater vulnerability to default but currently has
the capacity to meet interest payments and principal repayments. Adverse
business, financial or economic conditions will likely impair capacity or
willingness to pay interest and repay principal. The B rating category is also
used for debt subordinated to senior debt that is assigned an actual or implied
BB or BB- rating.
CCC: Debt rated CCC has a currently identifiable vulnerability to default,
and is dependent upon favorable business, financial and economic conditions to
meet timely payment of interest and repayment of principal. In the event of
adverse business, financial or economic conditions, it is not likely to have the
capacity to pay interest and repay principal. The CCC rating category is also
used for debt subordinated to senior debt that is assigned an actual or implied
B or B- rating.
CC: The rating CC is typically applied to debt subordinated to senior
debt which is assigned an actual or implied CCC debt rating.
C: The rating C is typically applied to debt subordinated to senior debt
which is assigned an actual or implied CCC debt rating. The C rating may be used
to cover a situation where a bankruptcy petition has been filed, but debt
service payments are continued.
A-1
<PAGE>
CI: The rating CI is reserved for income bonds on which no interest is
being paid.
D: Debt rated D is in payment default. The D rating category is used when
interest payments or principal payments are not made on the date due even if the
applicable grace period has not expired, unless S&P believes that such payments
will be made during such grace period. The D rating also will be used upon the
filing of a bankruptcy petition if debt service payments are jeopardized.
Plus (+) or Minus (-): The ratings from AA to CCC may be modified by the
addition of a plus or minus sign to show relative standing within the major
rating categories.
S&P may attach the "r" symbol to derivative, hybrid, and certain other
obligations that S&P believes may experience high volatility or high variability
in expected returns due to noncredit risks created by the terms of the
obligation, such as securities whose principal or interest return is indexed to
equities, commodities, or currencies; certain swaps and options; and interest
only (IO) and principal only (PO) mortgage securities.
SP-1: Notes rated SP-1 are of the highest quality with very strong or
strong capacity to pay principal and interest. Issues determined to possess
overwhelming safety characteristics are given a plus (+) designation.
SP-2: Notes rated SP-2 are of high quality with satisfactory capacity to
pay principal and interest.
Moody's Investors Service, Inc.
- -------------------------------
Aaa: Bonds which are rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally referred to as
"gilt edge." Interest payments are protected by a large or by an exceptionally
stable margin and principal is secure. While the various protective elements are
likely to change, such changes as can be visualized are most unlikely to impair
the fundamentally strong position of such issues.
Aa: Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally known as
high grade bonds. They are rated lower than the best bonds because margins of
protection may not be as large as in Aaa securities or fluctuation of protective
elements may be of greater amplitude or there may be other elements present
which make the long-term risks appear somewhat larger than in Aaa securities.
A: Bonds which are rated A possess many favorable investment attributes
and are to be considered as upper medium grade obligations. Factors giving
security to principal and interest are considered adequate but elements may be
present which suggest a susceptibility to impairment sometime in the future.
Baa: Bonds which are rated Baa are considered as medium grade obligations;
i.e., they are neither highly protected nor poorly secured. Interest payments
and principal security appear adequate for the present, but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as 0ell.
A-2
<PAGE>
Ba: Bonds which are rated Ba are judged to have speculative elements;
their future cannot be considered as well assured. Often the protection of
interest and principal payments may be very moderate, and thereby not well
safeguarded during other good and bad times over the future. Uncertainty of
position characterizes bonds in this class.
B: Bonds which are rated B generally lack characteristics of the desirable
investment. Assurance of interest and principal payments or of maintenance or
other terms of the contract over any long period of time may be small.
Caa: Bonds which are rated Caa are of poor standing. Such issues may
be in default or there may be present elements of danger with respect to
principal or interest.
Ca: Bonds which are rated Ca represent obligations which are
speculative in a high degree. Such issues are often in default or have other
marked shortcomings.
C: Bonds which are rated C are the lowest rated class of bonds, and issues
so rated can be regarded as having extremely poor prospects of ever attaining
any real investment standing.
MIG-1: Notes bearing this designation are the best quality, enjoying
strong protection from established cash flows of funds for their servicing or
from established and broad-based access to the market for refinancing, or both.
MIG-2: Notes bearing this designation are of high quality, with margins or
protection ample although not so large as in the preceding group.
A-3
