[front cover]
[State Street Research logo]
Tax-Exempt Fund
This prospectus has information you should know
before you invest. Please read it carefully and
keep it with your investment records.
Although these securities have been registered
with the Securities and Exchange Commission, the
commission has not judged them for investment
merit and does not guarantee the accuracy or
adequacy of the information in this prospectus.
Anyone who informs you otherwise is committing a
federal crime.
A municipal bond fund
seeking income free
from federal taxes.
Prospectus
May 1, 1998
<PAGE>
Who May Want to Invest
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State Street Research Tax-Exempt Fund is designed for investors who seek one or
more of the following:
[bullet] high current income that is exempt from federal income tax
[bullet] a diversified portfolio of municipal securities
[bullet] a fund to complement a portfolio of more aggressive investments
The fund is not appropriate for investors who:
[bullet] want an investment for a tax-advantaged account such as an IRA or
401(k)
[bullet] do not pay U.S. income taxes
[bullet] want to avoid even moderate volatility or possible losses
[bullet] are seeking high growth or maximum income
[bullet] are investing emergency reserve money
The fund's shares will rise and fall in value. There is a risk that you could
lose money by investing in the fund.
The fund cannot be certain that it will achieve its goal.
Fund shares are not bank deposits and are not guaranteed, endorsed or insured by
any financial institution, government entity or the FDIC.
<PAGE>
Contents
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2 The Fund
--------
The fund's goal and strategy, main
risks, expenses and performance,
plus financial highlights
12 Your Account
------------
Managing your State Street Research
investments
12 Opening an Account
12 Choosing a Share Class
14 Sales Charges
16 Policies for Buying Shares
18 Policies for Selling Shares
20 Account Policies
21 Distributions and Taxes
23 Investor Services
24 Fund Details
------------
The fund's business structure
and dealer compensation, plus
additional policies
26 Other Securities and Risks
--------------------------
Information on additional portfolio
securities and practices, and the risks
associated with them
Back Cover For Additional Information
1
<PAGE>
Tax-Exempt Fund
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[Graphic: Chess piece--Knight]
Goal and Strategy
Fundamental Goal The fund seeks a high level of interest income exempt from
federal income tax.
Strategy Under normal market conditions, the fund invests at least 80% of net
assets in securities whose interest income is free from federal income tax and
that are investment grade at the time the fund buys them. These securities are
typically bonds issued by various U.S. states, counties, cities, towns,
territories and public authorities. The fund may invest up to 20% of net assets
in other securities, including junk bonds of similar issuers (that is, bonds
that are in or below the Standard & Poor's BB or Moody's Ba major rating
categories).
When bonds are rated by one or more independent rating agencies, the fund uses
these ratings to determine bond quality. In cases where a bond is rated in
conflicting categories by different rating agencies, the fund may choose to
follow the higher rating. If a bond is unrated, the fund may assign it to a
given category based on its own credit research. The fund may invest up to 25%
of net assets in unrated bonds.
In managing its portfolio, the fund focuses on security selection, using
proprietary research to identify those individual bonds that offer higher yields
or higher potential total return than others that appear to be of comparable
credit quality. The fund may invest in securities of any maturity, and may
invest in certain securities, such as municipal lease obligations and industrial
revenue bonds, that may have different risks than ordinary municipal bonds.
The fund may adjust the composition of its portfolio as market conditions and
economic outlooks change. For more information about the fund's investments and
practices, see page 26.
2
<PAGE>
[Graphic: Traffic Caution sign (arrows point in different directions)]
Portfolio Risks
Because the fund invests primarily in bonds and other fixed income securities,
its major risks are those of bond investing, including the tendency of prices to
fall when interest rates rise. Such a fall would lower the fund's share price
and the value of your investment.
Bond prices in general tend to move in the opposite direction from interest
rates, for the reason that new bonds issued after a rise in rates will offer
higher yields to investors; the only way an existing bond with a lower yield can
appear attractive to investors is by selling at a lower price. (This principal
works in reverse as well: a fall in interest rates will tend to cause a rise in
bond prices).
- --------------------------------------------------------------------------------
[Graphic: Magnifying glass showing magnified words on paper]
Municipal Bonds
and Taxes
The municipal bond category is defined as including securities issued by
municipalities as well as states and various agencies and authorities.
Some of these bonds are backed by the issuer's authority to levy taxes and are
considered an obligation of the issuer (hence the name "general obligation
bonds"). Other bonds are issued to raise money for a particular project -- for
example, a water system or a toll road -- and are backed by revenues earned by
that project ("revenue bonds"). So-called industrial revenue bonds are typically
issued by municipal issuers on behalf of private companies. Because revenue
bonds are backed only by income from a certain source and may not be an
obligation of the issuer itself, they may be less creditworthy than general
obligation bonds -- a fact that is usually reflected in their ratings.
The federal government allows the interest from municipal bonds to be tax-exempt
in order to make it easier for municipalities to finance public projects.
Investors in municipal bonds thus play a role in helping to finance roads,
hospitals and other public facilities.
- --------------------------------------------------------------------------------
3
<PAGE>
Tax-Exempt Fund continued
- --------------------------------------------------------------------------------
The fund's performance may be affected by political and economic conditions at
the state, regional or federal level. These may include budgetary problems,
declines in the tax base and other factors that may cause rating agencies to
downgrade the credit ratings on certain issues. Actual or proposed changes in
tax rates, regulations or federal programs could also affect your net return on
investment.
The issuer of any bond, particularly a junk bond, could default on principal or
interest payments, which would cause a loss for the fund. Lower-rated bonds also
tend to be more sensitive to economic changes and may increase the volatility of
the fund's share price.
The success of the fund's investment strategy depends largely on the investment
manager's skill in assessing the direction and impact of interest rate movements
and the creditworthiness of the securities the fund buys.
The fund's management approach, which may include short-term trading, could
cause the fund's portfolio turnover rate to be above average for a bond fund.
High portfolio turnover will increase the fund's transaction cost and may
increase your tax liability.
Information on other securities and risks appears on page 26.
A "snapshot" of the fund's investments may be found in the current annual or
semiannual report (see back cover).
[Graphic: "The Thinker" statue]
Investment Management
The fund's investment manager is State Street Research & Management Company. The
firm traces its heritage back to 1924 and the founding of one of America's first
mutual funds. Today the firm has more than $51 billion in assets under
management (as of March 31, 1998), including more than $16 billion in mutual
funds.
Paul J. Clifford, Jr. has been responsible for the fund's day-to-day portfolio
management since March 1993. A vice president, he joined the firm in 1989 and
has worked as an investment professional since 1986.
4
<PAGE>
Investor Expenses
- --------------------------------------------------------------------------------
Shareholder fees are paid directly by investors.
Class descriptions begin on page 12
------------------------------------------------
Shareholder Fees
(% of offering price)(1) Class A Class B Class C(2) Class S(2)
- --------------------------------------------------------------------------------
Maximum front-end
sales charge 4.50 0.00 0.00 0.00
Maximum deferred
sales charge 0.00(3) 5.00 1.00 0.00
Annual fund expenses are deducted from fund assets.
Annual Fund Expenses
(% of average net assets) Class A Class B Class C Class S
- --------------------------------------------------------------------------------
Management fee 0.55 0.55 0.55 0.55
Marketing/service
(12b-1) fees(4) 0.25 1.00 1.00 0.00
Other expenses 0.28 0.28 0.28 0.28
---- ---- ---- ----
Total annual fund expenses 1.08 1.83 1.83 0.83
==== ==== ==== ====
Example Here is what you would pay if you invested $1,000 over the years
indicated. The example is for comparison only and does not represent the fund's
actual expenses, either past or future(5).
Year Class A Class B(6) Class C(6) Class S
- --------------------------------------------------------------------------------
1 $56 $69/$19 $29/$19 $8
3 $78 $88/$58 $58/$58 $26
5 $102 $119/$99 $99/$99 $46
10 $171 $195/$195 $215/$215 $103
(1) Not charged on reinvestments or exchanges.
(2) Before November 1, 1997, Class C shares were designated Class D and Class S
shares were designated Class C.
(3) Except for investments of $1 million or more; see page 14.
(4) For share classes that have 12b-1 fees, long-term shareholders may pay more
than the equivalent of the regulatory maximum sales charge.
(5) Example assumes dividend reinvestment, hypothetical 5% annual return,
maximum applicable sales charges and conversion of Class B shares to Class
A after eight years.
(6) The first number assumes you sold all your shares at the end of the period,
the second assumes you stayed in the fund.
5
<PAGE>
Financial Highlights
- --------------------------------------------------------------------------------
The information in these tables has been audited by Price Waterhouse LLP, the
fund's independent accountants. The top section of each table shows information
for a single share of the fund. Total return figures assume reinvestment of all
distributions.
<TABLE>
<CAPTION>
Years ended December 31
------------------------------------------------------------------------------------------
Class A 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net asset value,
beginning of year ($) 6.86 7.24 7.42 7.30 7.69 7.94 8.43 7.46 8.26 8.10
---- ---- ---- ---- ---- ---- ---- ---- ---- ----
Net investment
income ($) 0.52 0.50 0.46 0.44 0.43 0.40 0.40 0.39 0.39 0.40
Net realized and
unrealized gain (loss)
on investments and
futures contracts ($) 0.38 0.18 (0.12) 0.39 0.27 0.54 (0.98) 0.82 (0.16) 0.40
---- ---- ---- ---- ---- ---- ---- ---- ---- ----
Total from investment
operations ($) 0.90 0.68 0.34 0.83 0.70 0.94 (0.58) 1.21 0.23 0.80
---- ---- ---- ---- ---- ---- ---- ---- ---- ----
Dividends from net
investment income ($) (0.52) (0.50) (0.46) (0.44) (0.43) (0.39) (0.38) (0.41) (0.39) (0.39)
Distributions from
capital gains ($) -- -- -- -- (0.02) (0.06) (0.01) -- -- --
---- ---- ---- ---- ---- ---- ---- ---- ---- ----
Total distributions ($) (0.52) (0.50) (0.46) (0.44) (0.45) (0.45) (0.39) (0.41) (0.39) (0.39)
---- ---- ---- ---- ---- ---- ---- ---- ---- ----
Net asset value,
end of year ($) 7.24 7.42 7.30 7.69 7.94 8.43 7.46 8.26 8.10 8.51
==== ==== ==== ==== ==== ==== ==== ==== ==== ====
Total return (%)(2) 13.50 9.63 4.84 11.81 9.34 12.11 (6.90) 16.58 2.93 10.17
Ratios/Supplemental Data:
Net assets at end
of year ($ thousands) 31,378 68,392 84,925 118,157 203,312 302,845 238,097 253,402 223,407 209,552
Expense ratio (%) 1.25 1.25 1.25 1.25 1.20 1.20 1.20 1.13 1.04 1.08
Ratio of net investment
income to average
net assets (%) 7.24 6.72 6.43 6.00 5.48 4.85 5.07 4.95 4.82 4.91
Portfolio turnover
rate (%) 126.27 106.86 84.12 81.75 27.44 36.16 78.63 97.32 125.24 60.48
</TABLE>
6
<PAGE>
<TABLE>
<CAPTION>
Years ended December 31
-----------------------------------------------------
Class B 1993(1) 1994 1995 1996 1997
- ----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Net asset value,
beginning of year ($) 8.25 8.43 7.46 8.26 8.10
---- ---- ---- ---- ----
Net investment income ($) 0.19 0.34 0.33 0.32 0.34
Net realized and
unrealized gain (loss)
on investments and
futures contracts ($) 0.24 (0.97) 0.82 (0.15) 0.40
---- ---- ---- ---- ----
Total from investment
operations ($) 0.43 (0.63) 1.15 0.17 0.74
---- ---- ---- ---- ----
Dividends from net
investment income ($) (0.19) (0.33) (0.35) (0.33) (0.33)
Distributions from
capital gains ($) (0.06) (0.01) -- -- --
---- ---- ---- ---- ----
Total distributions ($) (0.25) (0.34) (0.35) (0.33) (0.33)
---- ---- ---- ---- ----
Net asset value,
end of year ($) 8.43 7.46 8.26 8.10 8.51
==== ==== ==== ==== ====
Total return (%)(2) 5.20(3) (7.59) 15.72 2.15 9.35
Ratios/Supplemental Data:
Net assets at
end of year ($ thousands) 27,695 35,338 51,827 51,710 54,093
Expense ratio (%) 1.95(4) 1.95 1.88 1.79 1.83
Ratio of net investment
income to average
net assets (%) 3.93(4) 4.35 4.19 4.07 4.15
Portfolio turnover rate (%) 36.16 78.63 97.32 125.24 60.48
</TABLE>
(1) June 7, 1993 (commencement of share class designations) to December 31,
1993.
(2) Does not reflect any front-end or contingent deferred sales charge.
(3) Not annualized.
(4) Annualized.
7
<PAGE>
Financial Highlights continued
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Years ended December 31
---------------------------------------------------
Class C (formerly Class D) 1993(1) 1994 1995 1996 1997
- ----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Net asset value,
beginning of year ($) 8.25 8.43 7.46 8.25 8.10
---- ---- ---- ---- ----
Net investment
income ($) 0.19 0.34 0.33 0.32 0.34
Net realized and
unrealized gain (loss)
on investments and
futures contracts ($) 0.23 (0.97) 0.81 (0.14) 0.39
---- ---- ---- ---- ----
Total from investment
operations ($) 0.42 (0.63) 1.14 0.18 0.73
---- ---- ---- ---- ----
Dividends from net
investment income ($) (0.18) (0.33) (0.35) (0.33) (0.33)
Distributions from
capital gains ($) (0.06) (0.01) -- -- --
---- ---- ---- ---- ----
Total distributions ($) (0.24) (0.34) (0.35) (0.33) (0.33)
---- ---- ---- ---- ----
Net asset value,
end of year ($) 8.43 7.46 8.25 8.10 8.50
==== ==== ==== ==== ====
Total return (%)(2) 5.19(3) (7.59) 15.58 2.28 9.23
Ratios/Supplemental Data:
Net assets at
end of year
($ thousands) 1,115 958 4,183 2,889 2,836
Expense ratio (%) 1.99(4) 1.95 1.88 1.79 1.83
Ratio of net
investment income
to average net assets (%) 3.92(4) 4.31 4.13 4.06 4.16
Portfolio turnover rate (%) 36.16 78.63 97.32 125.24 60.48
</TABLE>
8
<PAGE>
<TABLE>
<CAPTION>
Years ended December 31
---------------------------------------------------
Class S (formerly Class C) 1993(1) 1994 1995 1996 1997
- ----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Net asset value,
beginning of year ($) 8.25 8.41 7.45 8.24 8.09
---- ---- ---- ---- ----
Net investment income ($) 0.23 0.42 0.40 0.39 0.42
Net realized and
unrealized gain (loss) on
investments and
futures contracts ($) 0.22 (0.96) 0.81 (0.13) 0.39
---- ---- ---- ---- ----
Total from investment
operations ($) 0.45 (0.54) 1.21 0.26 0.81
---- ---- ---- ---- ----
Dividends from net
investment income ($) (0.23) (0.41) (0.42) (0.41) (0.41)
Distributions from
capital gains ($) (0.06) (0.01) -- -- --
---- ---- ---- ---- ----
Total distributions ($) (0.29) (0.42) (0.42) (0.41) (0.41)
---- ---- ---- ---- ----
Net asset value,
end of year ($) 8.41 7.45 8.24 8.09 8.49
==== ==== ==== ==== ====
Total return (%)(2) 5.54(3) (6.56) 16.76 3.30 10.33
Ratios/Supplemental Data:
Net assets at
end of year
($ thousands) 477 334 22,614 8,990 8,817
Expense ratio (%) 0.96(4) 0.95 0.88 0.79 0.83
Ratio of net
investment income to
average net assets (%) 4.92(4) 5.26 4.85 5.04 5.15
Portfolio turnover rate (%) 36.16 78.63 97.32 125.24 60.48
</TABLE>
(1) June 7, 1993 (commencement of share class designations) to December 31,
1993.
(2) Does not reflect any front-end or contingent deferred sales charge.
(3) Not annualized.
(4) Annualized.
9
<PAGE>
Performance and Volatility
- --------------------------------------------------------------------------------
As of December 31, 1997
-------------------------------------
Average Annual Total Return(1) 1 Year 5 Years 10 Years
- --------------------------------------------------------------------------------
Class A (%) 5.21 5.67 7.70
Class B (%) 4.35 5.61 7.83
Class C (%) 8.23 5.90 7.82
Class S (%) 10.33 6.85 8.30
Lehman Brothers Municipal
Bond Index (%) 9.19 7.36 8.58
Lipper General Municipal
Debt Funds Index (%) 9.03 6.90 8.29
[bar chart:]
<TABLE>
<CAPTION>
Class A Years ended December 31
Year-by-Year ----------------------------------------------------------------------
Total Return(1) 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
13.50 9.63 4.84 11.81 9.34 12.11 (6.90) 16.58 2.93 10.17
</TABLE>
(1) Fund returns include performance from before the creation of share classes
in 1993. Because Classes B and C involve higher marketing/service (12b-1)
fees (as described on page 5), performance since that time is somewhat
lower for these classes.
10
<PAGE>
- --------------------------------------------------------------------------------
[Graphic: Magnifying glass showing magnified words on paper]
Understanding
Performance
and Volatility
The information on the opposite page is designed to show two aspects of the
fund's track record:
[bullet] Average annual total return is a measure of the fund's performance over
time. It is determined by taking the fund's performance over a given
period and expressing it as an average annual rate. Average annual
total return includes the effects of fund expenses and maximum sales
charges for each class, and assumes that you sold your shares at the
end of the period.
[bullet] The graph of year-by-year returns shows how volatile the fund has been:
how much the difference has been, historically, between its best years
and worst years. In general, funds with higher average annual total
returns will also have higher volatility. The graph includes the
effects of fund expenses, but not sales charges.
Also included are two independent measures of performance. The Lehman Brothers
Municipal Bond Index is an unmanaged index of 8,000 fixed-rate investment-grade
municipal bonds, all from issues larger than $50 million and with maturities
greater than two years. The Lipper General Municipal Debt Funds Index shows the
performance of a category of mutual funds with similar goals. The Lipper index,
which is also unmanaged, shows you how well the fund has done compared to
competing funds.
While the fund does not seek to match the returns or the volatility of any
index, these indices can be used as rough guides when gauging the return of this
and other investments. When making comparisons, keep in mind that none of the
indices includes the effects of sales charges. Also, even if your bond portfolio
were identical to the Lehman Brothers Municipal Bond Index, your returns would
always be lower, because this index does not include brokerage and
administrative expenses.
- --------------------------------------------------------------------------------
11
<PAGE>
Your Account
- --------------------------------------------------------------------------------
[Graphic: Key]
Opening an Account
If you are opening an account through a financial professional, he or she can
assist you with all phases of your investment.
If you are investing through a special program, follow the instructions in your
program materials.
To open an account without the help of a financial professional, please use the
instructions on these pages.
[Graphic: Paper with list of shares, pencil ready to check off choice of share]
Choosing a Share Class
The fund offers four share classes, each with its own sales charge and expense
structure.
If you are investing a substantial amount and plan to hold your shares for a
long period, Class A shares may make the most sense for you. If you are
investing a lesser amount, you
- --------------------------------------------------------------------------------
Class A -- Front Load
[bullet] Initial sales charge of 4.5% or less; schedule on page 14
[bullet] Lower sales charges for larger investments; see sidebar on facing page
and sales charge schedule
[bullet] Lower annual expenses than Class B or C shares due to lower
marketing/service (12b-1) fee of 0.25%
Class B -- Back Load
[bullet] No initial sales charge
[bullet] Deferred sales charge of 5% or less on shares you sell within five
years; schedule on page 14
[bullet] Annual marketing/service (12b-1) fee
[bullet] Automatic conversion to Class A shares after eight years, reducing
future annual expenses
Class C(1) -- Level Load
[bullet] No initial sales charge
[bullet] Deferred sales charge of 1%, paid if you sell shares within one year of
purchase
[bullet] Lower deferred sales charge than Class B shares
[bullet] Annual marketing/service (12b-1) fee
[bullet] No conversion to Class A shares after eight years, so annual expenses
do not decrease
(1) Before November 1, 1997, these were designated Class D.
- --------------------------------------------------------------------------------
12
<PAGE>
may want to consider Class B shares (if investing for at least five years) or
Class C shares (if investing for less than five years). If you are investing
through a special program, such as a large employer-sponsored retirement plan or
certain programs available through brokers, you may be eligible to purchase
Class S shares.
Because all future investments in your account will be made in the share class
you designate when opening the account, you should make your decision carefully.
Your financial professional can help you choose the share class that makes the
most sense for you.
- --------------------------------------------------------------------------------
Class S(2) -- No Load
[bullet] No sales charges of any kind
[bullet] No marketing/service (12b-1) fees; annual expenses are lower than other
share classes
[bullet] Available through certain advisory accounts of the investment manager
and special programs, including broker programs with record-keeping and
other services; these programs usually involve special conditions and
separate fees (contact your financial professional for information)
(2) Before November 1, 1997, these were designated Class C.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
[Graphic: Magnifying glass showing magnified words on paper]
Class A Sales
Charge Reductions
and Waivers
[bullet] Substantial investments receive lower sales charge rates; see
information on the following page.
[bullet] The "right of accumulation" allows you to include your existing State
Street Research investments (except Money Market Fund Class E shares)
as part of your current investment for sales charge purposes.
[bullet] A "letter of intent" allows you to count all investments in this or
other State Street Research funds over the next 13 months as if you
were making them all at once, for purposes of calculating sales
charges.
To take advantage of right of accumulation or letter of intent waivers, consult
your financial professional or State Street Research.
- ------------------------------------------------------------------------------
13
<PAGE>
Your Account continued
- --------------------------------------------------------------------------------
Sales Charges
Class A -- Front Load
when you invest this % is which equals
this amount deducted this % of
for sales your net
charges investment
Up to $99,999 4.50 4.71
$100,000 - $249,999 3.50 3.63
$250,000 - $499,999 2.50 2.56
$500,000 - $999,999 2.00 2.04
$1 million or more see next column
With Class A shares, you pay a sales charge only when you buy shares.
If you are investing $1 million or more (either as a lump sum or through any of
the methods described on the previous page), you can purchase Class A shares
without any sales charge. However, you may be charged a "contingent deferred
sales charge" (CDSC) if you sell any shares you have held for less than one
year. Policies regarding the calculation of the CDSC are the same as for Class
B.
Class A shares are also offered with low or no sales charges through various
wrap-fee programs and other sponsored arrangements (contact your financial
professional for information).
Class B -- Back Load
this % of net asset value
when you sell shares at the time of purchase (or
in this year after you of sale, if lower) is
bought them deducted from your proceeds
- -----------------------------------------------------------------
First year 5.00
Second year 4.00
Third year 3.00
Fourth year 3.00
Fifth year 2.00
Sixth year or later None
With Class B shares, you pay no sales charge when you invest, but you are
charged a "contingent deferred sales charge" (CDSC) when you sell shares you
have held for five years or less, as described in the table above. Any shares
acquired through reinvestment are not subject to the CDSC. There is no CDSC on
exchanges into other State Street Research funds, and the
14
<PAGE>
date of your initial investment will continue to be used as the basis for CDSC
calculations when you exchange. To ensure that you pay the lowest CDSC possible,
the fund will always use the shares with the lowest CDSC to fill your sell
requests.
The CDSC is waived on shares sold for mandatory retirement distributions or
because of disability or death. Consult your financial professional or the State
Street Research Service Center.
Class B shares automatically convert to Class A shares after eight years,
lowering your annual expenses from that time on.
Class C (Formerly Class D) -- Level Load
this % of net asset value
when you sell shares at the time of purchase (or
in this year after you of sale, if lower) is
bought them deducted from your proceeds
- ----------------------------------------------------------------
First year 1.00
Second year or later None
With Class C shares, you pay no sales charge when you invest, but you are
charged a "contingent deferred sales charge" (CDSC) when you sell shares you
have held for one year or less, as described in the table above. Policies
regarding the calculation of the CDSC are the same as for Class B.
Class C shares currently have the same annual expenses as Class B shares, but
never convert to Class A shares (with their lower annual expenses).
Class S (Formerly Class C) -- No Load
Class S shares have no sales charges or CDSC.
15
<PAGE>
Your Account continued
- --------------------------------------------------------------------------------
[Graphic: Old-fashioned crank cash register]
Policies for
Buying Shares
Once you have chosen a share class, the next step is to determine the amount you
want to invest.
Minimum Initial Investments:
[bullet] $1,000 for accounts that use the Investamatic program
[bullet] $2,500 for all other accounts
Minimum Additional Investments:
[bullet] $50 for any account
Complete the enclosed application. You can avoid future inconvenience by signing
up now for any services you might later use.
Timing of Requests All requests received by State Street Research before 4:00
p.m. eastern time will be executed the same day, at that day's closing share
price. Orders received after 4:00 p.m. will be executed the following day, at
that day's closing share price.
Wire Transactions Funds may be wired between 8:00 a.m. and 4:00 p.m. eastern
time. To make a same-day wire investment, please notify State Street Research by
12:00 noon of your intention to wire funds, and make sure your wire arrives by
4:00 p.m. Your bank may charge a fee for wiring money.
16
<PAGE>
Buying Shares
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
To Open an Account To Add to an Account
<S> <C> <C>
Through a Financial Contact your financial Contact your financial
Professional professional. professional.
[Graphic: Briefcase]
By Mail Make your check payable to Fill out the investment stub
[Graphic: Mail Box] "State Street Research from an account statement, or
Funds." Forward the check indicate the fund name and
and your application to account number on your check.
State Street Research. Make your check payable to
"State Street Research Funds."
Forward the check and stub to
State Street Research.
By Federal Funds Wire Forward your application to Call State Street Research to
[Graphic: Capitol State Street Research, then obtain a control number.
Building] call to obtain an account Instruct your bank to wire funds
number. Wire funds using the to:
instructions at right.
[bullet] State Street Bank and
Trust Company,
Boston, MA
[bullet] ABA: 011000028
[bullet] BNF: fund name and
share class you want
to buy
[bullet] AC: 99029761
[bullet] OBI: your name and your
account number
[bullet] Control: the number
given to you by
State Street Research
By Electronic Funds Verify that your bank is a Call State Street Research to
Transfer (ACH) member of the ACH (Automated verify that the necessary bank
[Graphic: plug] Clearing House) system. information is on file for your
Forward your application to account. If it is, you may
State Street Research. request a transfer with the same
Please be sure to include phone call. If not, please ask
the appropriate bank State Street Research to provide
information. Call State you with an EZ Trader application.
Street Research to request a
purchase.
By Investamatic Forward your application, Call State Street Research to
[Graphic: calendar] with all appropriate verify that Investamatic is in
sections completed, to State place on your account, or to
Street Research, along with request a form to add it.
a check for your initial Investments are automatic once
investment payable to "State Investamatic is in place.
Street Research Funds."
By Exchange Call State Street Research Call State Street Research or
[Graphic: arrows or visit our Web site. visit our Web site.
pointing in 2
different directions]
</TABLE>
State Street Research Service Center PO Box 8408, Boston, MA 02266-8408
Internet www.ssrfunds.com
Call toll-free: 1-800-562-0032 (business days 8:00 a.m. - 6:00 p.m.,
eastern time)
17
<PAGE>
Your Account continued
- --------------------------------------------------------------------------------
[Graphic: Old-fashioned crank adding machine with receipt coming from the top]
Policies for
Selling Shares
Circumstances that Require Written Requests Please submit instructions in
writing when any of the following apply:
[bullet] you are selling more than $100,000 worth of shares
[bullet] the name or address on the account has changed within the last 30 days
[bullet] you want the proceeds to go to a name or address not on the account
registration
[bullet] you are transferring shares to an account with a different registration
or share class
[bullet] you are selling shares held in a corporate or fiduciary account; for
these accounts, additional documents are required:
corporate accounts: certified copy of a corporate resolution
fiduciary accounts: copy of power of attorney or other governing
document
To protect your account against fraud, all signatures on these documents must be
guaranteed. You may obtain a signature guarantee at most banks and securities
dealers. A notary public cannot provide a signature guarantee.
Incomplete Sell Requests State Street Research will attempt to notify you
promptly if any information necessary to process your request is missing.
Timing of Requests All requests received in good order by State Street Research
before 4:00 p.m. eastern time will be executed the same day, at that day's
closing share price. Requests received after 4:00 p.m. will be executed the
following day, at that day's closing share price.
Wire Transactions Proceeds sent by federal funds wire must total at least
$5,000. A fee of $7.50 will be deducted from all proceeds sent by wire, and your
bank may charge an additional fee to receive wired funds.
Selling Recently Purchased Shares If you sell shares before the check or
electronic funds transfer (ACH) for those shares has been collected, you will
not receive the proceeds until your initial payment has cleared. This may take
up to 15 days after your purchase was recorded (in rare cases, longer). If you
open an account with shares purchased by wire, you cannot sell those shares
until your application has been processed.
18
<PAGE>
Selling Shares
- --------------------------------------------------------------------------------
To Sell Some or All of Your Shares
Contact your financial professional.
Through a Financial
Professional
[Graphic: Briefcase]
By Mail Send a letter of instruction, an endorsed stock
[Graphic: Mailbox] power or share certificates (if you hold
certificate shares) to State Street Research.
Specify the fund, the account number and the
dollar value or number of shares. Be sure to
include all necessary signatures and any
additional documents, as well as signature
guarantees if required (see facing page).
By Federal Check with State Street Research to make sure that
Funds Wire a wire redemption privilege, including a bank
[Graphic: Capitol designation, is in place on your account. Once
Building] this is established, you may place your request
to sell shares with State Street Research.
Proceeds will be wired to your pre-designated
bank account. (See "Wire Transactions" on facing
page.)
By Electronic Funds Check with State Street Research to make sure that
Transfer(ACH) the EZ Trader feature, including a bank
[Graphic: plug] designation, is in place on your account. Once
this is established, you may place your request to
sell shares with State Street Research. Proceeds
will be sent to your pre-designated bank account.
By Telephone As long as the transaction does not require a
[Graphic: telephone] written request (see facing page), you or your
financial professional can sell shares by calling
State Street Research. A check will be mailed to
you on the following business day.
By Exchange Read the prospectus for the fund into which you
[Graphic: arrows are exchanging. Call State Street Research or
pointing in 2 visit our Web site.
different directions]
By Systematic See plan information on page 23.
Withdrawal Plan
[Graphic: calendar]
State Street Research Service Center PO Box 8408, Boston, MA 02266-8408
Internet www.ssrfunds.com
Call toll-free: 1-800-562-0032 (business days 8:00 a.m. - 6:00 p.m.,
eastern time)
19
<PAGE>
Your Account continued
- --------------------------------------------------------------------------------
Account Policies
[Graphic: Stack of papers]
The Fund's Business Hours The fund is open the same days as the New York Stock
Exchange (generally Monday through Friday). Fund representatives are available
from 8:00 a.m. to 6:00 p.m. eastern time on these days.
Calculating Share Price The fund calculates its net asset value per share (NAV)
every business day at the close of regular trading on the New York Stock
Exchange (usually at 4:00 p.m. eastern time). Each class's share price is
calculated by dividing its net assets by the number of its shares outstanding.
Telephone Requests When you open an account you automatically receive telephone
privileges, allowing you to place requests on your account by telephone. Your
financial professional can also use these privileges to request exchanges on
your account and, with your written permission, redemptions. For your
protection, all telephone calls are recorded.
As long as State Street Research takes certain measures to authenticate
telephone requests on your account, you may be held responsible for unauthorized
requests. Unauthorized telephone requests are rare, but if you want to protect
yourself completely, you can decline the telephone privilege on your
application. The fund may suspend or eliminate the telephone privilege at any
time.
Exchange Privileges There is no fee to exchange shares among State Street
Research funds. Your new fund shares will be the equivalent class as your
current shares. Any contingent deferred sales charges will continue to be
calculated from the date of your initial investment.
Frequent exchanges can interfere with fund management and drive up costs for all
shareholders. Because of this, the fund currently limits each account, or group
of accounts under common ownership or control, to six exchanges per calendar
year. The fund may change or eliminate the exchange privilege at any time, may
limit or cancel any shareholder's exchange privilege and may refuse to
20
<PAGE>
accept any exchange request, particularly those associated with "market timing"
strategies.
For Merrill Lynch customers, exchange privileges extend to Summit Cash Reserves
Fund, which is related to the fund for purposes of investment and investor
services.
Accounts with Low Balances If the value of your account falls below $1,500,
State Street Research may mail you a notice asking you to bring the account back
up to $1,500 or close it out. If you do not take action within 60 days, State
Street Research may either sell your shares and mail the proceeds to you at the
address of record or may deduct an annual maintenance fee (currently $18).
Reinstating Recently Sold Shares For 120 days after you sell shares, you have
the right to "reinstate" your investment by putting some or all of the proceeds
into any currently available State Street Research fund at net asset value. Any
CDSC you paid on the amount you are reinstating will be credited to your
account. You may only use this privilege once in any twelve-month period with
respect to your shares of a given fund.
Distributions and Taxes
[Graphic: "Uncle Sam"]
Income and Capital Gains Distributions The fund distributes its net income and
net capital gains to shareholders. Using projections of its future income, the
fund declares dividends daily and pays them monthly. Net capital gains, if any,
are distributed in December.
You may have your distributions reinvested in the fund, invested in a different
State Street Research fund, deposited in a bank account or mailed out by check.
If you do not give State Street Research other instructions, your distributions
will automatically be reinvested in the fund.
21
<PAGE>
Your Account continued
- -------------------------------------------------------------------------------
[Graphic: Magnifying glass showing magnified words on paper]
The Alternative Minimum Tax
The Alternative Minimum Tax (AMT) is a federal tax that could affect you if you
are a high-income individual who would pay comparatively little tax under the
ordinary tax schedules -- for example, because you have significant deductions
or certain types of tax-free income.
Interest from industrial revenue bonds and other so-called private activity
bonds is generally subject to AMT; because of this, the fund does not invest
more than 20% of its net assets in these securities. For corporations, all
tax-exempt interest is considered in calculating AMT.
- -------------------------------------------------------------------------------
Tax Effects of Distributions and Transactions As a general rule, the fund's
income distributions are exempt from federal income tax for all investors
(including corporations). A small portion of these distributions may be exempt
from state or local personal income taxes; these exemptions, if any, will vary
from state to state. You may have federal or state tax liability to the extent
that the fund earns income from non-tax-exempt securities or realizes net
capital gains. In addition, even tax-exempt income may be subject to the federal
alternative minimum tax (see sidebar).
In general, any taxable income distributions and short-term capital gain
distributions are taxable as ordinary income. Distributions of other capital
gains are generally taxable as capital gains. This is true no matter how long
you have owned your shares and whether you reinvest your distributions or take
them in cash.
Every year, the fund will send you information detailing the amount of federal,
state and city tax-exempt income distributed to you during the previous year, as
well as taxable ordinary income and capital gains.
22
<PAGE>
The sale of shares in your account may produce a gain or loss, and is a taxable
event. For tax purposes, an exchange is the same as a sale.
Your investment in the fund could have additional tax consequences. Please
consult your tax professional for assistance.
Backup Withholding By law, the fund must withhold 31% of your distributions and
proceeds if you have not provided complete, correct taxpayer information.
Investor Services
[Graphic: 2 hands]
Investamatic Program Use Investamatic to set up regular automatic investments in
the fund from your bank account. You determine the frequency and amount of your
investments, and you can skip an investment with three days notice. Not
available with Class S shares.
Systematic Withdrawal Plan This plan is designed for retirees and other
investors who want regular withdrawals from a fund account. The plan is free and
allows you to withdraw up to 8% of your fund assets a year without incurring any
contingent deferred sales charges. Certain terms and minimums apply.
Dividend Allocation Plan This plan automatically invests your distributions from
the fund into another fund of your choice, without any fees or sales charges.
Automatic Bank Connection This plan lets you route any distributions or
Systematic Withdrawal Plan payments directly to your bank account.
State Street Research also offers a full range of prototype retirement plans for
individuals, sole proprietors, partnerships, corporations and employees. Call
1-800-562-0032 for information on retirement plans or any of the services
described above.
23
<PAGE>
Fund Details
- --------------------------------------------------------------------------------
[Graphic: top of Ionic column]
Business Structure Formed in 1985, the fund is a diversified series of State
Street Research Tax-Exempt Trust, an open-end management investment company that
is organized as a Massachusetts business trust. A board of trustees representing
shareholder interests oversees the fund's operations, including the hiring of
the investment manager and other service providers.
The fund does not hold regular shareholder meetings, but may call meetings when
matters arise that require shareholder approval. These may include amendments to
the investment management agreement, the election of trustees or proposed
changes in the fund's fundamental goal, which cannot be changed without
shareholder approval.
The investment manager is responsible for the fund's investment and business
activities, and receives the management fee as compensation (0.55% of fund
assets, annually). The investment manager and the distributor are subsidiaries
of Metropolitan Life Insurance Company.
Brokers for Portfolio Trades
When placing trades for the fund's portfolio, State Street Research chooses
brokers that provide the best execution (a term defined by service as well as
price), but may also consider a broker's sales of fund shares.
Investment Manager
State Street Research & Management Company
One Financial Center, Boston, MA 02111
Distributor
State Street Research Investment Services, Inc.
One Financial Center, Boston, MA 02111
Service Center
State Street Research Service Center
P.O. Box 8408, Boston, MA 02266
Custodian
State Street Bank and Trust Company
225 Franklin Street, Boston, MA 02110
24
<PAGE>
Dealer Compensation
[Graphic: check]
Dealers who sell shares of the fund and perform services for fund investors
receive sales commissions and annual fees. These are paid by the fund's
distributor, using money from sales charges, marketing/service (12b-1) fees and
its other resources.
Maximum Dealer Compensation Class A Class B Class C Class S
- --------------------------------------------------------------------------------
Initial commission (%) -- 4.00 1.00 0.00
Investments up to $100,000 (%) 4.00 -- -- --
$100,000 - $249,999 (%) 3.00 -- -- --
$250,000 - $499,999 (%) 2.00 -- -- --
$500,000 - $999,999 (%) 1.75 -- -- --
First $1-3 million (%) 1.00(1) -- -- --
Next $2 million (%) 0.50(1) -- -- --
Next $1 and above (%) 0.25(1) -- -- --
Annual fee (%) 0.25 0.25 0.90 0.00
Additional Policies Please note that the fund maintains additional policies and
reserves certain rights, including:
[bullet] The fund may vary its initial or additional investments in the case of
exchanges, reinvestments, periodic investment plans, sponsored
arrangements and other similar programs.
[bullet] All orders to purchase shares are subject to acceptance by the fund.
[bullet] At any time, the fund may change or discontinue its sales charge
waivers and any of its order acceptance practices, and may suspend the
sale of its shares.
[bullet] To permit investors to obtain the current price, dealers are
responsible for transmitting all orders to the State Street Research
Service Center promptly.
[bullet] Dealers may impose a transaction fee on the purchase or sale of shares
by shareholders.
[bullet] The distributor may pay its affiliate MetLife Securities, Inc.
additional compensation of up to 0.25% of certain sales or assets.
(1) If your broker declines this commission, the one-year CDSC on your
investment is waived.
25
<PAGE>
Other Securities and Risks
- --------------------------------------------------------------------------------
Other Securities and Risks
[Graphic: Stock certificates]
Each of the fund's portfolio securities and investment practices offers certain
opportunities and carries various risks. Major investments and risk factors are
outlined in the fund description starting on page 2. Below are brief
descriptions of other securities and practices, along with their associated
risks. A table of limitations follows.
Limited Obligation Securities Certain municipal securities are not general
obligations of their issuers, meaning that in the event of a default or
termination the securities holders may have limited recourse. These securities
may include:
[bullet] lease obligations and installment contracts: issued by government
entities to obtain funds to lease or acquire equipment and other
property
[bullet] project finance obligations: issued in connection with the financing of
infrastructure projects, such as toll roads or housing projects
[bullet] industrial revenue bonds: issued in the name of a public authority to
finance infrastructure used by a private entity (these are generally
obligations of the private entity, not the issuer)
Restricted and Illiquid Securities Any securities that are thinly traded or
whose resale is restricted can be difficult to sell at a desired time and price.
Some of these securities are new and complex, and trade only among institutions;
the markets for these securities are still developing, and may not function as
efficiently as established markets. Owning a large percentage of restricted and
illiquid securities could hamper the fund's ability to raise cash to meet
redemptions. Also, because there may not be an established market price for
these securities, the fund may have to estimate their value, which means that
their valuation (and, to a much smaller extent, the valuation of the fund) may
have a subjective element.
26
<PAGE>
Derivatives Derivatives, a category that includes options and futures, are
financial instruments whose value derives from another security or an index.
Depending on a derivative's issuer and structure, its income may be taxable or
tax-exempt to shareholders. The fund may use derivatives for hedging (attempting
to offset a potential loss in one position by establishing an interest in an
opposite position). The fund may also use derivatives for speculation (investing
for potential income or capital gain).
While hedging can guard against potential risks, it adds to the fund's expenses
and can eliminate some opportunities for gains. There is also a risk that a
derivative intended as a hedge may not perform as expected.
The main risk with derivatives is that some types can amplify a gain or loss,
potentially earning or losing substantially more money than the actual cost of
the derivative.
With all derivatives, whether used for hedging or speculation, there is also the
risk that the counterparty may fail to honor its contract terms, causing a loss
for the fund.
Securities Lending The fund may seek additional income by lending portfolio
securities to qualified institutions. By reinvesting collateral it receives in
these transactions, the fund could magnify any gain or loss it realizes on the
underlying investment. If the borrower fails to return the securities and the
collateral is insufficient to cover the loss, the fund could lose money.
When-issued Securities The fund may invest in securities prior to their date of
issue. These securities could fall in value by the time they are actually
issued, which may be anytime from a few days to over a year.
Repurchase Agreements The fund may buy securities with the understanding that
the seller will buy them back with interest at a later date. If the seller is
unable to honor its commitment to repurchase the securities, the fund could lose
money.
27
<PAGE>
Other Securities and Risks continued
- --------------------------------------------------------------------------------
Zero (or Step) Coupons A zero coupon security is a debt security that is
purchased and traded at a discount to its face value because it pays no interest
for some or all of its life. Interest, however, is reported as income to the
fund and the fund is required to distribute to shareholders an amount equal to
the amount reported. Those distributions may force the fund to liquidate
portfolio securities at a disadvantageous time.
Defensive Investing During unusual market conditions, the fund may place up to
100% of total assets in cash or quality short-term debt securities.
Investment Limitations
Limitation at the time of investment
--------------------------------------------
Practice % of total assets % of net assets
- --------------------------------------------------------------------------------
Investing in securities of
any given issuer (other
than the U.S. government
and its agencies)(1) 5(2) --
Investing in securities of
issuers conducting
principal activities in
same state (other than
the U.S. government and
its agencies)(1)(3) 25 --
Lending securities 33-1/3 --
Lending money(1) Prohibited --
Repurchase agreements -- 30(3)
Swap arrangements -- 5
Security
- --------------------------------------------------------------------------------
Commodity futures contracts
and options contracts
(for non-hedging purposes) -- 5(4)
Other options contracts
(for non-hedging purposes) -- 5(4)
Illiquid securities -- 15(5)
Restricted securities 10(6) --
(1) Fundamental policy; may not be changed without shareholder approval.
(2) Applies only to 75% of fund's total assets. The fund is also prohibited
from investing in more than 10% of an issuer's voting securities.
(3) Does not include repurchase agreements involving U.S. government
securities.
(4) Initial margin deposits plus premiums may not exceed 5% of the market value
of the fund's net assets in non-hedging transactions. No limits apply when
used in hedging strategies.
(5) Includes repurchase agreements extending over more than seven days.
(6) Does not include Rule 144A securities.
28
<PAGE>
Notes
- --------------------------------------------------------------------------------
29
<PAGE>
[Back Cover]
For Additional Information
- --------------------------------------------------------------------------------
You can obtain a free copy of the
current annual/semiannual report
or SAI by contacting:
[State Street Research logo]
Service Center
P.O. Box 8408, Boston, MA 02266
Telephone: 1-800-562-0032
Internet: www.ssrfunds.com
Or you can visit the SEC Web site at:
www.sec.gov
You can find additional information on the fund's structure and its performance
in the following documents:
Annual/Semiannual Reports While the prospectus describes the fund's potential
investments, these reports detail the fund's actual investments as of the report
date. Reports include a discussion by fund management of recent economic and
market trends and fund performance. The annual report also includes the report
of the fund's independent accountants.
Statement of Additional Information (SAI) A supplement to the prospectus, the
SAI contains further information about the fund and its investment limitations
and policies. It also includes the most recent annual report and the independent
accountants' report. A current SAI for this fund is on file with the Securities
and Exchange Commission and is incorporated by reference (is legally part of
this prospectus).
prospectus
--------------
Control Number: 4708-980428(0599)SSR-LD TE-965E-598IBS
<PAGE>
[State Street Research logo]
New York Tax-Free Fund
This prospectus has information you should know before you invest. Please read
it carefully and keep it with your investment records.
Although these securities have been registered with the Securities and Exchange
Commission, the commission has not judged them for investment merit and does not
guarantee the accuracy or adequacy of the information in this prospectus. Anyone
who informs you otherwise is committing a federal crime.
A municipal bond fund seeking tax-free income for New York State taxpayers.
Prospectus
May 1, 1998
<PAGE>
Who May Want To Invest
- --------------------------------------------------------------------------------
State Street Research New York Tax-Free Fund is designed for New York State
taxpayers seeking one or more of the following:
[bullet] high current income that is exempt from federal, New York State and
City income taxes
[bullet] a diversified portfolio of municipal securities
[bullet] a fund to complement a portfolio of more aggressive investments
The fund is not appropriate for investors who:
[bullet] want an investment for a tax-advantaged account such as an IRA or
401(k)
[bullet] do not pay personal income taxes in New York State
[bullet] want to avoid even moderate volatility or potential losses
[bullet] are seeking high growth or maximum income
[bullet] are investing emergency reserve money
The fund's shares will rise and fall in value. There is a risk that you could
lose money by investing in the fund.
The fund cannot be certain that it will achieve its goal.
Fund shares are not bank deposits and are not guaranteed, endorsed or insured by
any financial institution, government entity or the FDIC.
<PAGE>
Contents
- --------------------------------------------------------------------------------
2 The Fund
--------
The fund's goal and strategy, main
risks, expenses and performance,
plus financial highlights
12 Your Account
------------
Managing your State Street Research
investments
12 Opening an Account
12 Choosing a Share Class
14 Sales Charges
16 Policies for Buying Shares
18 Policies for Selling Shares
20 Account Policies
21 Distributions and Taxes
23 Investor Services
24 Fund Details
------------
The fund's business structure
and dealer compensation, plus
additional policies
26 Other Securities and Risks
--------------------------
Information on additional
portfolio securities and
practices, and the risks
associated with them
Back Cover For Additional Information
1
<PAGE>
The Fund
[Graphic: Chess piece--Knight]
Goal and Strategy
Fundamental Goal The fund seeks a high level of interest income exempt from
federal income taxes and New York State and New York City personal income taxes.
Strategy Under normal market conditions, the fund invests at least 80% of net
assets in securities whose interest income is free from certain taxes as
described in the fund's goal, and that are investment grade at the time the fund
buys them. These securities are typically bonds issued by the State of New York,
its counties, cities, towns and public authorities. They may also be securities
of issuers with special tax status, such as the Commonwealth of Puerto Rico. The
fund may invest up to 20% of net assets in other securities, including junk
bonds of similar issuers (that is, bonds that are in or below the Standard &
Poor's BB or Moody's Ba major rating categories).
When bonds are rated by one or more independent rating agencies, the fund uses
these ratings to determine bond quality. In cases where a bond is rated in
conflicting categories by different rating agencies, the fund may choose to
follow the higher rating. If a bond is unrated, the fund may assign it to a
given category based on its own credit research. The fund may invest up to 25%
of net assets in unrated bonds.
In managing its portfolio, the fund focuses on security selection, using
proprietary research to identify those individual bonds that offer higher yields
or higher potential total return than others that appear to be of comparable
credit quality. The fund may invest in securities of any maturity, and may
invest in certain securities, such as municipal lease obligations and industrial
revenue bonds, that may have different risks than ordinary municipal bonds.
The fund may adjust the composition of its portfolio as market conditions and
economic outlooks change. For more information about the fund's investments and
practices, see page 26.
2
<PAGE>
[Graphic: Traffic Caution sign (arrows point in different directions)]
Portfolio Risks
Because the fund invests primarily in bonds and other fixed income securities,
its major risks are those of bond investing, including the tendency of prices to
fall when interest rates rise. Such a fall would lower the fund's share price
and the value of your investment.
Bond prices in general tend to move in the opposite direction from interest
rates, for the reason that new bonds issued after a rise in rates will offer
higher yields to investors; the only way an existing bond with a lower yield can
appear attractive to investors is by selling at a lower price. (This principle
works in reverse as well: a fall in interest rates will tend to cause a rise in
bond prices).
[Graphic: Magnifying glass showing magnified words on paper]
- -------------------------------------------------------------------------------
Municipal Bonds
and Taxes
The municipal bond category is defined as including securities issued by
municipalities as well as states and various agencies and authorities.
Some of these bonds are backed by the issuer's authority to levy taxes and are
considered an obligation of the issuer (hence the name "general obligation
bonds"). Other bonds are issued to raise money for a particular project -- for
example, a water system or a toll road -- and are backed by revenues earned by
that project ("revenue bonds"). So-called industrial revenue bonds are typically
issued by municipal issuers on behalf of private companies. Because revenue
bonds are backed only by income from a certain source and may not be an
obligation of the issuer itself, they may be less creditworthy than general
obligation bonds -- a fact that is usually reflected in their ratings.
The federal government allows the interest from municipal bonds to be tax-exempt
in order to make it easier for municipalities to finance public projects.
Investors in municipal bonds thus play a role in helping to finance roads,
hospitals and other public facilities.
- -------------------------------------------------------------------------------
3
<PAGE>
The Fund continued
- --------------------------------------------------------------------------------
Because most of the fund's securities are from the State of New York, the fund's
performance may be affected by political and economic conditions at the state or
local level. These may include state or city budgetary problems, declines in the
tax base and other factors that may cause rating agencies to downgrade the
credit ratings on certain issues. Actual or proposed changes in tax rates,
regulations or federal programs could also affect your net return on investment.
The issuer of any bond, particularly a junk bond, could default on principal or
interest payments, which would cause a loss for the fund. Lower-rated bonds also
tend to be more sensitive to economic changes and may increase the volatility of
the fund's share price.
The success of the fund's investment strategy depends largely on the investment
manager's skill in assessing the direction and impact of interest rate movements
and the creditworthiness of the securities the fund buys.
Information on other securities and risks appears on page 26.
A "snapshot" of the fund's investments may be found in the current annual or
semiannual report (see back cover).
[Graphic: "The Thinker" statue]
Investment Management
The fund's investment manager is State Street Research & Management Company. The
firm traces its heritage back to 1924 and the founding of one of America's first
mutual funds. Today the firm has more than $51 billion in assets under
management (as of March 31, 1998), including more than $16 billion in mutual
funds.
Paul J. Clifford, Jr. has been responsible for the fund's day-to-day portfolio
management since March 1993. A vice president, he joined the firm in 1989 and
has worked as an investment professional since 1986.
4
<PAGE>
Investor Expenses
- --------------------------------------------------------------------------------
Class descriptions begin on page 12
Shareholder fees are paid directly by investors.
Shareholder Fees
(% of offering price)(1) Class A Class B Class C(2) Class S(2)
- --------------------------------------------------------------------------------
Maximum front-end sales charge 4.50 0.00 0.00 0.00
Maximum deferred sales charge 0.00(3) 5.00 1.00 0.00
Annual fund expenses are deducted from fund assets.
Annual Fund Expenses
(% of average net assets) Class A Class B Class C Class S
- --------------------------------------------------------------------------------
Management fee 0.55 0.55 0.55 0.55
Marketing/service (12b-1)
fees(4) 0.25 1.00 1.00 0.00
Other expenses, after
voluntary reduction(5) 0.30 0.30 0.30 0.30
---- ---- ---- ----
Total annual fund expenses 1.10 1.85 1.85 0.85
==== ==== ==== ====
Example Here is what you would pay if you invested $1,000 over the years
indicated. The example is for comparison only and does not represent the fund's
actual expenses, either past or future(6).
Year Class A Class B(7) Class C(7) Class S
- --------------------------------------------------------------------------------
1 $56 $69/$19 $29/$19 $9
3 $78 $88/$58 $58/$58 $27
5 $103 $120/$100 $100/$100 $47
10 $173 $197/$197 $217/$217 $105
(1) Not charged on reinvestments or exchanges.
(2) Before November 1, 1997, Class C shares were designated Class D and Class S
shares were designated Class C.
(3) Except for investments of $1 million or more; see page 14.
(4) For share classes that have 12b-1 fees, long-term shareholders may pay more
than the equivalent of the regulatory maximum sales charge.
(5) Without reduction, other expenses would have been 0.46%, 0.46%, 0.46% and
0.46%; and total expenses would have been 1.26%, 2.01%, 2.01% and 1.01% for
class A, B, C and S, respectively. If the subsidy is reduced or elminated,
which could happen at any time, performance would be reduced accordingly.
(6) Example assumes dividend reinvestment, hypothetical 5% annual return,
maximum applicable sales charges and conversion of Class B shares to Class
A after eight years.
(7) The first number assumes you sold all your shares at the end of the period,
the second assumes you stayed in the fund.
5
<PAGE>
Financial Highlights
- --------------------------------------------------------------------------------
The information in these tables has been audited by Price Waterhouse LLP, the
fund's independent accountants. The top section of each table shows information
for a single share of the fund. Total return figures assume reinvestment of all
distributions.
<TABLE>
<CAPTION>
Years ended December 31
-------------------------------------------------------
Class A 1993(1) 1994 1995 1996 1997
- ----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Net asset value,
beginning of year ($) 8.20 8.43 7.53 8.23 8.13
---- ---- ---- ---- ----
Net investment income ($) 0.22 0.40 0.40 0.38 0.39
Net realized and
unrealized gain (loss)
on investments and
futures contracts ($) 0.25 (0.90) 0.71 (0.09) 0.35
---- ---- ---- ---- ----
Total from investment
operations ($) 0.47 (0.50) 1.11 0.29 0.74
---- ---- ---- ---- ----
Dividends from net
investment income ($) (0.22) (0.39) (0.41) (0.39) (0.39)
Distributions from
capital gains ($) (0.02) (0.01) -- -- --
---- ---- ---- ---- ----
Total distributions ($) (0.24) (0.40) (0.41) (0.39) (0.39)
---- ---- ---- ---- ----
Net asset value,
end of year ($) 8.43 7.53 8.23 8.13 8.48
==== ==== ==== ==== ====
Total return (%)(2) 5.79(3) (6.04) 15.11 3.68 9.22
Ratios/Supplemental Data:
Net assets at end of year
($ thousands) 15,175 18,214 20,043 19,636 20,193
Expense ratio (%)* 1.10(4) 1.10 1.10 1.10 1.10
Ratio of net investment
income to average
net assets (%)* 4.68(4) 5.07 5.07 4.76 4.88
Portfolio turnover rate (%) 33.11 64.80 109.74 89.14 50.92
*Reflects voluntary assumption
of fees or expenses per
share in each year ($) 0.01 0.03 0.02 0.01 0.01
</TABLE>
6
<PAGE>
<TABLE>
<CAPTION>
Years ended December 31
--------------------------------------------------------
Class B 1993(1) 1994 1995 1996 1997
- -----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Net asset value,
beginning of year ($) 8.20 8.43 7.53 8.23 8.13
---- ---- ---- ---- ----
Net investment income ($) 0.19 0.34 0.34 0.32 0.33
Net realized and
unrealized gain (loss) on
investments and futures
contracts ($) 0.25 (0.90) 0.71 (0.09) 0.35
---- ---- ---- ---- ----
Total from investment
operations ($) 0.44 (0.56) 1.05 0.23 0.68
---- ---- ---- ---- ----
Dividends from net
investment income ($) (0.19) (0.33) (0.35) (0.33) (0.33)
Distributions from
capital gains ($) (0.02) (0.01) -- -- --
---- ---- ---- ---- ----
Total distributions ($) (0.21) (0.34) (0.35) (0.33) (0.33)
---- ---- ---- ---- ----
Net asset value,
end of year ($) 8.43 7.53 8.23 8.13 8.48
==== ==== ==== ==== ====
Total return (%)(2) 5.35(3) (6.74) 14.26 2.91 8.41
Ratios/Supplemental Data:
Net assets at end of year
($ thousands) 7,567 12,131 15,084 19,824 17,426
Expense ratio (%)* 1.85(4) 1.85 1.85 1.85 1.85
Ratio of net investment
income to average
net assets (%)* 3.93(4) 4.34 4.32 4.01 4.12
Portfolio turnover rate (%) 33.11 64.80 109.74 89.14 50.92
*Reflects voluntary
assumption of fees
or expenses per share
in each year ($) 0.01 0.03 0.02 0.01 0.01
</TABLE>
(1) June 7, 1993 (commencement of share class designations) to December 31,
1993.
(2) Does not reflect any front-end or contingent deferred sales charge. Total
return would be lower if the distributor and its affiliates had not
voluntarily assumed a portion of the fund's expenses.
(3) Not annualized.
(4) Annualized.
7
<PAGE>
Financial Highlights continued
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Years ended December 31
--------------------------------------------------------
Class C (formerly Class D) 1993(1) 1994 1995 1996 1997
- -----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Net asset value,
beginning of year ($) 8.20 8.44 7.53 8.23 8.13
---- ---- ---- ---- ----
Net investment income ($) 0.19 0.34 0.35 0.32 0.34
Net realized and
unrealized gain (loss) on
investments and futures
contracts ($) 0.25 (0.91) 0.70 (0.09) 0.35
---- ---- ---- ---- ----
Total from investment
operations ($) 0.44 (0.57) 1.05 0.23 0.69
---- ---- ---- ---- ----
Dividends from net
investment income ($) (0.18) (0.33) (0.35) (0.33) (0.33)
Distributions from
capital gains ($) (0.02) (0.01) -- -- --
---- ---- ---- ---- ----
Total distributions ($) (0.20) (0.34) (0.35) (0.33) (0.33)
---- ---- ---- ---- ----
Net asset value,
end of year ($) 8.44 7.53 8.23 8.13 8.49
==== ==== ==== ==== ====
Total return (%)(3) 5.46(4) (6.86) 14.25 2.90 8.53
Ratios/Supplemental Data:
Net assets at end of year
($ thousands) 821 774 651 622 805
Expense ratio (%)* 1.85(5) 1.85 1.85 1.85 1.85
Ratio of net investment
income to average
net assets (%)* 3.94(5) 4.31 4.35 4.03 4.11
Portfolio turnover rate (%) 33.11 64.80 109.74 89.14 50.92
*Reflects voluntary
assumption of fees
or expenses per share
in each year ($) 0.01 0.03 0.02 0.01 0.01
</TABLE>
8
<PAGE>
<TABLE>
<CAPTION>
Years ended December 31
-------------------------------------------------------------------------------------------------
Class S (formerly Class C) 1989(2) 1990 1991 1992 1993 1994 1995 1996 1997
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net asset value,
beginning of year ($) 7.40 7.32 7.11 7.61 7.84 8.44 7.54 8.24 8.14
---- ---- ---- ---- ---- ---- ---- ---- ----
Net investme
/ nt income ($) 0.20 0.45 0.45 0.44 0.42 0.42 0.42 0.40 0.43
Net realized and
unrealized gain (loss) on
investments and
futures contracts ($) (0.08) (0.22) 0.51 0.23 0.62 (0.90) 0.71 (0.09) 0.33
---- ---- ---- ---- ---- ---- ---- ---- ----
Total from investment
operations ($) 0.12 0.23 0.96 0.67 1.04 (0.48) 1.13 0.31 0.76
---- ---- ---- ---- ---- ---- ---- ---- ----
Dividends from net
investment income ($) (0.20) (0.44) (0.46) (0.44) (0.42) (0.41) (0.43) (0.41) (0.41)
Distributions from
capital gains ($) -- -- -- -- (0.02) (0.01) -- -- --
---- ---- ---- ---- ---- ---- ---- ---- ----
Total distributions ($) (0.20) (0.44) (0.46) (0.44) (0.44) (0.42) (0.43) (0.41) (0.41)
---- ---- ---- ---- ---- ---- ---- ---- ----
Net asset value,
end of year ($) 7.32 7.11 7.61 7.84 8.44 7.54 8.24 8.14 8.49
==== ==== ==== ==== ==== ==== ==== ==== ====
Total return (%)(2) 1.72(4) 3.32 13.88 9.08 13.46 (5.79) 15.37 3.93 9.48
Ratios/Supplemental Data:
Net assets at end
of year ($ thousands) 8,154 12,620 21,512 41,558 56,515 40,750 38,757 34,050 31,759
Expense ratio (%)* 0.85(5) 0.85 0.85 0.85 0.85 0.85 0.85 0.85 0.85
Ratio of net
investment income to
average net assets (%)* 5.84(5) 6.39 6.21 5.71 5.10 5.29 5.33 5.01 5.13
Portfolio turnover rate (%) 0.00 35.54 30.24 29.39 33.11 64.80 109.74 89.14 50.92
*Reflects voluntary
assumption of fees or
expenses per share
in each year ($) 0.06 0.07 0.05 0.02 0.01 0.03 0.02 0.01 0.01
</TABLE>
(1) June 7, 1993 (commencement of share class designations) to December 31,
1993.
(2) July 5, 1989 (commencement of operations) to December 31, 1989.
(3) Does not reflect any front-end or contingent deferred sales charge. Total
return would be lower if the distributor and its affiliates had not
voluntarily assumed a porton of the fund's expenses.
(4) Not annualized.
(5) Annualized.
9
<PAGE>
Performance and Volatility
- --------------------------------------------------------------------------------
As of December 31, 1997
-------------------------------------------
Average Annual Total Return(1) 1 Year 5 Years Since Inception*
- ----------------------------------------------------------------------------
Class A (%) 4.31 5.77 6.65
Class B (%) 3.41 5.71 6.80
Class C (%) 7.53 6.04 6.81
Class S (%) 9.48 7.01 7.38
Lehman Brothers New York
Municipal Bond Index (%) 9.19 7.36 8.11
Lipper New York Municipal
Debt Funds Index (%) 8.75 6.46 7.45
[bar graph:]
<TABLE>
<CAPTION>
Class A Years ended December 31
Year-by-Year --------------------------------------------------------------------
Total Return(1) 1989* 1990 1991 1992 1993 1994 1995 1996 1997
- ----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
1.72 3.32 13.88 9.08 13.19 (6.04) 15.11 3.68 9.22
</TABLE>
1) Fund returns include performance from before the creation of share classes in
1993. Because Classes A, B and C involve higher marketing/service (12b-1) fees
(as described on page 5), performance since that time is somewhat lower for
these classes.
*Since inception (7/5/89)
10
<PAGE>
- -------------------------------------------------------------------------------
[Graphic: Magnifying glass showing magnified words on paper]
Understanding
Performance
and Volatility
The information on the opposite page is designed to show two aspects of the
fund's track record:
[bullet] Average annual total return is a measure of the fund's performance over
time. It is determined by taking the fund's performance over a given
period and expressing it as an average annual rate. Average annual
total return includes the effects of fund expenses and maximum sales
charges for each class, and assumes that you sold your shares at the
end of the period.
[bullet] The graph of year-by-year returns shows how volatile the fund has been:
how much the difference has been, historically, between its best years
and worst years. In general, funds with higher average annual total
returns will also have higher volatility. The graph includes the
effects of fund expenses, but not sales charges.
Also included are two independent measures of performance. The Lehman Brothers
New York Municipal Bond Index is an unmanaged index of 8,000 fixed-rate
investment-grade municipal bonds, all from New York issues larger than $50
million and with maturities greater than two years. The Lipper New York
Municipal Debt Funds Index shows the performance of a category of mutual funds
with similar goals. The Lipper index, which is also unmanaged, shows you how
well the fund has done compared to competing funds.
While the fund does not seek to match the returns or the volatility of any
index, these indices can be used as rough guides when gauging the return of this
and other investments. When making comparisons, keep in mind that none of the
indices includes the effects of sales charges. Also, even if your bond portfolio
were identical to the Lehman Brothers New York Municipal Bond Index, your
returns would always be lower, because this index does not include brokerage and
administrative expenses.
- -------------------------------------------------------------------------------
11
<PAGE>
Your Account
- --------------------------------------------------------------------------------
[Graphic: Key]
Opening an Account
If you are opening an account through a financial professional, he or she can
assist you with all phases of your investment.
If you are investing through a special program, follow the instructions in your
program materials.
To open an account without the help of a financial professional, please use the
instructions on these pages.
[Graphic: Paper with list of shares, pencil ready to check off choice of share]
Choosing a Share Class
The fund offers four share classes, each with its own sales charge and expense
structure.
If you are investing a substantial amount and plan to hold your shares for a
long period, Class A shares may make the most sense for you. If you are
investing a lesser amount, you
- -------------------------------------------------------------------------------
Class A -- Front Load
[bullet] Initial sales charge of 4.5% or less; schedule on page 14
[bullet] Lower sales charges for larger investments; see sidebar on facing page
and sales charge schedule
[bullet] Lower annual expenses than Class B or C shares due to lower
marketing/service (12b-1) fee of 0.25%
Class B -- Back Load
[bullet] No initial sales charge
[bullet] Deferred sales charge of 5% or less on shares you sell within five
years; schedule on page 14
[bullet] Annual marketing/service (12b-1) fee
[bullet] Automatic conversion to Class A shares after eight years, reducing
future annual expenses
Class C(1) -- Level Load
[bullet] No initial sales charge
[bullet] Deferred sales charge of 1%, paid if you sell shares within one year of
purchase
[bullet] Lower deferred sales charge than Class B shares
[bullet] Annual marketing/service (12b-1) fee
[bullet] No conversion to Class A shares after eight years, so annual expenses
do not decrease
(1) Before November 1, 1997, these were designated Class D.
- -------------------------------------------------------------------------------
12
<PAGE>
may want to consider Class B shares (if investing for at least five years) or
Class C shares (if investing for less than five years). If you are investing
through a special program, such as a large employer-sponsored retirement plan or
certain programs available through brokers, you may be eligible to purchase
Class S shares.
Because all future investments in your account will be made in the share class
you designate when opening the account, you should make your decision carefully.
Your financial professional can help you choose the share class that makes the
most sense for you.
- -------------------------------------------------------------------------------
Class S(2) -- No Load
[bullet] No sales charges of any kind
[bullet] No marketing/service (12b-1) fees; annual expenses are lower than other
share classes
[bullet] Available through certain advisory accounts of the investment manager
and special programs, including broker programs with record-keeping and
other services; these programs usually involve special conditions and
separate fees (contact your financial professional for information)
(2) Before November 1, 1997, these were designated Class C.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
[Graphic: Magnifying glass showing magnified words on paper]
Class A Sales
Charge Reductions
and Waivers
[bullet] Substantial investments receive lower sales charge rates; see
information on the following page.
[bullet] The "right of accumulation" allows you to include your existing State
Street Research investments (except Money Market Fund Class E shares)
as part of your current investment for sales charge purposes.
[bullet] A "letter of intent" allows you to count all investments in this or
other State Street Research funds over the next 13 months as if you
were making them all at once, for purposes of calculating sales
charges.
To take advantage of right of accumulation or letter of intent waivers, consult
your financial professional or State Street Research.
- -------------------------------------------------------------------------------
13
<PAGE>
Your Account continued
- --------------------------------------------------------------------------------
Sales Charges
Class A -- Front Load
when you invest this % is which equals
this amount deducted this % of
for sales your net
charges investment
- --------------------------------------------------------------------------
Up to $99,999 4.50 4.71
$100,000 - $249,999 3.50 3.63
$250,000 - $499,999 2.50 2.56
$500,000 - $999,999 2.00 2.04
$1 million or more see next column
With Class A shares, you pay a sales charge only when you buy shares.
If you are investing $1 million or more (either as a lump sum or through any of
the methods described on the previous page), you can purchase Class A shares
without any sales charge. However, you may be charged a "contingent deferred
sales charge" (CDSC) if you sell any shares you have held for less than one
year. Policies regarding the calculation of the CDSC are the same as for
Class B.
Class A shares are also offered with low or no sales charges through various
wrap-fee programs and other sponsored arrangements (contact your financial
professional for information).
Class B -- Back Load
this % of net asset value
when you sell shares at the time of purchase (or
in this year after you of sale, if lower) is
bought them deducted from your proceeds
- --------------------------------------------------------------------------
First year 5.00
Second year 4.00
Third year 3.00
Fourth year 3.00
Fifth year 2.00
Sixth year or later None
With Class B shares, you pay no sales charge when you invest, but you are
charged a "contingent deferred sales charge" (CDSC) when you sell shares you
have held for five years or less, as described in the table above. Any shares
acquired through reinvestment are not subject to the CDSC. There is no CDSC on
exchanges into other State Street Research funds, and the
14
<PAGE>
date of your initial investment will continue to be used as the basis for CDSC
calculations when you exchange. To ensure that you pay the lowest CDSC possible,
the fund will always use the shares with the lowest CDSC to fill your sell
requests.
The CDSC is waived on shares sold for mandatory retirement distributions or
because of disability or death. Consult your financial professional or the State
Street Research Service Center.
Class B shares automatically convert to Class A shares after eight years,
lowering your annual expenses from that time on.
Class C (Formerly Class D) -- Level Load
this % of net asset value
when you sell shares at the time of purchase (or
in this year after you of sale, if lower) is
bought them deducted from your proceeds
- --------------------------------------------------------------------------
First year 1.00
Second year or later None
With Class C shares, you pay no sales charge when you invest, but you are
charged a "contingent deferred sales charge" (CDSC) when you sell shares you
have held for one year or less, as described in the table above. Policies
regarding the calculation of the CDSC are the same as for Class B.
Class C shares currently have the same annual expenses as Class B shares, but
never convert to Class A shares (with their lower annual expenses).
Class S (Formerly Class C) -- No Load
Class S shares have no sales charges or CDSC.
15
<PAGE>
Your Account continued
- --------------------------------------------------------------------------------
[Graphic: Old-fashioned crank cash register]
Policies for
Buying Shares
Once you have chosen a share class, the next step is to determine the amount you
want to invest.
Minimum Initial Investments:
[bullet] $1,000 for accounts that use the Investamatic program
[bullet] $2,500 for all other accounts
Minimum Additional Investments:
[bullet] $50 for any account
Complete the enclosed application. You can avoid future inconvenience by signing
up now for any services you might later use.
Timing of Requests All requests received by State Street Research before 4:00
p.m. eastern time will be executed the same day, at that day's closing share
price. Orders received after 4:00 p.m. will be executed the following day, at
that day's closing share price.
Wire Transactions Funds may be wired between 8:00 a.m. and 4:00 p.m. eastern
time. To make a same-day wire investment, please notify State Street Research by
12:00 noon of your intention to wire funds, and make sure your wire arrives by
4:00 p.m. Your bank may charge a fee for wiring money.
16
<PAGE>
Buying Shares
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
To Open an Account To Add to an Account
<S> <C> <C>
Through a Financial Contact your financial Contact your financial
Professional professional. professional.
[Graphic: Briefcase]
By Mail Make your check payable to Fill out the investment stub
[Graphic: Mail Box] "State Street Research from an account statement, or
Funds." Forward the check indicate the fund name and
and your application to account number on your check.
State Street Research. Make your check payable to
"State Street Research Funds."
Forward the check and stub to
State Street Research.
By Federal Funds Wire Forward your application to Call State Street Research to
[Graphic: Capitol State Street Research, then obtain a control number.
Building] call to obtain an account Instruct your bank to wire funds
number. Wire funds using the to:
instructions at right.
[bullet] State Street Bank and
Trust Company,
Boston, MA
[bullet] ABA: 011000028
[bullet] BNF: fund name and
share class you want
to buy
[bullet] AC: 99029761
[bullet] OBI: your name and your
account number
[bullet] Control: the number
given to you by
State Street Research
By Electronic Funds Verify that your bank is a Call State Street Research to
Transfer (ACH) member of the ACH (Automated verify that the necessary bank
[Graphic: plug] Clearing House) system. information is on file for your
Forward your application to account. If it is, you may
State Street Research. request a transfer with the same
Please be sure to include phone call. If not, please ask
the appropriate bank State Street Research to provide
information. Call State you with an EZ Trader application.
Street Research to request a
purchase.
By Investamatic Forward your application, Call State Street Research to
[Graphic: calendar] with all appropriate verify that Investamatic is in
sections completed, to State place on your account, or to
Street Research, along with request a form to add it.
a check for your initial Investments are automatic once
investment payable to "State Investamatic is in place.
Street Research Funds."
By Exchange Call State Street Research Call State Street Research or
[Graphic: arrows or visit our Web site. visit our Web site.
pointing in 2
different directions]
</TABLE>
State Street Research Service Center PO Box 8408, Boston, MA 02266-8408
Internet www.ssrfunds.com
Call toll-free: 1-800-562-0032 (business days 8:00 a.m. - 6:00 p.m.,
eastern time)
17
<PAGE>
Your Account continued
- --------------------------------------------------------------------------------
[Graphic: Old-fashioned crank adding machine with receipt coming from the top]
Policies for
Selling Shares
Circumstances that Require Written Requests Please submit instructions in
writing when any of the following apply:
[bullet] you are selling more than $100,000 worth of shares
[bullet] the name or address on the account has changed within the last 30 days
[bullet] you want the proceeds to go to a name or address not on the account
registration
[bullet] you are transferring shares to an account with a different registration
or share class
[bullet] you are selling shares held in a corporate or fiduciary account; for
these accounts, additional documents are required:
corporate accounts: certified copy of a corporate resolution
fiduciary accounts: copy of power of attorney or other governing
document
To protect your account against fraud, all signatures on these documents must be
guaranteed. You may obtain a signature guarantee at most banks and securities
dealers. A notary public cannot provide a signature guarantee.
Incomplete Sell Requests State Street Research will attempt to notify you
promptly if any information necessary to process your request is missing.
Timing of Requests All requests received in good order by State Street Research
before 4:00 p.m. eastern time will be executed the same day, at that day's
closing share price. Requests received after 4:00 p.m. will be executed the
following day, at that day's closing share price.
Wire Transactions Proceeds sent by federal funds wire must total at least
$5,000. A fee of $7.50 will be deducted from all proceeds sent by wire, and your
bank may charge an additional fee to receive wired funds.
Selling Recently Purchased Shares If you sell shares before the check or
electronic funds transfer (ACH) for those shares has been collected, you will
not receive the proceeds until your initial payment has cleared. This may take
up to 15 days after your purchase was recorded (in rare cases, longer). If you
open an account with shares purchased by wire, you cannot sell those shares
until your application has been processed.
18
<PAGE>
Selling Shares
- --------------------------------------------------------------------------------
To Sell Some or All of Your Shares
Contact your financial professional.
Through a Financial
Professional
[Graphic: Briefcase]
By Mail Send a letter of instruction, an endorsed stock
[Graphic: Mailbox] power or share certificates (if you hold
certificate shares) to State Street Research.
Specify the fund, the account number and the
dollar value or number of shares. Be sure to
include all necessary signatures and any
additional documents, as well as signature
guarantees if required (see facing page).
By Federal Check with State Street Research to make sure that
Funds Wire a wire redemption privilege, including a bank
[Graphic: Capitol designation, is in place on your account. Once
Building] this is established, you may place your request
to sell shares with State Street Research.
Proceeds will be wired to your pre-designated
bank account. (See "Wire Transactions" on facing
page.)
By Electronic Funds Check with State Street Research to make sure that
Transfer(ACH) the EZ Trader feature, including a bank
[Graphic: plug] designation, is in place on your account. Once
this is established, you may place your request to
sell shares with State Street Research. Proceeds
will be sent to your pre-designated bank account.
By Telephone As long as the transaction does not require a
[Graphic: telephone] written request (see facing page), you or your
financial professional can sell shares by calling
State Street Research. A check will be mailed to
you on the following business day.
By Exchange Read the prospectus for the fund into which you
[Graphic: arrows are exchanging. Call State Street Research or
pointing in 2 visit our Web site.
different directions]
By Systematic See plan information on page 23.
Withdrawal Plan
[Graphic: calendar]
State Street Research Service Center PO Box 8408, Boston, MA 02266-8408
Internet www.ssrfunds.com
Call toll-free: 1-800-562-0032 (business days 8:00 a.m. - 6:00 p.m.,
eastern time)
19
<PAGE>
Account Policies
- --------------------------------------------------------------------------------
[Graphic: Stack of Papers]
The Fund's Business Hours The fund is open the same days as the New York Stock
Exchange (generally Monday through Friday). Fund representatives are available
from 8:00 a.m. to 6:00 p.m. eastern time on these days.
Calculating Share Price The fund calculates its net asset value per share (NAV)
every business day at the close of regular trading on the New York Stock
Exchange (usually at 4:00 p.m. eastern time). Each class's share price is
calculated by dividing its net assets by the number of its shares outstanding.
Telephone Requests When you open an account you automatically receive telephone
privileges, allowing you to place requests on your account by telephone. Your
financial professional can also use these privileges to request exchanges on
your account and, with your written permission, redemptions. For your
protection, all telephone calls are recorded.
As long as State Street Research takes certain measures to authenticate
telephone requests on your account, you may be held responsible for unauthorized
requests. Unauthorized telephone requests are rare, but if you want to protect
yourself completely, you can decline the telephone privilege on your
application. The fund may suspend or eliminate the telephone privilege at any
time.
Exchange Privileges There is no fee to exchange shares among State Street
Research funds. Your new fund shares will be the equivalent class as your
current shares. Any contingent deferred sales charges will continue to be
calculated from the date of your initial investment.
Frequent exchanges can interfere with fund management and drive up costs for all
shareholders. Because of this, the fund currently limits each account, or group
of accounts under common ownership or control, to six exchanges per calendar
year. The fund may change or eliminate the exchange privilege at any time, may
limit or cancel any shareholder's exchange privilege and may refuse to
20
<PAGE>
accept any exchange request, particularly those associated with "market timing"
strategies.
For Merrill Lynch customers, exchange privileges extend to Summit Cash Reserves
Fund, which is related to the fund for purposes of investment and investor
services.
Accounts with Low Balances If the value of your account falls below $1,500,
State Street Research may mail you a notice asking you to bring the account back
up to $1,500 or close it out. If you do not take action within 60 days, State
Street Research may either sell your shares and mail the proceeds to you at the
address of record or may deduct an annual maintenance fee (currently $18).
Reinstating Recently Sold Shares For 120 days after you sell shares, you have
the right to "reinstate" your investment by putting some or all of the proceeds
into any currently available State Street Research fund at net asset value. Any
CDSC you paid on the amount you are reinstating will be credited to your
account. You may only use this privilege once in any twelve-month period with
respect to your shares of a given fund.
[Graphic: "Uncle Sam"]
Distributions and Taxes
Income and Capital Gains Distributions The fund distributes its net income and
net capital gains to shareholders. Using projections of its future income, the
fund declares dividends daily and pays them monthly. Net capital gains, if any,
are distributed in December.
You may have your distributions reinvested in the fund, invested in a different
State Street Research fund, deposited in a bank account or mailed out by check.
If you do not give State Street Research other instructions, your distributions
will automatically be reinvested in the fund.
21
<PAGE>
Your Account continued
- --------------------------------------------------------------------------
[Graphic: Magnifying glass showing magnified words on paper]
The Alternative Minimum Tax
The Alternative Minimum Tax (AMT) is a federal tax that could affect you if you
are a high-income individual who would pay comparatively little tax under the
ordinary tax schedules -- for example, because you have significant deductions
or certain types of tax-free income.
Interest from industrial revenue bonds and other so-called private activity
bonds is generally subject to AMT; because of this, the fund does not invest
more than 20% of its net assets in these securities. For corporations, all
tax-exempt interest is considered in calculating AMT.
- --------------------------------------------------------------------------
Tax Effects of Distributions and Transactions As a general rule, the fund's
income distributions are exempt from federal income tax for all investors
(including corporations) as well as New York State or New York City personal
income taxes. However, you may have federal or state tax liability to the extent
that the fund earns income from non-tax-exempt securities or realizes net
capital gains. In addition, even tax-exempt income may be subject to the federal
alternative minimum tax (see sidebar) or certain state or local taxes, such as
corporate franchise tax.
In general, any taxable income distributions and short-term capital gain
distributions are taxable as ordinary income. Distributions of other capital
gains are generally taxable as capital gains. This is true no matter how long
you have owned your shares and whether you reinvest your distributions or take
them in cash.
Every year, the fund will send you information detailing the amount of federal,
New York State and New York City tax-exempt income distributed to you during the
previous year, as well as taxable ordinary income and capital gains.
22
<PAGE>
The sale of shares in your account may produce a gain or loss, and is a taxable
event. For tax purposes, an exchange is the same as a sale.
Your investment in the fund could have additional tax consequences, especially
for corporate investors. Please consult your tax professional for assistance.
Backup Withholding By law, the fund must withhold 31% of your distributions and
proceeds if you have not provided complete, correct taxpayer information.
Investor Services
[Graphic: Two Hands]
Investamatic Program
Use Investamatic to set up regular automatic investments in the fund from your
bank account. You determine the frequency and amount of your investments, and
you can skip an investment with three days notice. Not available with Class S
shares.
Systematic Withdrawal Plan
This plan is designed for retirees and other investors who want regular
withdrawals from a fund account. The plan is free and allows you to withdraw up
to 8% of your fund assets a year without incurring any contingent deferred sales
charges. Certain terms and minimums apply.
Dividend Allocation Plan This plan automatically invests your distributions from
the fund into another fund of your choice, without any fees or sales charges.
Automatic Bank Connection This plan lets you route any distributions or
Systematic Withdrawal Plan payments directly to your bank account.
State Street Research also offers a full range of prototype retirement plans for
individuals, sole proprietors, partnerships, corporations and employees. Call
1-800-562-0032 for information on retirement plans or any of the services
described above.
23
<PAGE>
Fund Details
- --------------------------------------------------------------------------------
[Graphic: top of Ionic column]
Business Structure
Formed in 1989, the fund is a diversified series of State Street Research
Tax-Exempt Trust, an open-end management investment company that is organized as
a Massachusetts business trust. A board of trustees representing shareholder
interests oversees the fund's operations, including the hiring of the investment
manager and other service providers.
The fund does not hold regular shareholder meetings, but may call meetings when
matters arise that require shareholder approval. These may include amendments to
the investment management agreement, the election of trustees or proposed
changes in the fund's fundamental goal, which cannot be changed without
shareholder approval.
The investment manager is responsible for the fund's investment and business
activities, and receives the management fee as compensation (0.55% of fund
assets, annually). The investment manager and the distributor are subsidiaries
of Metropolitan Life Insurance Company.
Brokers for Portfolio Trades
When placing trades for the fund's portfolio, State Street Research chooses
brokers that provide the best execution (a term defined by service as well as
price), but may also consider a broker's sales of fund shares.
Investment Manager
State Street Research & Management Company
One Financial Center, Boston, MA 02111
Distributor
State Street Research Investment Services, Inc.
One Financial Center, Boston, MA 02111
Service Center
State Street Research Service Center
P.O. Box 8408, Boston, MA 02266
Custodian
State Street Bank and Trust Company
225 Franklin Street, Boston, MA 02110
24
<PAGE>
[Graphic: check]
Dealer Compensation
Dealers who sell shares of the fund and perform services for fund investors
receive sales commissions and annual fees. These are paid by the fund's
distributor, using money from sales charges, marketing/service (12b-1) fees and
its other resources.
Maximum Dealer
Compensation Class A Class B Class C Class S
- --------------------------------------------------------------------------------
Initial commission (%) -- 4.00 1.00 0.00
Investments up to $100,000 (%) 4.00 -- -- --
$100,000 - $249,999 (%) 3.00 -- -- --
$250,000 - $499,999 (%) 2.00 -- -- --
$500,000 - $999,999 (%) 1.75 -- -- --
First $1-3 million (%) 1.00(1) -- -- --
Next $2 million (%) 0.50(1) -- -- --
Next $1 and above (%) 0.25(1) -- -- --
Annual fee (%) 0.25 0.25 0.90 0.00
Additional Policies Please note that the fund maintains additional policies and
reserves certain rights, including:
[bullet] The fund may vary its initial or additional investments in the case of
exchanges, reinvestments, periodic investment plans, sponsored
arrangements and other similar programs.
[bullet] All orders to purchase shares are subject to acceptance by the fund.
[bullet] At any time, the fund may change or discontinue its sales charge
waivers and any of its order acceptance practices, and may suspend the
sale of its shares.
[bullet] To permit investors to obtain the current price, dealers are
responsible for transmitting all orders to the State Street Research
Service Center promptly.
[bullet] Dealers may impose a transaction fee on the purchase or sale of shares
by shareholders.
[bullet] The distributor may pay its affiliate MetLife Securities, Inc.
additional compensation of up to 0.25% of certain sales or assets.
(1) If your broker declines this commission, the one-year CDSC on your
investment is waived.
25
<PAGE>
Other Securities and Risks
- --------------------------------------------------------------------------------
[Graphic: Stock certificates]
Other Securities and Risks
Each of the fund's portfolio securities and investment practices offers certain
opportunities and carries various risks. Major investments and risk factors are
outlined in the fund description starting on page 2. Below are brief
descriptions of other securities and practices, along with their associated
risks. A table of limitations follows.
Limited Obligation Securities Certain municipal securities are not general
obligations of their issuers, meaning that in the event of a default or
termination the securities holders may have limited recourse. These securities
may include:
[bullet] lease obligations and installment contracts: issued by government
entities to obtain funds to lease or acquire equipment and other
property
[bullet] project finance obligations: issued in connection with the financing of
infrastructure projects, such as toll roads or housing projects
[bullet] industrial revenue bonds: issued in the name of a public authority to
finance infrastructure used by a private entity (these are generally
obligations of the private entity, not the issuer)
Restricted and Illiquid Securities Any securities that are thinly traded or
whose resale is restricted can be difficult to sell at a desired time and price.
Some of these securities are new and complex, and trade only among institutions;
the markets for these securities are still developing, and may not function as
efficiently as established markets. Owning a large percentage of restricted and
illiquid securities could hamper the fund's ability to raise cash to meet
redemptions. Also, because there may not be an established market price for
these securities, the fund may have to estimate their value, which means that
their valuation (and, to a much smaller extent, the valuation of the fund) may
have a subjective element.
26
<PAGE>
Derivatives Derivatives, a category that includes options and futures, are
financial instruments whose value derives from another security or an index.
Depending on a derivative's issuer and structure, its income may be taxable or
tax-exempt to shareholders. The fund may use derivatives for hedging (attempting
to offset a potential loss in one position by establishing an interest in an
opposite position). The fund may also use derivatives for speculation (investing
for potential income or capital gain).
While hedging can guard against potential risks, it adds to the fund's expenses
and can eliminate some opportunities for gains. There is also a risk that a
derivative intended as a hedge may not perform as expected.
The main risk with derivatives is that some types can amplify a gain or loss,
potentially earning or losing substantially more money than the actual cost of
the derivative.
With all derivatives, whether used for hedging or speculation, there is also the
risk that the counterparty may fail to honor its contract terms, causing a loss
for the fund.
Securities Lending The fund may seek additional income by lending portfolio
securities to qualified institutions. By reinvesting collateral it receives in
these transactions, the fund could magnify any gain or loss it realizes on the
underlying investment. If the borrower fails to return the securities and the
collateral is insufficient to cover the loss, the fund could lose money.
When-issued Securities The fund may invest in securities prior to their date of
issue. These securities could fall in value by the time they are actually
issued, which may be anytime from a few days to over a year.
Short-term Trading While the fund ordinarily does not trade securities
for short-term profits, it will sell any security at the time it believes best,
which may result in short-term trading. Short-term trading can increase the
fund's transaction costs and may increase your tax liability.
Repurchase Agreements The fund may buy securities with the understanding that
the seller will buy them back with interest at a later date. If the seller is
unable to honor its commitment to repurchase the securities, the fund could lose
money.
27
<PAGE>
Other Securities and Risks continued
Zero (or Step) Coupons A zero coupon security is a debt security that is
purchased and traded at a discount to its face value because it pays no interest
for some or all of its life. Interest, however, is reported as income to the
fund and the fund is required to distribute to shareholders an amount equal to
the amount reported. Those distributions may force the fund to liquidate
portfolio securities at a disadvantageous time.
Defensive Investing During unusual market conditions, the fund may place up to
100% of total assets in cash or quality short-term debt securities.
Investment Limitations
Limitation at the time of investment
----------------------------------------
Practice % of total assets % of net assets
- ----------------------------------------------------------------------------
Investing in securities of any
given issuer (other than the
U.S. government and its
agencies)(1) 5(2) --
Investing in any given
industry(1)(3) 25 --
Lending securities 33-1/3 --
Lending money(1) Prohibited --
Repurchase agreements -- 30
Swap arrangements -- 5
Security
- ----------------------------------------------------------------------------
Commodity futures contracts
and options contracts
(for non-hedging purposes) -- 5(4)
Other options contracts
(for non-hedging purposes) -- 5(4)
Illiquid securities -- 15(5)
Restricted securities 10(6) --
(1) Fundamental policy; may not be changed without shareholder approval.
(2) Applies only to 75% of fund's total assets. The fund is also prohibited
from investing in more than 10% of an issuer's voting securities.
(3) The fund is also prohibited from investing more than 25% of total assets in
industrial revenue bonds based on credit of private issuers in the
industry.
(4) Initial margin deposits plus premiums may not exceed 5% of the market value
of the fund's net assets in non-hedging transactions. No limits apply when
used in hedging strategies.
(5) Includes repurchase agreements extending over more than seven days.
(6) Does not include Rule 144A securities.
28
<PAGE>
Notes
- --------------------------------------------------------------------------------
29
<PAGE>
[back cover]
For Additional Information
You can obtain a free copy of the current annual/semiannual report or SAI by
contacting:
[State Street Research Logo]
Service Center
P.O. Box 8408, Boston, MA 02266
Telephone: 1-800-562-0032
Internet: www.ssrfunds.com
Or you can visit the SEC Web site at:
www.sec.gov
You can find additional information on the fund's structure and its performance
in the following documents:
Annual/Semiannual Reports While the prospectus describes the fund's potential
investments, these reports detail the fund's actual investments as of the report
date. Reports include a discussion by fund management of recent economic and
market trends and fund performance. The annual report also includes the report
of the fund's independent accountants.
Statement of Additional Information (SAI) A supplement to the prospectus, the
SAI contains further information about the fund and its investment limitations
and policies. It also includes the most recent annual report and the independent
accountants' report. A current SAI for this fund is on file with the Securities
and Exchange Commission and is incorporated by reference (is legally part of
this prospectus).
prospectus
---------------
Control Number: 4706-980428(0599)SSR-LD NY-964E-598IBS
<PAGE>
STATE STREET RESEARCH TAX-EXEMPT FUND
a Series of
STATE STREET RESEARCH TAX-EXEMPT TRUST
STATEMENT OF ADDITIONAL INFORMATION
May 1, 1998
TABLE OF CONTENTS
Page
INVESTMENT OBJECTIVE........................................................ 2
ADDITIONAL INVESTMENT POLICIES AND RESTRICTIONS............................. 2
TAX-EXEMPT OBLIGATIONS...................................................... 4
ADDITIONAL INFORMATION CONCERNING
CERTAIN INVESTMENT TECHNIQUES...................................... 6
DEBT INSTRUMENTS AND
PERMITTED CASH INVESTMENTS......................................... 15
THE TRUST, THE FUND AND ITS SHARES.......................................... 22
TRUSTEES AND OFFICERS....................................................... 24
INVESTMENT ADVISORY SERVICES................................................ 29
PURCHASE AND REDEMPTION OF SHARES........................................... 30
SHAREHOLDER ACCOUNTS........................................................ 35
NET ASSET VALUE............................................................. 40
PORTFOLIO TRANSACTIONS...................................................... 41
CERTAIN TAX MATTERS......................................................... 44
DISTRIBUTION OF SHARES OF THE FUND.......................................... 47
CALCULATION OF PERFORMANCE DATA............................................. 52
CUSTODIAN................................................................... 58
INDEPENDENT ACCOUNTANTS..................................................... 58
FINANCIAL STATEMENTS........................................................ 58
The following Statement of Additional Information is not a Prospectus. It
should be read in conjunction with the Prospectus of State Street Research
Tax-Exempt Fund (the "Fund") dated May 1, 1998, 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: 1285Q-98501(0699)SSR-LD TE-879D-598
<PAGE>
INVESTMENT OBJECTIVE
As set forth under "The Fund--Goal and Strategy--Fundamental Goal" in the
Prospectus of State Street Research Tax-Exempt Fund (the "Fund"), the Fund's
investment goal, which is to seek a high level of interest income exempt from
federal income taxes, is fundamental and may not be changed by the Fund except
by the affirmative vote of a majority of the outstanding voting securities of
the Fund, as defined in the Investment Company Act of 1940, as amended (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 the 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.)
ADDITIONAL INVESTMENT POLICIES AND RESTRICTIONS
As set forth under "Tax-Exempt Fund--Portfolio Risks" and "Other Securities
and Risks" in the Fund's Prospectus, the Fund has adopted certain investment
restrictions, and those restrictions are either fundamental or not fundamental.
Fundamental restrictions may not be changed by the Fund except by the
affirmative vote of a majority of the outstanding voting securities of the Fund.
Restrictions that are not fundamental may be changed by a vote of a majority of
the Trustees of the Trust.
The Fund's fundamental investment restrictions are set forth below. Under
these restrictions, it is the Fund's policy:
(1) not to purchase a security of any one issuer (other than securities issued
or guaranteed as to principal or interest by the U.S. Government or its
agencies or instrumentalities or mixed-ownership Government corporations)
if such purchase would, with respect to 75% of the Fund's total assets,
cause more than 5% of the Fund's total assets to be invested in the
securities of such issuer or cause more than 10% of the voting securities
of such issuer to be held by the Fund;
(2) not to issue senior securities;
(3) not to underwrite or participate in the marketing of securities of other
issuers, although 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; [as a matter of interpretation, which is not part of the
fundamental policy, this restriction does not apply to the extent that, in
connection with the disposition of the
2
<PAGE>
Fund's securities, the Fund may be deemed to be an underwriter under
certain federal securities laws];
(4) not to purchase or sell real estate in fee simple;
(5) not to invest in physical commodities or physical commodity contracts or
options in excess of 10% of the Fund's total assets, except that
investments in essentially financial items or arrangements such as, but not
limited to, swap arrangements, hybrids, currencies, currency and other
forward contracts, delayed delivery and when-issued contracts, futures
contracts and options on futures contracts on securities, securities
indices, interest rates and currencies, shall not be deemed investments in
commodities or commodities contracts;
(6) not to lend money; however, the Fund may lend portfolio securities and
purchase bonds, debentures, notes and similar obligations (and enter into
repurchase agreements with respect thereto);
(7) not to conduct arbitrage transactions (provided that investments in futures
and options for hedging purposes as provided herein and in the Fund's
Prospectus shall not be deemed arbitrage transactions);
(8) not to invest in oil, gas or other mineral exploration programs (provided
that the Fund may invest in securities which are based, directly or
indirectly, on the credit of companies which invest in or sponsor such
programs);
(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 conducting
their principal activities in the same state (for purposes of this
restriction securities issued or guaranteed by the U.S. Government or its
agencies or instrumentalities or backed by the U.S. Government shall be
excluded); and
(10) not to borrow money (through reverse repurchase agreements or otherwise)
except for extraordinary and emergency purposes, such as permitting
redemption requests to be honored, and then not in an amount in excess of
10% of the value of its total assets, provided that reverse repurchase
agreements shall not exceed 5% of its total assets, and provided further
that additional investments will be suspended during any period when
borrowing exceeds 5% of total assets. Reverse repurchase agreements occur
when the Fund sells money market securities and agrees to repurchase such
securities at an agreed-upon price, date and interest payment. The Fund
would use the proceeds from the transaction to buy other money market
securities, which are either maturing or under the terms of a resale
agreement, on the same day as (or day prior to) the expiration of the
reverse repurchase agreement, and would employ a reverse repurchase
agreement when interest income from investing the proceeds of the
3
<PAGE>
transaction is greater than the interest expense of the reverse repurchase
agreement.
The following investment restrictions are not fundamental. Under these
restrictions, it is the Fund's policy:
(1) not to purchase any security or enter into a repurchase agreement if as a
result more than 15% of its net assets would be invested in securities that
are illiquid (including repurchase agreements not entitling the holder to
payment of principal and interest within seven days);
(2) not to purchase securities on margin, make a short sale of any securities
or purchase or deal in puts, calls, straddles or spreads with respect to
any security, except in connection with the purchase or writing of options,
including options on financial futures, and futures contracts to the extent
set forth in the Fund's Prospectus and this Statement of Additional
Information;
(3) not to hypothecate, mortgage or pledge any of its assets except as may be
necessary in connection with permitted borrowings and then not in excess of
15% of the Fund's total assets, taken at cost (for the purpose of this
restriction financial futures and options on financial futures are not
deemed to involve a pledge of assets);
(4) not to purchase a security issued by another investment company, except to
the extent permitted under the 1940 Act or except by purchases in the open
market involving only customary brokers' commissions, or securities
acquired as dividends or distributions or in connection with a merger,
consolidation or similar transaction or other exchange.
(5) not to invest in companies for the purpose of exercising control over their
management, although the Trust may from time to time present its views on
various matters to the management of issuers in which it holds investments.
TAX-EXEMPT OBLIGATIONS
As used in the Fund's Prospectus and this Statement of Additional
Information, the term "tax-exempt" refers to debt obligations the interest on
which was at the time of issuance, in the opinion of bond counsel to the issuer,
exempt from federal income tax. Tax-exempt obligations include debt obligations
issued by a state, the District of Columbia or a territory or possession of the
United States, or any political subdivision thereof, in order to obtain funds
for various public purposes, including the construction of such public
facilities as airports, bridges, highways, housing, mass transportation, roads,
schools and water and sewer works. Other public purposes for which tax-exempt
obligations may be issued include refunding
4
<PAGE>
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 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, airports, 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 tax-exempt bonds if the interest paid thereon is exempt
from federal income tax. Interest on industrial development bonds used to fund
the acquisition, construction, equipment, repair or improvement of privately
operated industrial or commercial facilities may also be exempt from federal
income tax, but the size of such issues is limited under current federal tax
law.
The two principal classifications of 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 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).
Municipal lease obligations, that is, lease obligations or installment
purchase contract obligations supported by lease payments made by a
municipality, may be issued by state and government authorities to obtain funds
to acquire a wide variety of equipment and facilities, such as fire and
sanitation vehicles, computer equipment, buildings and other capital assets.
Although municipal lease obligations do not normally constitute general
obligations of the municipality, a lease obligation is ordinarily based by the
municipality's agreement to make the payments due under the lease obligation.
However, certain lease obligations contain "non-appropriation" clauses which
provide that the municipality has no obligation to make lease or installment
purchase payments in later years unless money is appropriated in the future.
Municipal lease obligations are a relatively new form of financing instrument
and the market for such obligations is still developing.
Depending on the development of such markets, such municipal lease
obligations may be deemed to be liquid as determined by or in accordance with
methods adopted by the Trustees. In determining the liquidity and appropriate
valuation of a municipal lease
5
<PAGE>
obligation, the following factors relating to the security are considered, among
others: (1) the frequency of trades and quotes; (2) the number of dealers
willing to purchase or sell the security; (3) the willingness of dealers to
undertake to make a market; (4) the nature of the marketplace trades and (5) the
likelihood that the obligation will continue to be marketable based on the
credit quality of the municipality or relevant obligor. Municipal lease
obligations initially deemed to be liquid could later become illiquid.
Prices and yields on tax-exempt bonds are dependent on a variety of
factors, including general money market conditions, the financial condition of
the issuer, general conditions in the tax-exempt bond market, 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 may not be as extensive as
that which is made available by corporations whose securities are publicly
traded.
The ratings of Moody's Investor's Services, Inc. ("Moody's") and Standard &
Poor's Corporation ("S&P") represent their opinions and are not absolute
standards of quality. Tax-exempt bonds with the same maturity, interest rate
and rating may have different yields while tax-exempt bonds of the same maturity
and interest rate with different ratings may have the same yield.
Obligations of issuers of tax-exempt bonds 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
legislators 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 bonds 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 bonds or certain segments thereof, or materially
affecting the credit risk with respect to particular bonds. Adverse economic,
business, legal or political developments might affect all or a substantial
portion of the Fund's tax-exempt bonds in the same manner.
ADDITIONAL INFORMATION CONCERNING
CERTAIN INVESTMENT TECHNIQUES
Derivatives
The Fund may buy and sell certain types of derivatives such as options,
futures contracts, options on futures contracts, and swaps under circumstances
in which such instruments are expected by State Street Research & Management
Company (the "Investment Manager") to aid in achieving the Fund's investment
objective. The Fund may also purchase instruments with characteristics of both
futures and securities (e.g., debt instruments with
6
<PAGE>
interest and principal payments determined by reference to the value of a
commodity or a currency at a future time) and which, therefore, possess the
risks of both futures and securities investments.
Derivatives, such as options, futures contracts, options on futures
contracts, and swaps enable the Fund to take both "short" positions (positions
which anticipate a decline in the market value of a particular asset or index)
and "long" positions (positions which anticipate an increase in the market value
of a particular asset or index). The Fund may also use strategies which involve
simultaneous short and long positions in response to specific market conditions,
such as where the Investment Manager anticipates unusually high or low market
volatility.
The Investment Manager may enter into derivative positions for the Fund for
either hedging or non-hedging purposes. The term hedging is applied to defensive
strategies designed to protect the Fund from an expected decline in the market
value of an asset or group of assets that the Fund owns (in the case of a short
hedge) or to protect the Fund from an expected rise in the market value of an
asset or group of assets which it intends to acquire in the future (in the case
of a long or "anticipatory" hedge). Non-hedging strategies include strategies
designed to produce incremental income (such as the option writing strategy
described below) or "speculative" strategies which are undertaken to profit from
an expected decline in the market value of an asset or group of assets which the
Fund does not own or expected increases in the market value of an asset which it
does not plan to acquire. Information about specific types of instruments is
provided below.
Futures Contracts. Futures contracts are publicly traded contracts to buy
or sell an underlying asset or group of assets, such as a currency, 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 an equity security or an index of
equity 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. The Fund will initially be required to deposit with the Trust's
custodian or the broker effecting the futures transaction an amount of "initial
margin" in cash or securities, as permitted under applicable regulatory
policies.
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
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in a futures contract and the value of the underlying instrument 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 the
Fund's 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.
In transactions establishing a long position in a futures contract, assets
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, assets 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 utilize such
assets and methods of cover as appropriate under applicable exchange and
regulatory policies.
Options. The Fund may use options to implement its investment strategy.
There are two basic types of options: "puts" and "calls." Each type of option
can establish either a long or a short position, depending upon whether the Fund
is the purchaser or the writer of the option. 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. 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, that is, 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. In general, a purchased put increases in value
as the value of the underlying security falls and a purchased call increases in
value as the value of the underlying security rises.
The principal reason to write options is to generate extra income (the
premium paid by the buyer). 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,
that is, 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, that is, 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.
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The obligation of the writer of an option continues until the writer
effects a closing purchase transaction or until the option expires. To secure
its 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.
Among the options which the Fund may enter are options on securities
indices. In general, options on indices of securities are similar to options on
the securities themselves except that delivery requirements are different. For
example, a put option on an index of securities does not give the holder the
right to make actual delivery of a basket of securities but instead 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. As with options on equity securities or futures contracts,
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.
A securities index assigns relative values to the securities included in
the index and the index options are based on a broad market index. In connection
with the use of such options, the Fund may cover its position by identifying
assets having a value equal to the aggregate face value of the option position
taken.
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.
Limitations and Risks of Options and Futures Activity. 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. The Fund applies a
similar policy to options that are not commodities.
As noted above, the Fund may engage in both hedging and nonhedging
strategies. Although effective hedging can generally capture the bulk of a
desired risk adjustment, no hedge is completely effective. The Fund's ability to
hedge effectively through transactions in futures and options depends on the
degree to which price movements in its holdings correlate with price movements
of the futures and options.
Nonhedging strategies typically involve special risks. The profitability of
the Fund's non-hedging strategies will depend on the ability of the Investment
Manager to analyze both the applicable derivatives market and the market for the
underlying asset or group of assets.
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Derivatives markets are often more volatile than corresponding securities
markets and a relatively small change in the price of the underlying asset or
group of assets can have a magnified effect upon the price of a related
derivative instrument.
Derivatives markets also are often less liquid than the market for the
underlying asset or group of assets. 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 to effectively carry out their derivative
strategies and might, in some cases, require the Fund to deposit cash to meet
applicable margin requirements. The Fund will enter into an option or futures
position only if it appears to be a liquid investment.
Swaps. The Fund may enter into various forms of swap arrangements with
counterparties with respect to interest rates, currency 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 a currency
swap the Fund would agree with the other party to exchange cash flows based on
the relative differences in values of a notional amount of two (or more)
currencies; 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.
The Fund may enter credit protection swap arrangements involving the sale
by the Fund of a put option on a debt security which is exercisable by the buyer
upon certain events, such as a default by the referenced creditor on the
underlying debt or a bankruptcy event of the creditor.
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.
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These arrangements will be made primarily for hedging purposes, to preserve
the return on an investment or on a portion of the Fund's portfolio. However,
the Fund may, as noted above, enter into such arrangements for income purposes
to the extent permitted by the Commodities 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 nonstandard 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 forecasts 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 forecasts, there is a risk that the swap position may correlate
imperfectly with the price of the asset or liability being hedged.
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 net assets, except that
repurchase agreements extending for more than seven days when combined with any
other illiquid securities held by the Fund will be limited to 15% of the Fund's
net assets. To the extent excludable under relevant regulatory interpretations,
repurchase agreements involving U.S. Government securities are not subject to
the Fund's investment restrictions which otherwise limit the amount of the
Fund's total assets which may be invested to (a) not more than 5% in any one
issuer; (b) not more than 5% in issuers with less than three years continuous
operations; and (c) not more than 25% in issuers conducting their principal
activities in the same state.
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Reverse Repurchase Agreements
The Fund may enter into reverse repurchase agreements. However, the Fund
may not engage in reverse repurchase agreements in excess of 5% of the Fund's
total assets. 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 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.
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 months, or over a year 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.
Securities transactions involving delayed deliveries or forward commitments are
frequently characterized as when-issued transactions and are similarly treated
by the Fund.
Restricted Securities
It is the Fund's policy not to make an investment in restricted securities,
including restricted securities sold in accordance with Rule 144A under the
Securities Act of 1933 ("Rule 144A Securities") if, as a result, more than 35%
of the Fund's total assets are invested in restricted securities, provided not
more than 10% of the Fund's total assets are invested in restricted securities
other than 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
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markets, 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, market making 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 a market for them. Restricted securities that are not resalable
under Rule 144A may be subject to risks of illiquidity and subjective valuations
to a greater degree than Rule 144A Securities.
Lower Quality Debt Securities ("Junk Bonds")
Lower quality convertible or nonconvertible debt securities generally
involve more credit risk than higher rated securities and are considered by S&P
and Moody's to be speculative with respect to capacity to pay interest and repay
principal in accordance with the terms of the obligation. Further, such
securities may be subject to greater market fluctuations and risk of loss of
income and principal than lower yielding, higher rated debt securities. Risk of
lower quality debt securities, commonly known as "junk bonds," include (i)
limited liquidity and secondary market support; (ii) substantial market price
volatility resulting from changes in prevailing interest rates and/or investor
perceptions; (iii) subordination to the prior claims of banks and other senior
lenders; (iv) the operation of mandatory sinking fund or call/redemption
provisions during periods of declining interest rates when the Fund may be
required to reinvest premature redemption proceeds in lower yielding portfolio
securities; (v) the possibility that earnings of the issuer may be insufficient
to meet its debt service; and (vi) the issuer's low creditworthiness and
potential for insolvency during period of rising interest rates and economic
downturn. For further information concerning the rating categories of debt
securities, see the Appendix to this Statement of Additional Information.
As of the fiscal year ended December 31, 1997, the percentage of the Fund's
total investments on an average annual basis invested in debt securities of any
particular rating category or its equivalent as determined by the Investment
Manager, was as follows:
19% AAA
22% AA
13% A
37% BBB
9% BB,
on a dollar weighted basis, comprising 100% of total investments. Of these
bonds, 85% were rated by a nationally recognized statistical organization and
15% were unrated but considered to be equivalent as determined by the Investment
Manager.
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.
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 any loaned securities plus accrued interest. Collateral
received by the Fund will generally be held in the form tendered, although cash
may be invested in unaffiliated mutual funds with quality short-term portfolios,
securities issued or guaranteed by the U.S. Government or its agencies
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<PAGE>
or instrumentalities or certain unaffiliated mutual funds, irrevocable stand-by
letters of credit issued by a bank, or repurchase agreements, or other similar
investments. 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 rights to dividends, interest or other distributions,
on the loaned securities. Voting rights pass with the lending, 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 or its agents to be of good financial standing.
Short-Term Trading
The Fund may engage in short-term trading of securities and reserves full
freedom with respect to portfolio turnover. In periods where there are rapid
changes in economic conditions and security price levels or when reinvestment
strategy changes significantly, portfolio turnover may be higher than during
times of economic and market price stability or when investment strategy remains
relatively constant. The Fund's portfolio turnover rate may involve greater
transaction costs, relative to other funds in general, and may have tax and
other consequences.
Temporary and Defensive Investments
The Fund may hold up to 100% of its assets in cash or short-term debt
securities for temporary defensive purposes. The Fund will adopt a temporary
defensive position when, in the opinion of the Investment Manager, such a
position is more likely to provide protection against adverse market conditions
than adherence to the Fund's other investment policies. The types of short-term
instruments in which the Fund may invest for such purposes include short-term
money market securities, such as repurchase agreements, and securities issued or
guaranteed by the U.S. Government or its agencies or instrumentalities,
certificates of deposit, time deposits and bankers' acceptances of certain
qualified financial institutions and corporate commercial paper, which at the
time of purchase are rated at least within the "A" major rating category by
Standard & Poor's Corporation ("S&P") or the "Prime" major rating category by
Moody's Investor's Service, Inc. ("Moody's"), or, if not rated, issued by
companies having an outstanding long-term unsecured debt issued rated at least
within the "A" category by S&P or Moody's.
The Fund intends that short-term securities acquired for temporary
defensive purposes will be tax-exempt. However, if 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 50% of its total assets in
short-term securities the interest on which is not exempt from federal income
taxes.
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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.
DEBT INSTRUMENTS AND
PERMITTED CASH INVESTMENTS
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.
Managing Volatility. In administering the Fund's portfolio, the Investment
Manager attempts to reduce volatility in part by managing the duration and
weighted average maturity of the Fund's bond position.
Duration is an indicator of the expected volatility of a bond position in
response to changes in interest rates. In calculating duration, the Fund
measures the average time required to receive all cash flows associated with
those debt securities held in the Fund's portfolio -- representing payments of
principal and interest -- by considering the timing, frequency and amount of
payment expected from each portfolio security. The higher the duration, the
greater the gains and losses when interest rates change. Duration generally is a
more accurate measure of potential volatility with a portfolio composed of
high-quality debt securities, such as U.S. government securities, municipal
securities and high-grade U.S. corporate bonds, than with lower-grade
securities.
The Investment Manager may use several methods to manage the duration of
the Fund's bond position in order to increase or decrease its exposure to
changes in interest rates. First, the Investment Manager may adjust portfolio
duration by adjusting the mix of debt securities held
15
<PAGE>
by the Fund. For example, if the Investment Manager intends to shorten the
duration, it may sell debt instruments that individually have a long duration
and purchase other debt instruments that individually have a shorter duration.
Among the factors that will affect a debt security's duration are the length of
time to maturity, the timing of interest and principal payments, and whether the
terms of the security give the issuer of the security the right to call the
security prior to maturity. Second, the Investment Manager may adjust bond
duration using derivative transactions, especially with interest rate futures
and options contracts. For example, if the Investment Manager wants to lengthen
the duration of the Fund's bond position, it could purchase interest rate
futures contracts instead of buying longer-term bonds or selling shorter-term
bonds. Similarly, during periods of lower interest rate volatility, the
Investment Manager may use a technique to extend duration in the event rates
rise writing an out-of-the-money put option and receiving premium income with
the expectation the option could be exercised. In managing duration, the use of
such derivatives may be faster and more efficient than trading specific
portfolio securities.
Weighted average maturity is another indicator of potential volatility used
by the Investment Manager with respect to the Fund's bond portfolio, although
for certain types of debt securities, such as high quality debt securities, it
is not as accurate as duration in quantifying potential volatility. Weighted
average maturity is the average of all maturities of the individual debt
securities held by the Fund, weighted by the market value of each security.
Generally, the longer the weighted average maturity, the more bond prices will
vary in response to changes in interest rates.
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:
[bullet] direct obligations of the U.S. Treasury, i.e., U.S. Treasury bills,
notes, certificates and bonds;
[bullet] obligations of U.S. Government agencies or instrumentalities, such as
the Federal Home Loan Banks, the Federal Farm Credit Banks, the Federal
National Mortgage Association, the Government National Mortgage
Association and the Federal Home Loan Mortgage Corporation; and
[bullet] 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, are backed by the full faith and credit of the U.S. Treasury. Other
obligations, such as those of the Federal National
16
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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 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-related 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.
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
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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 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 within the "A" major rating category by S&P or within the
"Prime" major rating category by Moody's, or, if not rated, issued by companies
having an outstanding long-term unsecured debt issue rated at least within the
"A" category 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 within the "A"
category by S&P or within the "Prime" category by Moody's.
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Commercial paper rated within the "A" category (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 within the "A" category or better,
although in some cases credits within the "BBB" category 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 category 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.
In the event the lowering of ratings of debt instruments held by the Fund
by applicable rating agencies results in a material decline in the overall
quality of the Fund's portfolio, the Trustees of the Trust will review the
situation and take such action as they deem in the best interests of the Fund's
shareholders, including, if necessary, changing the composition of the
portfolio.
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
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<PAGE>
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 exposures to adverse conditions.
BB: Debt rated BB has less near-term vulnerability to default than other
speculative issues. However, it faces major ongoing uncertainties or exposure to
adverse business, financial or economic conditions which could lead to
inadequate capacity to meet timely interest and principal payments. The BB
rating category is also used for debt subordinated to senior debt that is
assigned an actual or implied BBB- rating.
B: Debt rated B has a greater vulnerability to default but currently has
the capacity to meet interest payments and principal repayments. Adverse
business, financial or economic conditions will likely impair capacity or
willingness to pay interest and repay principal. The B rating category is also
used for debt subordinated to senior debt that is assigned an actual or implied
BB or BB- rating.
CCC: Debt rated CCC has a currently identifiable vulnerability to default,
and is dependent upon favorable business, financial and economic conditions to
meet timely payment of interest and repayment of principal. In the event of
adverse business, financial or economic conditions it is not likely to have the
capacity to pay interest and repay principal. The CC 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 CC 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.
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.
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<PAGE>
Plus (+) or Minus (-): The rating 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.
SP-3: Notes rated SP-3 have a speculative 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 well.
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<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.
1, 2 or 3: The ratings from Aa through B may be modified by the addition of
a numeral indicating a bond's rank within its rating category.
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 of
protection ample although not so large as in the preceding group.
THE TRUST, THE FUND AND ITS SHARES
State Street Research Tax-Exempt Trust is currently comprised of the
following series: State Street Research Tax-Exempt Fund and State Street
Research New York Tax-Free Fund. 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. The Trustees also 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. 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 authorized shares of the Fund to be issued in four
classes: Class A, Class B, Class C and Class S shares. Prior to November 1,
1997, the Fund's current Class C shares were designated as Class D shares and
the Fund's current Class S shares were designated as Class C shares.
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<PAGE>
Each share of each class of shares represents an identical legal interest
in the same portfolio of investments of the Fund, has the same rights and is
identical in all respects, except that Class A, Class B and Class C shares bear
the expenses of the deferred sales arrangement and any expenses (including the
higher service and distribution fees) resulting from such sales arrangement, and
certain other incremental expenses related to a class. Each class will have
exclusive voting rights with respect to provisions of the Rule 12b-1
distribution plan pursuant to which the service and distribution fees, if any,
are paid. Although the legal rights of holders of each class of shares are
identical, it is likely that the different expenses borne by each class will
result in different net asset values and dividends. The different classes of
shares of the Fund also have different exchange privileges. Except for those
differences between classes of shares described above, in the Fund's Prospectus
and otherwise this Statement of Additional Information, each share of the Fund
has equal dividend, redemption and liquidation rights with other shares of the
Fund, and when issued, is fully paid and nonassessable by the Fund.
The rights of holders of shares may be modified by the Trustees at any
time, so long as such modifications do not have a material, adverse effect on
the rights of any shareholder. On any matter submitted to the shareholders, the
holder of a Fund share is entitled to one vote per share (with proportionate
voting for fractional shares) regardless of the relative net asset value
thereof.
Under the Master Trust Agreement, no annual or regular meeting of
shareholders is required. Thus, there ordinarily will be no shareholder meetings
unless required by the 1940 Act. Except as otherwise provided under the 1940
Act, the Board of Trustees will be a self-perpetuating body until fewer than
two-thirds of the Trustees serving as such are Trustees who were elected by
shareholders of the Trust. In the event less than a majority of the Trustees
serving as such were elected by shareholders of the Trust, a meeting of
shareholders will be called to elect Trustees. Under the Master Trust Agreement,
any Trustee may be removed by vote of two-thirds of the outstanding Trust
shares; holders of 10% or more of the outstanding shares of the Trust can
require that the Trustees call a meeting of shareholders for purposes of voting
on the removal of one or more Trustees. In connection with such meetings called
by shareholders, shareholders will be assisted in shareholder communications to
the extent required by applicable law.
Under Massachusetts law, the shareholders of the Trust could, under certain
circumstances, be held personally liable for the obligations for the Trust.
However, the Master Trust Agreement of the Trust disclaims shareholder liability
for acts or obligations of the Trust and provides for indemnification for all
losses and expenses of any shareholder of the Fund held personally liable for
the obligations of the Trust. Thus, the risk of a shareholder incurring
financial loss on account of shareholder liability is limited to circumstances
in which the Fund would be unable to meet its obligations. The Investment
Manager believes that, in view of the above, the risk of personal liability to
shareholders is remote.
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<PAGE>
TRUSTEES AND OFFICERS
The Trustees and principal 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 35. 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.
+Steve A. Garban, The Pennsylvania State University, 210 Old Main,
University Park, PA 16802, serves as Trustee of the Trust. He is 60. He is
retired and was formerly Senior Vice President for Finance and Operations and
Treasurer of The Pennsylvania State University.
+Malcolm T. Hopkins, 14 Brookside Road, Biltmore Forest, Asheville, NC
28803, serves as Trustee of the Trust. He is 70. He is engaged principally in
private investments. Previously, he was Vice Chairman of the Board and Chief
Financial Officer of St. Regis Corp.
*+John H. Kallis, One Financial Center, Boston, MA 02111, serves as Vice
President of the Trust. He is 57. 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 71. He is engaged principally in private investments
and civic affairs and is an author of business history. Previously, he was with
an affiliate of J.P. Morgan & Co. in New York.
+Robert A. Lawrence, 175 Federal Street, Boston, MA 02110, serves as
Trustee of the Trust. He is 71. He is retired and was formerly a Partner in
Saltonstall & Co., a private investment firm.
*+Gerard P. Maus, One Financial Center, Boston, MA 02111, serves as
Treasurer of the Trust. He is 47. His principal occupation is currently, and
during the past five years has been, Executive Vice President, Treasurer, Chief
Financial Officer and Director of State Street Research & Management Company.
Mr. Maus's other principal business affiliations include Executive Vice
President, Treasurer, Chief Financial Officer and Director of State Street
Research Investment Services, Inc. and Executive Vice President, Chief Financial
Officer, Administrative Officer and Director, GFM International Investors, Inc.
- ------------------
* or +, see footnotes on page 26.
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<PAGE>
*+Francis J. McNamara, III, One Financial Center, Boston, MA 02111, serves
as Secretary and General Counsel of the Trust. He is 42. His principal
occupation is Executive Vice President, General Counsel and Secretary of State
Street Research & Management Company. During the past five years he has also
served as Senior Vice President of State Street Research & Management Company
and as Senior Vice President, General Counsel and Assistant Secretary of The
Boston Company, Inc., Boston Safe Deposit and Trust Company and The Boston
Company Advisors, Inc. Mr. McNamara's other principal business affiliations
include Senior Vice President, Clerk and General Counsel of State Street
Research Investment Services, Inc. and Executive Vice President and General
Counsel, GFM International Investors, Inc.
+Dean O. Morton, 3200 Hillview Avenue, Palo Alto, CA 94304, serves as
Trustee of the Trust. He is 66. He is retired and was formerly Executive Vice
President, Chief Operating Officer and Director of Hewlett-Packard Company.
+Toby Rosenblatt, 3409 Pacific Avenue, San Francisco, CA 94118, serves as
Trustee of the Trust. He is 59. 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 Investments Ltd.
+Michael S. Scott Morton, Massachusetts Institute of Technology, 77
Massachusetts Avenue, Cambridge, MA 02139, serves as Trustee of the Trust. He is
60. 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 43. His principal occupation is Executive Vice
President and Director of State Street Research & Management Company. During the
past five years he has also served as Senior Vice President of State Street
Research & Management Company. Mr. Shively's other principal business
affiliation is Director of State Street Research Investment Services, Inc.
- ------------------
* or +, see footnotes on page 26.
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<PAGE>
*+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 55. His principal occupation is currently, and for the past five
years has been, Chairman of the Board, President, Chief Executive Officer and
Director of State Street Research & Management Company. Mr. Verni's other
principal business affiliations include Chairman of the Board and Director of
State Street Research Investment Services, Inc. (until February, 1996, prior
positions as President and Chief Executive Officer of that company) and Chairman
of the Board, President, Chief Executive Officer and Director of GFM
International Investors, Inc.
- ----------------
* 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/Director and/or officer of one or more of the following
investment companies, each of which has an advisory relationship with the
Investment Manager or its parent, Metropolitan Life Insurance Company
("Metropolitan"): State Street Research Equity Trust, State Street Research
Financial Trust, State Street Research Income Trust, State Street Research
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.
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<PAGE>
As of January 31, 1998, the Trustees and officers of the Trust as a group
owned less than 1% of the Fund's outstanding Class A shares and owned none of
the Fund's outstanding Class B, C and S shares.
Record ownership of shares of the Fund as of January 31, 1998 was as
follows:
% of
Class Holder Class
- ----- ------ -----
B Merrill Lynch(2) 6.1
C(1) Merrill Lynch(2) 6.2
M.G. and J.M. Loncar 10.9
c/o State Street Research Service Center
One Financial Center
Boston, MA 02111
- ------------------
(1) Prior to November 1, 1997, the Fund's current Class C shares were
designated as Class D shares and the Fund's current Class S shares were
designated as Class C shares.
(2) The full name of the above institution is Merrill Lynch, Pierce, Fenner &
Smith, Inc. Its address is 4800 Deerlake Drive E., Jacksonville, FL 32246.
The Fund believes that Merrill Lynch does not have beneficial ownership of
such shares.
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.
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<PAGE>
The Trustees were compensated as follows:
Aggregate Total Compensation From
Name of Compensation Trust and Complex
Trustee From Trust(a) Paid to Trustees(b)
Steve A. Garban $4,738 $ 75,899
Malcolm T. Hopkins $5,183 $ 78,499
Edward M. Lamont $5,900 $ 68,741
Robert A. Lawrence $6,100 $ 93,125
Dean O. Morton $6,500 $ 97,125
Toby Rosenblatt $5,900 $ 68,741
Michael S. Scott Morton $7,100 $103,625
Ralph F. Verni $ 0 $ 0
(a) For the Fund's fiscal year ended December 31, 1997. Includes compensation
received from multiple series of the Trust. See "The Trust, the Fund and
its Shares" in this Statement of Additional Information for a listing of
series.
(b) Includes compensation on behalf of all series of 12 investment companies
for which the Investment Manager or its parent, Metropolitan, served as
investment adviser. "Total Compensation from Trust and Complex Paid to
Trustees" for the 12 months ended December 31, 1997. The Trust does not
provide any pension or retirement benefits for the Trustees.
28
<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 Investment
Manager was founded by Paul Cabot, Richard Saltonstall and Richard Paine to
serve as investment adviser to one of the nation's first mutual funds, presently
known as State Street Research Investment Trust, which they had formed in 1924.
Their investment management philosophy emphasized comprehensive fundamental
research and analysis, including meetings with the management of companies under
consideration for investment. The Investment Manager's portfolio management
group has extensive investment industry experience managing equity and debt
securities. In managing debt securities, if any, for a portfolio, the Investment
Manager may consider yield curve positioning, sector rotation and duration,
among other factors.
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.
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 regular trading on 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 advisory fees paid by the Fund to the Investment Manager for the last
three fiscal years, prior to the assumption of fees or expenses, were as
follows: 1997, $1,510,208; 1996, $1,665,478 and 1995, $1,523,237.
The Advisory Agreement provides that it shall continue in effect from year
to year with respect to the Fund 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 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.
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<PAGE>
Under the Funds' Administration Agreement between the Investment Manager
and the Distributor, the Distributor provides assistance to the Investment
Manager in performing certain fund administration services for the Trust, such
as assistance in determining the daily net asset value of shares of each 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, such as employee benefit
plans, through or under which the Fund's shares may be purchased.
Under the Code of Ethics of the Investment Manager, investment management
personnel are only permitted to engage in personal securities transactions in
accordance with certain conditions relating to such person's position, the
identity of the security, the timing of the transaction, and similar factors.
Such personnel 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 State Street Research Investment
Services, Inc., 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 S 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 C shares). General
information on how to buy shares of the Fund, as well as sales charges involved,
are set forth under "Your Account" 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
regular trading on the NYSE on the day the purchase order is received by State
Street Research Service Center (the "Service Center"), provided that the order
is received prior to the close of regular trading on 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 the Service Center in order to permit the 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.
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<PAGE>
Class A Shares--Reduced Sales Charges. The reduced sales charges set forth
under "Your Account--Class A Sales Charge Reductions and Waivers" in the Fund's
Prospectus apply to purchases made at any one time by any "person," which
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"
(which include the Fund and other funds as designated by the Distributor from
time to time) 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 S 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 the right is determined on the amount arrived at
by combining the dollar amount of the 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
31
<PAGE>
herein as eligible to join with the investor in a single purchase. Class B,
Class C and Class S 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.
Other Programs Related to Class A Shares. Class A shares of the Fund may be
sold or issued in an exchange at a reduced sales charge or without sales charge
pursuant to certain sponsored arrangements, which include programs under which a
company, employee benefit plan or other organization makes recommendations to,
or permits group solicitation of, its employees, members or participants, except
any organization created primarily for the purpose of obtaining shares of the
Fund at a reduced sales charge or without a sales charge. Sales without a sales
charge, or with a reduced sales charge, may also be made through brokers,
registered investment advisers, financial planners, institutions, and others,
under managed fee-based programs (e.g., "wrap fee" or similar programs) which
meet certain requirements established from time to time by the Distributor.
Information on such arrangements and further conditions and limitations is
available from the Distributor.
In addition, no sales charge is imposed in connection with the sale of
Class A shares of the Fund to the following entities and person: (A) the
Investment Manager, Distributor or any affiliated entities, including any direct
or indirect parent companies and other subsidiaries of such parents
(collectively "Affiliated Companies"); (B) employees, officers, sales
representatives or current or retired directors or trustees of the Affiliated
Companies or any investment company managed by any of the Affiliated Companies,
any relatives of any such individuals whose relationship is directly verified by
such individuals to the Distributor, or any beneficial account for such
relatives or individuals; and (C) employees, officers, sales representatives or
directors of dealers and other entities with a selling agreement with the
Distributor to sell shares of any aforementioned investment company, any spouse
or child of such person, or any beneficial account for any of them. The purchase
must be made for investment and the shares purchased may not be resold except
through redemption. This purchase program is subject to such administrative
policies, regarding the qualification of purchasers and any other matters, as
may be adopted by the Distributor from time to time.
Conversion of Class B Shares to Class A Shares. A shareholder's Class B
shares of the Fund, including all shares received as dividends or distributions
with respect to such shares, will automatically convert to Class A shares of the
Fund at the end of eight years following the issuance of such Class B shares;
consequently, they will no longer be subject to the higher expenses borne by
Class B shares. The conversion rate will be determined on the basis of the
relative per share net asset values of the two classes and may result in a
shareholder receiving either a greater or fewer number of Class A shares than
the Class B shares so converted. As noted above, holding periods for Class B
shares received in exchange for Class B shares of other Eligible Funds will be
counted toward the eight-year period.
Contingent Deferred Sales Charges. The amount of any contingent deferred
sales charge paid on Class A shares (on sales of $1 million or more and which do
not involve an
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initial sales charge) or on Class B or Class C shares of the Fund will be paid
to the Distributor. The Distributor will pay dealers at the time of sale a 4%
commission for selling Class B shares and a 1% commission for selling Class C
shares. In certain cases, a dealer may elect to waive the 4% commission on Class
B shares and receive in lieu thereof a 1% annual fee with respect to such
outstanding shares until the shares convert to Class A shares. The proceeds of
the contingent deferred sales charges and the distribution fees are used to
offset distribution expenses and thereby permit the sale of Class B and Class C
shares without an initial sales charge.
In determining the applicability and rate of any contingent deferred sales
charge of Class B or Class C shares, it will be assumed that a redemption of the
shares is made first of those shares having the greatest capital appreciation,
next of shares representing reinvestment of dividends and capital gains
distributions and finally of remaining shares held by shareholder for the
longest period of time. Class B shares that are redeemed within a five-year
period after their purchase, and Class C shares that are redeemed within a
one-year period after their purchase, will not be subject to a contingent
deferred sales charge to the extent that the value of such shares represents (1)
capital appreciation of Fund assets or (2) reinvestment of dividends or capital
gains distributions. The holding period for purposes of applying a contingent
deferred sales charge for a particular class of shares of the Fund acquired
through an exchange from another Eligible Fund will be measured from the date
that such shares were initially acquired in the other Eligible Fund, and shares
of the same class being redeemed will be considered to represent, as applicable,
capital appreciation or dividend and capital gains distribution reinvestments in
such other Eligible Fund. These determinations will result in any contingent
deferred sales charge being imposed at the lowest possible rate. For federal
income tax purposes, the amount of the contingent deferred sales charge will
reduce the gain or increase the loss, as the case may be, on the amount realized
on redemption.
Contingent Deferred Sales Charge Waivers. With respect to Class A shares
(on sales of $1 million or more and which do not involve an initial sales
charge), and Class B and Class C shares of the Fund, the contingent deferred
sales charge does not apply to exchanges or to redemptions under a systematic
withdrawal plan which meets certain conditions. In addition, the contingent
deferred sales charge will be waived for: (i) redemptions made within one year
of the death or total disability, as defined by the Social Security
Administration, of all shareholders of an account; (ii) redemptions made after
attainment of a specific age in an amount which represents the minimum
distribution required at such age under Section 401(a)(9) of the Internal
Revenue Code of 1986, as amended, for retirement accounts or plans (e.g., age
70-1/2 for Individual Retirement Accounts and Section 403(b) plans), calculated
solely on the basis of assets invested in the Fund or other Eligible Funds; and
(iii) a redemption resulting from a tax-free return of an excess contribution to
an Individual Retirement Account. (The foregoing waivers do not apply to a
tax-free rollover or transfer of assets out of the Fund). The Fund may modify or
terminate the waivers at any time; for example, the Fund may limit the
application of multiple waivers and establish other conditions for employee
benefit plans.
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Class S Shares. Class S shares are currently available to certain employee
benefit plans such as qualified retirement plans which meet criteria relating to
number of participants, service arrangements, or similar factors; insurance
companies; investment companies; advisory accounts of the Investment Manager;
endowment funds of nonprofit organizations with substantial minimum assets
(currently a minimum of $10 million); and other similar institutional investors.
Class S shares may be acquired through programs or products sponsored by
Metropolitan, its affiliates, or both for which Class S shares have been
designated. In addition, Class S shares are available through programs under
which, for example, investors pay an asset-based fee and/or a transaction fee to
intermediaries. Class S share availability is determined by the Distributor and
intermediaries based on the overall direct and indirect costs of a particular
program, expected assets, account sizes and similar considerations.
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, 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.
Systematic Withdrawal Plan. A shareholder who owns noncertificated Class A
or Class S shares with a value of $5,000 or more, or Class B or Class C shares
with a value of $10,000 or more, may elect, by participating in the Fund's
Systematic Withdrawal Plan, to have periodic checks issued for specified
amounts. These amounts may not be less than certain minimums, depending on the
class of shares held. The Plan provides that all income dividends and capital
gains distributions of the Fund shall be credited to participating shareholders
in additional shares of the Fund. Thus, the withdrawal amounts paid can only be
realized by redeeming shares of the Fund under the Plan. To the extent such
amounts paid exceed dividends and distributions from the Fund, a shareholder's
investment will decrease and may eventually be exhausted.
In the case of shares otherwise subject to contingent deferred sales
charges, no such charges will be imposed on withdrawals of up to 8% annually of
either (a) the value, at the time the Systematic Withdrawal Plan is initiated,
of the shares then in the account or (b) the value, at the time of a withdrawal,
of the same number of shares as in the account when the Systematic Withdrawal
Plan was initiated, whichever is higher.
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Expenses of the Systematic Withdrawal Plan are borne by the Fund. A
participating shareholder may withdraw from the Systematic Withdrawal Plan, and
the Fund may terminate the Systematic Withdrawal Plan at any time on written
notice. Purchase of additional shares while a shareholder is receiving payments
under a Systematic Withdrawal Plan is ordinarily disadvantageous because of
duplicative sales charges. For this reason, a shareholder may not participate in
the Investamatic Program (see "Your Account--Investor Services--Investamatic
Program" in the Fund's Prospectus) and the Systematic Withdrawal Plan at the
same time.
Request to Dealer to Repurchase. For the convenience of shareholders, the
Fund has authorized the Distributor as its agent to accept orders from dealers
by wire or telephone for the repurchase of shares by the Distributor from the
dealer. The Fund may revoke or suspend this authorization at any time. The
repurchase price is the net asset value for the applicable shares next
determined following the time at which the shares are offered for repurchase by
the dealer to the Distributor. The dealer is responsible for promptly
transmitting a shareholder's order to the Distributor.
Signature Guarantees. Signature guarantees are required for, among other
things: (1) written requests for redemptions for more than $100,000; (2) written
requests for redemptions for any amount if the proceeds are transmitted to other
than the current address of record (unchanged in the past 30 days); (3) written
requests for redemptions for any amount submitted by corporations and certain
fiduciaries and other intermediaries; and (4) requests to transfer the
registration of shares to another owner. Signatures must be guaranteed by a
bank, a member firm of a national stock exchange, or other eligible guarantor
institution. The Transfer Agent will not accept guarantees (or notarizations)
from notaries public. The above requirements may be waived in certain instances.
Dishonored Checks. If a purchaser's check is not honored for its full
amount, the purchaser could be subject to additional charges to cover collection
costs and any investment loss, and the purchase may be canceled.
Processing Charges. Purchases and redemptions processed through securities
dealers may be subject to processing charges imposed by the securities dealer in
addition to sales charges that may be imposed by the Fund or the Distributor.
SHAREHOLDER ACCOUNTS
General information on shareholder accounts is included in the Fund's
Prospectus under "Your Account." The following supplements that information.
Maintenance Fees and Involuntary Redemption. Because of the relatively high
cost of maintaining small shareholder accounts, the Fund reserves the right to
redeem at its option any shareholder account which remains below $1,500 for a
period of 60 days after notice is mailed to the applicable shareholder, or to
impose a maintenance fee on such
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account after 60 days' notice. Such involuntary redemptions will be subject to
applicable sales charges, if any. The Fund may increase such minimum account
value above such amount in the future after notice to affected shareholders.
Involuntarily redeemed shares will be priced at the net asset value on the date
fixed for redemption by the Fund, and the proceeds of the redemption will be
mailed to the affected shareholder at the address of record. Currently, the
maintenance fee is $18 annually, which is paid to the Transfer Agent. The fee
does not apply to certain retirement accounts or if the shareholder has more
than an aggregate $50,000 invested in the Fund and other Eligible Funds
combined. Imposition of a maintenance fee on a small account could, over time,
exhaust the assets of such account.
To cover the cost of additional compliance administration, a $20 fee will
be charged against any shareholder account that has been determined to be
subject to escheat under applicable state laws.
The Fund may not suspend the right of redemption or postpone the date of
payment of redemption proceeds for more than seven days, except that (a) it may
elect to suspend the redemption of shares or postpone the date of payment of
redemption proceeds: (1) during any period that the NYSE is closed (other than
customary weekend and holiday closings) or trading on the NYSE is restricted;
(2) during any period in which an emergency exists as a result of which disposal
of portfolio securities is not reasonably practicable or it is not reasonably
practicable to fairly determine the Fund's net asset values; or (3) during such
other periods as the Securities and Exchange Commission (the "SEC") may by order
permit for the protection of investors; and (b) the payment of redemption
proceeds may be postponed as otherwise provided under "Purchase and Redemption
of Shares" in this Statement of Additional Information.
The Open Account System. Under the Open Account System full and fractional
shares of the Fund owned by shareholders are credited to their accounts by the
Transfer Agent, State Street Bank and Trust Company, 225 Franklin Street,
Boston, Massachusetts 02110. Certificates representing Class B or Class C shares
will not be issued, while certificates representing Class A or Class S shares
will only be issued if specifically requested in writing and, in any case, will
only be issued for full shares, with any fractional shares to be carried on the
shareholder's account. Shareholders will receive periodic statements of
transactions in their accounts.
The Fund's Open Account System provides the following options:
1. Additional purchases of shares of the Fund may be made through dealers, by
wire or by mailing a check payable to "State Street Research Funds" under
the terms set forth above under "Purchase and Redemption of Shares" in this
Statement of Additional Information.
2. The following methods of receiving dividends from investment income and
distributions from capital gains generally are available:
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(a) All income dividends and capital gains distributions reinvested in
additional shares of the Fund.
(b) All income dividends and capital gains distributions in cash.
(c) All income dividends and capital gains distributions invested in any one
available Eligible Fund designated by the shareholder as described below.
See "--Dividend Allocation Plan" herein.
Dividend and distribution selections should be made on the Application
accompanying the initial investment. If no selection is indicated on the
Application, that account will be automatically coded for reinvestment of all
dividends and distributions in additional shares of the same class of the Fund.
Selections may be changed at any time by telephone or written notice to the
Service Center. Dividends and distributions are reinvested at net asset value
without a sales charge.
Exchange Privileges. Shareholders of the Fund may exchange their shares for
available shares with corresponding characteristics of any of the other Eligible
Funds at any time on the basis of the relative net asset values of the
respective shares to be exchanged, subject to compliance with applicable
securities laws. Exchanges into the Fund are available only to investors who
meet the Fund's minimum investment and eligibility standards. Prior to making an
exchange, shareholders should obtain the Prospectus of the Eligible Fund into
which they are exchanging. Under the Direct Program, subject to certain
conditions, shareholders may make arrangements for regular exchanges from the
Fund into other Eligible Funds. To effect an exchange, Class A, Class B and
Class C shares may be redeemed without the payment of any contingent deferred
sales charge that might otherwise be due upon an ordinary redemption of such
shares. The State Street Research Money Market Fund issues Class E shares which
are sold without any sales charge. Exchanges of State Street Research Money
Market Fund Class E shares into Class A shares of the Fund or any other Eligible
Fund are subject to the initial sales charge or contingent deferred sales charge
applicable to an initial investment in such Class A shares, unless a prior Class
A sales charge has been paid directly or indirectly with respect to the shares
redeemed. For purposes of computing the contingent deferred sales charge that
may be payable upon disposition of any acquired Class A, Class B and Class C
shares, the holding period of the redeemed shares is "tacked" to the holding
period of any acquired shares. No exchange transaction fee is currently imposed
on any exchange.
Shares of the Fund may also be acquired or redeemed in exchange for shares
of the Summit Cash Reserves Fund ("Summit Cash Reserves") by customers of
Merrill Lynch, Pierce, Fenner & Smith Incorporated (subject to completion of
steps necessary to implement the program). The Fund and Summit Cash Reserves are
related mutual funds for purposes of investment and investor services. Upon the
acquisition of shares of Summit Cash Reserves by exchange for redeemed shares of
the Fund, (a) no sales charge is imposed by Summit Cash Reserves, (b) no
contingent deferred sales charge is imposed by the Fund on the Fund shares
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redeemed, and (c) any applicable holding period of the Fund shares redeemed is
"tolled," that is, the holding period clock stops running pending further
transactions. Upon the acquisition of shares of the Fund by exchange for
redeemed shares of Summit Cash Reserves, (a) the acquisition of Class A shares
shall be subject to the initial sales charges or contingent deferred sales
charges applicable to an initial investment in such Class A shares, unless a
prior Class A sales charge has been paid indirectly, and (b) the acquisition of
Class B or Class C shares of the Fund shall restart any holding period
previously tolled, or shall be subject to the contingent deferred sales charge
applicable to an initial investment in such shares.
The exchange privilege may be terminated or suspended or its terms changed
at any time, subject, if required under applicable regulations, to 60 days'
prior notice. New accounts established for investments upon exchange from an
existing account in another fund will have the same telephone privileges with
respect to the Fund (see "Your Account--Account Policies--Telephone Requests" in
the Fund's Prospectus and "--Telephone Privileges," below) as the existing
account unless the Service Center is instructed otherwise. Related
administrative policies and procedures may also be adopted with regard to a
series of exchanges, street name accounts, sponsored arrangements and other
matters.
The exchange privilege is not designed for use in connection with
short-term trading or market timing strategies. To protect the interests of
shareholders, the Fund reserves the right to temporarily or permanently
terminate the exchange privilege for any person who makes more than six
exchanges out of or into the Fund per calendar year. Accounts under common
ownership or control, including accounts with the same taxpayer identification
number, may be aggregated for purposes of the six exchange limit.
Notwithstanding the six exchange limit, the Fund reserves the right to refuse
exchanges by any person or group if, in the Investment Manager's judgment, the
Fund would be unable to invest effectively in accordance with its investment
objective and policies, or would otherwise potentially be adversely affected.
Exchanges may be restricted or refused if the Fund receives or anticipates
simultaneous orders affecting significant portions of the Fund's assets. In
particular, a pattern of exchanges that coincides with a "market timing"
strategy may be disruptive to the Fund. The Fund may impose these restrictions
at any time. The exchange limit may be modified for accounts in certain
institutional retirement plans because of plan exchange limits, Department of
Labor regulations or administrative and other considerations. Subject to the
foregoing, if an exchange request in good order is received by the Service
Center and delivered by the Service Center to the Transfer Agent by 12 noon
Boston time on any business day, the exchange usually will occur that day. For
further information regarding the exchange privilege, shareholders should
contact the Service Center.
Reinvestment Privilege. A shareholder of the Fund who has redeemed shares
or had shares repurchased at his or her request may reinvest all or any portion
of the proceeds (plus that amount necessary to acquire a fractional share to
round off his or her reinvestment to full shares) in shares, of the same class
as the shares redeemed, of the Fund or any other Eligible Fund at net asset
value and without subjecting the reinvestment to an initial sales charge,
provided such reinvestment is made within 120 calendar days after a redemption
or repurchase.
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Upon such reinvestment, the shareholder will be credited with any contingent
deferred sales charge previously charged with respect to the amount reinvested.
The redemption of shares is, for federal income tax purposes, a sale on which
the shareholder may realize a gain or loss. If a redemption at a loss is
followed by a reinvestment within 30 days, the transaction may be a "wash sale"
resulting in a denial of the loss for federal income tax purposes.
Any reinvestment pursuant to the reinvestment privilege will be subject to
any applicable minimum account standards imposed by the fund into which the
reinvestment is made. Shares are sold to a reinvesting shareholder at the net
asset value thereof next determined following timely receipt by the Service
Center of such shareholder's written purchase request and delivery of the
request by the Service Center to the Transfer Agent. A shareholder may exercise
this reinvestment privilege only once per 12-month period with respect to his or
her shares of the Fund.
Dividend Allocation Plan. The Dividend Allocation Plan allows shareholders
to elect to have all their dividends and any other distributions from the Fund
or any Eligible Fund automatically invested at net asset value in one other such
Eligible Fund designated by the shareholder, provided the account into which the
dividends and distributions are directed is initially funded with the requisite
minimum amount.
Telephone Privileges. A shareholder with the telephone privileges that are
offered with his or her Account (see "Your Account--Account Policies--Telephone
Requests") is deemed to authorize the Service Center and the Transfer Agent to:
(1) act upon the telephone instructions of any person purporting to be the
shareholder or the shareholder's financial professional to exchange, or to
redeem with the shareholder's permission, shares from any account; and (2) honor
any written instructions for a change of address regardless of whether such
request is accompanied by a signature guarantee. All telephone calls will be
recorded. Neither the Fund, the other Eligible Funds, the Transfer Agent, the
Investment Manager nor the Distributor will be liable for any loss, expense or
cost arising out of any request, including any fraudulent or unauthorized
requests. Shareholders assume the risk to the full extent of their accounts that
telephone requests may be unauthorized. Reasonable procedures will be followed
to confirm that instructions communicated by telephone are genuine. The
shareholder will not be liable for any losses arising from unauthorized or
fraudulent instructions if such procedures are not followed.
Alternative Means of Contacting the Fund. It is unlikely, even during
periods of extraordinary market conditions, that a shareholder will have
difficulty in reaching the Service Center. In that event, however, the
shareholder should contact the Service Center at 1-800-562-0032, 1-617-357-7800
or otherwise at its main office at One Financial Center, Boston, Massachusetts
02111-2690.
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NET ASSET VALUE
The net asset value of the shares of the Fund is determined once daily as
of the close of regular trading on 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, Martin
Luther King, Jr. Day, Presidents Day, Good Friday, Memorial Day, Independence
Day, Labor Day, Thanksgiving Day and Christmas Day.
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 as provided below, the
Trustees utilize one or more pricing services in lieu of market quotations for
certain securities which are not readily available on a daily basis. Such
services utilize information with respect to market transactions, quotations
from dealers and various relationships among securities in determining value and
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 New York or 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 New York or 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, Inc.'s (the "NASD"), NASDAQ 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 with the use of such pricing services as may be deemed appropriate or
methodologies approved by the Trustees.
The Trustees have authorized the use of the amortized cost method to value
short-term debt instruments issued with a maturity of one year or less and
having a remaining maturity of 60 days or less when the value obtained is fair
value, 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. 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
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premium is assumed regardless of the impact of fluctuating interest rates on the
market value of the security.
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 Fund's portfolio turnover rates for the fiscal years ended
December 31, 1996 and 1997, respectively, were as follows: 125.24% and 60.48%,
respectively. The Investment Manager believes that the portfolio turnover rate
was significantly lower in 1997 than for the previous fiscal year because in
1996, the Fund restructured its portfolio to adjust portfolio duration and
sensitivity to volatility.
Brokerage Allocation
The Investment Manager's policy is to seek for its clients, including the
Fund, what in the Investment Manager's judgment will be the best overall
execution of purchase or sale orders and the most favorable net prices in
securities transactions consistent with its judgment as to the business
qualifications of the various broker or dealer firms with whom the Investment
Manager may do business, and the Investment Manager may not necessarily choose
the broker offering the lowest available commission rate. Decisions with respect
to the market where the transaction is to be completed, to the form of
transaction (whether principal or agency), 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 their
proven integrity and financial responsibility, their demonstrated execution
experience and capabilities both generally and with respect to particular
markets or securities, the competitiveness of their commission rates in agency
transactions (and their net prices in principal transactions), their willingness
to commit capital, and their clearance and settlement capability. The Investment
Manager makes every effort to keep informed of commission rate structures and
prevalent bid/ask spread characteristics of the markets and securities in which
transactions for the Fund occur. Against this background, the Investment Manager
evaluates the reasonableness of a commission or a net price with respect to a
particular transaction by considering such factors as difficulty of execution or
security positioning by the executing firm. The Investment Manager may or may
not solicit competitive bids based on its judgment of the expected benefit or
harm to the execution process for that transaction.
When it appears that a number of firms could satisfy the required standards
in respect of a particular transaction, consideration may also be given to
services other than execution services which certain of such firms have provided
in the past or may provide in the future. Negotiated commission rates and
prices, however, are based upon the Investment Manager's
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judgment of the rate which reflects the execution requirements of the
transaction without regard to whether the broker provides services in addition
to execution. Among such other services are the supplying of supplemental
investment research; general economic, political and business information;
analytical and statistical data; relevant market information, quotation
equipment and services; reports and information about specific companies,
industries and securities; purchase and sale recommendations for stocks and
bonds; portfolio strategy services; historical statistical information; market
data services providing information on specific issues and prices; financial
publications; proxy voting data and analysis services; technical analysis of
various aspects of the securities markets, including technical charts; computer
hardware used for brokerage and research purposes; computer software and
databases (including those contained in certain trading systems and used for
portfolio analysis and modeling and also including software providing investment
personnel with efficient access to current and historical data from a variety of
internal and external sources); portfolio evaluation services and data relating
to the relative performance of accounts.
In the case of the Fund and other registered investment companies advised
by the Investment Manager or its affiliates, the above services may include data
relating to performance, expenses and fees of those investment companies and
other investment companies; this information is used by the Trustees or
Directors of the investment companies to fulfill their responsibility to oversee
the quality of the Investment Manager's advisory contracts between the
investment companies and the Investment Manager. The Investment Manager
considers these investment company services only in connection with the
execution of transactions on behalf of its investment company clients and not
its other clients.
The Investment Manager regularly reviews and evaluates the services
furnished by broker-dealers. The Investment Manager's investment management
personnel conduct internal surveys and use other methods to evaluate the quality
of the research and other services provided by various broker-dealer firms, and
the results of these efforts are made available to the equity trading department
which uses this information as a consideration to the extent described above in
the selection of brokers to execute portfolio transactions.
Some services furnished by broker-dealers may be used for research and
investment decision-making purposes, and also for marketing or administrative
purposes. Under these
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circumstances, the Investment Manager allocates the cost of such services to
determine the appropriate proportion of the cost which is allocable to research
or investment decision-making and the proportion allocable to other purposes.
The Investment Manager pays directly from its own funds for that portion
allocable to uses other than research or investment-decision making. Some
research and execution services may benefit the Investment Manager's clients as
a whole, while others may benefit a specific segment of clients. Not all such
services will necessarily be used exclusively in connection with the accounts
which pay the commissions to the broker-dealer producing the services.
The Investment Manager has no fixed agreements or understandings with any
broker-dealer as to the amount of brokerage business which the firm may expect
to receive for services supplied to the Investment Manager 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 brokerage business. These understandings are
honored to the extent possible in accordance with the policies set forth above.
It is not the Investment Manager's policy to intentionally pay a firm a
brokerage commission higher than that which another firm would charge for
handling the same transaction in recognition of services (other than execution
services) provided. However, the Investment Manager is aware that this is an
area where differences of opinion as to fact and circumstances may exist, and in
such circumstances, if any, relies on the provisions of Section 28(e) of the
Securities Exchange Act of 1934. During the fiscal years ended December 31,
1995, 1996 and 1997, the Fund paid no brokerage commissions in secondary
trading.
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.
In the case of the purchase of fixed income securities in underwriting
transactions, the Investment Manager follows any instructions received from its
clients as to the allocation of new issue discounts, selling commissions and
designations to brokers or dealers which provide the client with research,
performance evaluation, master trustee and other services. In the absence of
instructions from the client, the Investment Manager may make such allocations
to broker-dealers which have provided the Investment Manager with research and
brokerage services.
In some instances, certain clients of the Investment Manager request it to
place all or part of the orders for their account with certain brokers or
dealers, which in some cases provide services to those clients. The Investment
Manager generally agrees to honor these requests to the extent practicable.
Clients may condition their requests by requiring that the Investment Manager
only effect transactions with the specified broker-dealers if the broker-dealers
are competitive as to price and execution. In other cases, the Investment
Manager may be unable to negotiate commissions or obtain volume discounts or
best execution. In addition, a disparity may exist among the commissions charged
to clients who request the Investment Manager to use particular brokers or
dealers, and also between those clients and those who do not make such requests.
A client who requests the use of a particular broker-dealer should understand
that it may lose the possible advantage which non-requesting clients derive from
aggregation of orders for several clients as a single transaction for the
purchase or sale of a particular security. Among other reasons why best
execution may not be achieved with directed brokerage is that, in an effort to
achieve orderly execution of transactions, execution of orders that have
designated particular brokers may, at the discretion of the trading desk, be
delayed until execution of other non-designated orders has been completed.
When more than one client of the Investment Manager is seeking to buy or
sell the same security, the sale or purchase is carried out in a manner which is
considered fair and equitable to all accounts. In allocating investments among
various clients (including in what sequence orders for trades are placed), the
Investment Manager will use its best business judgment and will take into
account such factors as the investment objectives of the clients, the amount of
investment funds available to each, the size of the order, the amount already
committed for each client to a specific investment and the relative risks of the
investments, all in order to provide on
43
<PAGE>
balance a fair and equitable result to each client over time. Although sharing
in large transactions may sometimes affect price or volume of shares acquired or
sold, overall it is believed there may be an advantage in execution. The
Investment Manager may follow the practice of grouping orders of various clients
for execution to get the benefit of lower prices or commission rates. In certain
cases where the aggregate order may be executed in a series of transactions at
various prices, the transactions are allocated as to amount and price in a
manner considered equitable to each so that each receives, to the extent
practicable, the average price of such transactions. Exceptions may be made
based on such factors as the size of the account and the size of the trade. For
example, the Investment Manager may not aggregate trades where it believes that
it is in the best interests of clients not to do so, including situations where
aggregation might result in a large number of small transactions with consequent
increased custodial and other transactional costs which may disproportionately
impact smaller accounts. Such disaggregation, depending on the circumstances,
may or may not result in such accounts receiving more or less favorable
execution relative to other clients.
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) satisfy certain diversification
requirements; and (c) in order to be entitled to utilize the dividends paid
deduction, distribute annually at least 90% of its investment company taxable
income (determined without regard to the deduction for dividends paid).
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 or
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 to the extent thereof. Any distribution in excess of a shareholder's basis
in the shareholder's shares would be taxable as gain realized from the sale of
such shares.
44
<PAGE>
The Fund will be liable for a nondeductible 4% excise tax on amounts not
distributed (or deemed 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 (or be deemed to have distributed) 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 income 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 may 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 federal
income tax purposes. In the case of any debt security (other than a tax-exempt
obligation purchased before May 1, 1993) issued after July 18, 1984, or issued
on or before July 18, 1984 if purchased after April 30, 1993, 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 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 or continued 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
include original issue discount in income, it will be more difficult for the
Fund to make the distributions required for the Fund to maintain its status as a
regulated investment company under Subchapter M of the Code or 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 income for purposes of the 90% test, the excise tax and
the distribution requirements
45
<PAGE>
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 taxable distribution. The price of shares
purchased at that time includes the amount of any forthcoming distribution.
Those investors purchasing shares just prior to a taxable 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 85% 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, a
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 dividend) will be treated as
long-term capital loss to the extent of such capital gains distribution.
46
<PAGE>
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 generally
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
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 C shares). The Distributor may reallow all or
portions of such sales charges as concessions to dealers.
Total sales charges on Class A shares paid to the Distributor for the last
three fiscal years were as follows: 1997, $417,021; 1996, $575,326; and 1995,
$610,067.
For the same periods, the Distributor retained the following amounts after
reallowance of concessions to dealers: 1997, $58,730; 1996, $70,079; and 1995,
$74,456.
47
<PAGE>
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, managed fee-based programs and
so-called "mutual fund supermarkets", among other programs, the amount of the
sales charge reduction will similarly reflect the anticipated reduction in sales
expenses associated with such arrangements. The reductions in sales expenses,
and therefore the reduction in sales charges, will vary depending on factors
such as the size and other characteristics of the organization or program, and
the nature of its membership or the participants. 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
or similar programs 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 based on the aggregate of such sales. 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 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 A, Class B and Class C shares of the Fund
and paid initial commissions to securities dealers for sales of such Class A,
Class B, and Class C shares as follows:
48
<PAGE>
<TABLE>
<CAPTION>
Fiscal Year Fiscal Year Fiscal Year
Ended December 31, 1997 Ended December 31, 1996 Ended December 31, 1995
----------------------- ----------------------- -----------------------
Contingent Commissions Contingent Commissions Contingent Commissions
Deferred Paid to Deferred Paid to Deferred Paid to
Sales Charges Dealers Sales Charges Dealers Sales Charges Dealers
<S> <C> <C> <C> <C> <C> <C>
Class A $ 0 $358,291 $ 0 $505,247 $ 0 $535,611
Class B $163,953 $250,218 $183,514 $371,322 $417,782 $298,673
Class C $ 5,380 $ 6,959 $ 2,346 $ 6,882 $ 36 $ 3,424
</TABLE>
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 C 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 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 the servicing of shareholder accounts including
payments to securities dealers and others in consideration of the provision of
personal service to investors and/or the maintenance or servicing of shareholder
accounts and expenses associated with the provision of personal service 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.
Some or all of the service fees are used to pay or reimburse dealers
(including dealers that are affiliates of the Distributor) or others for
personal services and/or the maintenance of shareholder accounts. A portion of
any initial commission paid to dealers for the sale of shares of the Fund
represents payment for personal services and/or the maintenance or servicing of
shareholder accounts by such dealers. Dealers who have sold Class A shares are
eligible for further reimbursement commencing as of the time of such sale.
Dealers who have sold Class B and Class C shares are eligible for further
reimbursement after the first year during which such shares have been held of
record by such dealer as nominee for its clients (or by such clients directly).
Any service fees received by the Distributor and not allocated to dealers may be
49
<PAGE>
applied by the Distributor in reduction of expenses incurred by it directly for
personal services and the maintenance or servicing of shareholder accounts.
The distribution fees are used primarily to offset initial and ongoing
commissions paid to dealers for selling such shares. Any distribution fees
received by the Distributor and not allocated to dealers may be applied by the
Distributor in connection with sales or marketing efforts, including special
promotional fees and cash and noncash incentives based upon sales by dealers.
The Distributor provides distribution services on behalf of other funds
having distribution plans and receives similar payments from, and incurs similar
expenses on behalf of, such other funds. When expenses of the Distributor cannot
be identified as relating to a specific fund, the Distributor allocates expenses
among the funds in a manner deemed fair and equitable to each fund.
Commissions and other cash and noncash incentives and payments to dealers,
to the extent payable out of the general profits, revenues or other sources of
the Distributor (including the advisory fees paid by the Fund), have also been
authorized pursuant to the Distribution Plan.
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 C shares, an annual rate of 0.75% of the
average daily value of the net assets represented by such Class B or Class C
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 C shares (as the case may be) to make payments for personal
services and/or the maintenance or servicing of shareholder accounts. The
distribution and servicing expenses of a particular class will be borne solely
by that class. In addition, a rule of the NASD limits annual expenditures that
the Fund may incur under the Distribution Plan to 1%, of which 0.75% may be used
to pay distribution expenses and 0.25% may be used to pay shareholder service
fees. The NASD rule also limits the aggregate amount that the Fund may pay for
such distribution costs to 6.25% of gross share sales of a class since the
inception of any asset-based sales charge plus interest at the prime rate plus
1% on unpaid amounts thereof (less any contingent deferred sales charges). Such
limitation does not apply to shareholder service fees. Payments to the
Distributor or to dealers funded under the Distribution Plan may be discontinued
at any time.
The distribution and servicing expenses of a particular class will be borne
solely by that class.
Payments to this Distributor or to dealers under the Distribution Plan may
be discontinued at any time.
50
<PAGE>
The Distributor may pay certain dealers and other intermediaries additional
compensation for sales and administrative services. The Distributor may provide
cash and noncash incentives to intermediaries who, for example, sell significant
amounts of shares or develop particular distribution channels. The Distributor
may compensate dealers with clients who maintain their investments in the Fund
over a period of years. The incentives can include merchandise and trips to, and
attendance at, sales seminars at resorts. The Distributor may pay for
administrative services, such as technological and computer systems support for
the maintenance of pension plan participant records, for subaccounting, and for
distribution through mutual fund supermarkets or similar arrangements.
During the fiscal year ended December 31, 1997, 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 C
-------- -------- -------
Advertising $ 0 $ 0 $ 3,213
Printing and mailing of prospectuses 0 0 969
to other than current shareholders
Compensation to dealers 530,251 510,821 14,660
Compensation to sales personnel 0 0 6,899
Interest 0 0 0
Carrying or other financing charges 0 0 0
Other expenses: marketing;
general 0 0 3,268
-------- -------- -------
Total Fees $530,251 $510,821 $29,009
======== ======== =======
The Distributor may have also used additional resources of its own for
further expenses on behalf of the Fund.
No interested 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
51
<PAGE>
Plan, the Fund will make alternative arrangements for such services for
shareholders who acquired shares through such institutions.
CALCULATION OF PERFORMANCE DATA
From time to time, in advertisements or in communications to shareholders
or prospective investors, the Fund may compare the performance of its Class A,
Class B, Class C or Class S shares to the performance of other mutual funds with
similar investment objectives, to certificates of deposit, to taxable debt
instruments, such as Treasury bonds, as may be included in the Merrill Lynch
Treasury Master Index, and/or to other financial alternatives. The Fund may also
compare its performance to appropriate indices, such as the Lehman Brothers
Municipal Bond Index, the Merrill Lynch Revenue Index, the Merrill Lynch 500
Municipal Index or the Bond Buyer Revenue Bond Index and/or to appropriate
rankings and averages such as those compiled by Lipper Analytical Services,
Inc., Morningstar, Inc., Money Magazine, Business Week, Forbes Magazine, The
Wall Street Journal and Investor's Daily. For example, the performance of the
Fund might be compared to the Lipper General Municipal Debt Funds Average.
The average annual total return ("standard total return") and yield of the
Class A, Class B, Class C and Class S 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 on June 7, 1993, when designations
were assigned based on the pricing and Rule 12b-1 fees applicable to shares sold
thereafter. The application of the additional Rule 12b-1 fees, if any, of up to
1% will, for periods after June 7, 1993 adversely affect Fund performance
results. Thus, performance data or rankings for a given class of shares should
be interpreted carefully by investors who hold or may invest in a different
class of shares.
The performance data reflect Rule 12b-1 fees and, where applicable, sales
charges as follows:
52
<PAGE>
<TABLE>
<CAPTION>
Rule 12b-1 Fees Sales Charges
Current
Class Amount Period
- ----- ------- -----
<S> <C> <C> <C>
A 0.25% Since commencement of Maximum 4.5% sales charge reflected
operations to present
0.25% until June 7, 1993; 1%
B 1.00% June 7, 1993 to present; fee will 1- and 5-year periods reflect a 5% and a
reduce performance for periods 2% contingent deferred sales charge,
after June 7, 1993 respectively
C* 1.00% 0.25% until June 7, 1993; 1% 1-year period reflects a 1% contingent
June 7, 1993 to present; fee will deferred sales charge
reduce performance for periods
after June 7, 1993
S* None 0.25% until June 7, 1993; None
0% thereafter
</TABLE>
- ------------
* Prior to November 1, 1997, the Fund's current Class C shares were
designated as Class D shares and the Fund's current Class S shares were
designated as Class C shares.
All calculations of performance data in this section reflect the voluntary
measures, if any, by the Fund's affiliates to reduce fees or expenses relating
to the Fund; see "--Accrued Expenses and Recurring Charges" later in this
section.
Total Return
The Fund's standard average annual total returns ("standard total return")
of each class of shares were as follows:
<TABLE>
<CAPTION>
Ten Years Five Years One Year
Ended Ended Ended
Fund December 31, 1997 December 31, 1997 December 31, 1997
- ---- ----------------- ----------------- -----------------
<S> <C> <C> <C>
Class A 7.70% 5.67% 5.21%
Class B 7.83% 5.61% 4.35%
Class C* 7.82% 5.90% 8.23%
Class S* 8.30% 6.85% 10.33%
</TABLE>
- ------------
* Prior to November 1, 1997, the Fund's current Class C shares were
designated as Class D shares and the Fund's current Class S shares were
designated as Class C shares.
53
<PAGE>
Standard total return is computed separately for each class of shares 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 in accordance with 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 highest
applicable initial or contingent deferred sales charge 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 1997 was as follows:
Class A 4.47%
Class B 3.93%
Class C* 3.93%
Class S* 4.94%
- ------------
* Prior to November 1, 1997, the Fund's current Class C shares were
designated as Class D shares and the Fund's current Class S shares were
designated as Class C shares.
Yield for the Fund's Class A, Class B, Class C and Class S shares is
computed by dividing the net investment income per share earned during a recent
month or other specified 30-day period by the maximum offering price per share
on the last day of the period and annualizing the result in accordance with the
following formula:
54
<PAGE>
YIELD = 2[(a-b+1)6-1]
---
cd
Where: a = dividends and interest earned during the period
b = expenses accrued for the period (net of
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, as applicable, a maximum sales charge of 4.5%.
55
<PAGE>
All accrued expenses and recurring charges are taken into account as
described later herein.
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 often 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, 1997, assuming a federal income tax rate of 28% was as
follows:
Class A 6.21%
Class B 5.46%
Class C* 5.46%
Class S* 6.86%
- ------------
* Prior to November 1, 1997, the Fund's current Class C shares were
designated as Class D shares and the Fund's current Class S shares were
designated as Class C shares.
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 federal income tax rate of 28% (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 28% is 72%, that
is [1.00 - .28 = .72].
Accrued Expenses and Recurring Charges
Accrued expenses include all recurring charges 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.
56
<PAGE>
Nonstandardized Total Return
The Fund may provide the above described standard total return results for
Class A, Class B, Class C and Class S shares for periods which end no earlier
than the most recent calendar quarter end and which begin twelve months before,
five years before and ten years before. 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 the result may or may not be annualized, and as noted any
applicable sales charge 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 returns for the six months ended December 31, 1997,
without taking sales charges into account, were as follows:
Class A 6.79%
Class B 6.39%
Class C* 6.27%
Class S* 6.81%
- ------------
* Prior to November 1, 1997, the Fund's current Class C shares were
designated as Class D shares and the Fund's current Class S shares were
designated as Class C shares.
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 to which the distribution relates. 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.
57
<PAGE>
The distribution rate of each class of the Fund, based on the month of
December 1997 was as follows:
Class A 4.58%
Class B 4.03%
Class C* 4.04%
Class S* 5.06%
- ------------
* Prior to November 1, 1997, the Fund's current Class C shares were
designated as Class D shares and the Fund's current Class S shares were
designated as Class C shares.
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) audits of the Fund's annual financial statements, (2) assistance
and consultation in connection with SEC 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 financial reports may be made available from time to
time through electronic or other media. Shareholders with substantial holdings
in one or more State Street Research Funds may also receive reports and other
information which reflect or analyze their positions in a consolidated manner.
For more information, call State Street Research Service Center.
The following financial statements are for the Fund's fiscal year ended
December 31, 1997:
58
<PAGE>
DOCSC\359877.9
59
<PAGE>
STATE STREET RESEARCH TAX-EXEMPT FUND
- --------------------------------------------------------------------------------
INVESTMENT PORTFOLIO
- --------------------------------------------------------------------------------
December 31, 1997
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------
Principal Maturity Value
Amount Date (Note 1)
- --------------------------------------------------------------------------------------
<S> <C> <C> <C>
MUNICIPAL BONDS 102.9%
California 15.1%
Santa Clara County Financing
Authority, (VMC Facility
Replacement Project), 1994
Series A Bonds, AMBAC
Insured, 7.75% ................... $1,000,000 11/15/2008 $1,276,660
South Orange County Public
Financing Authority, Special Tax
Revenue Bonds, 1994 Series B
(Junior Lien Bonds), 7.00%* ...... 1,000,000 9/01/2009 1,039,550
Foothill/Eastern Transportation
Corridor Agency, Series 1995A
Senior Lien Convertible Capital
Appreciation Bonds, 0.00% ........ 1,695,000 1/01/2010 1,251,639
Port Hueneme Redevelopment
Agency, Central Community
Project, 1993 Tax Allocation
Refunding Bonds, AMBAC
Insured, 5.50% ................... 1,800,000 5/01/2014 1,922,328
California Pollution Control
Financing Authority, Pollution
Control Refunding Revenue
Bonds, (San Diego Gas &
Electric Company), 1996 Series
A, 5.90% ......................... 2,200,000 6/01/2014 2,440,636
Sacramento Power Authority,
Cogeneration Project Revenue
Bonds, (Procter & Gamble
Project), 1995 Series, 6.50% ..... 1,300,000 7/01/2014 1,426,490
California Housing Finance
Agency, Home Mortgage
Revenue Bonds, 1994 Series G,
7.20% ............................ 1,500,000 8/01/2014 1,653,795
City of Stockton, Revenue
Certificates of Participation,
1995 Series A, (Wastewater
Treatment Plant Expansion),
FGIC Insured, 6.70% .............. 1,000,000 9/01/2014 1,134,500
California Educational Facilities
Authority, Series 1994 Revenue
Bonds, (Southwestern
University Project), Series 1995,
MBIA Insured, 6.60% .............. 1,000,000 11/01/2014 1,111,830
</TABLE>
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------
Principal Maturity Value
Amount Date (Note 1)
- --------------------------------------------------------------------------------------
<S> <C> <C> <C>
County of Madera, California,
Certificates of Participation,
(Valley Childrens Hospital
Project), Series 1995, MBIA
Insured, 6.50% ................... $1,000,000 3/15/2015 $ 1,179,220
California Pollution Control
Financing Authority, Pollution
Control Revenue Bonds, (San
Diego Gas & Electric Company),
1991 Series A, Subject to AMT,
6.80% ............................ 600,000 6/01/2015 721,368
Roseville Joint Union High
School District, 1992 General
Obligation Bonds, Series B,
FGIC Insured, 0.00% .............. 1,000,000 8/01/2015 409,270
Foothill/Eastern Transportation
Corridor Agency, Toll Road
Revenue Bonds Series 1995 A
(Fixed Rate), Capital
Appreciation Bonds, Senior Lien
Series A, 0.00% .................. 5,000,000 1/01/2019 1,597,950
San Joaquin Hills
Transportation Corridor Agency,
Toll Road Refunding Revenue
Bonds, Series 1997A,
Convertible Capital
Appreciation Bonds, MBIA
Insured, 0.00% ................... 5,000,000 1/15/2019 3,166,750
City of Long Beach, California,
Harbor Revenue Refunding
Bonds, Series 1998A, Subject
to AMT, FGIC Insured, 6.00%+...... 4,000,000 5/15/2019 4,470,360
Fresno Sewer Revenue Bonds,
Series A-1, AMBAC Insured,
5.25% ............................ 5,100,000 9/01/2019 5,308,437
County of Sacramento, Laguna
Creek Ranch/Elliott Ranch
Community Facilities District
No.1, Improvement Area No. 2
Special Tax Refunding Bonds,
(Elliott Ranch), 6.30% ........... 1,500,000 9/01/2021 1,557,585
</TABLE>
The accompanying notes are an integral part of the financial statements.
60
<PAGE>
STATE STREET RESEARCH TAX-EXEMPT FUND
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------
Principal Maturity Value
Amount Date (Note 1)
- --------------------------------------------------------------------------------------
<S> <C> <C> <C>
California (cont'd)
Anaheim Public Financing
Authority, Lease Revenue
Bonds, (Anaheim Public
Improvement Project),
Subordinate, 1997 Series C
Capital Appreciation Bonds,
FSA Insured, 0.00% .................. $3,125,000 9/01/2025 $ 747,562
City of Davis, Public Facilities
Financing Authority, Local
Agency Revenue Bonds, 1997
Series A, 6.60% ..................... 1,500,000 9/01/2025 1,583,535
San Joaquin Hills
Transportation Corridor Agency,
(Orange County, California),
Senior Lien Toll Road Revenue
Bonds, 7.00% ........................ 950,000 1/01/2030 1,081,670
Foothill/Eastern Transportation
Corridor Agency, Toll Road
Revenue Bonds Series 1995A
Senior Lien, 6.50% .................. 6,000,000 1/01/2032 6,524,760
----------
41,605,895
----------
Colorado 4.7%
E-470 Public Highway Authority,
Senior Revenue Bonds, Series
1997B, (Capital Appreciation
Bonds), MBIA Insured, 0.00% ......... 5,000,000 9/01/2016 1,905,250
Eaglebend Affordable Housing
Corporation, Multifamily
Housing Project Revenue
Refunding Bonds, Series
1997A, 6.45% ........................ 2,000,000 7/01/2021 2,068,860
Colorado Housing and Finance
Authority, Single Family
Program, 1997 Series B-2
Senior Bonds (AMT), 7.00% ........... 1,165,000 5/01/2026 1,323,230
Arapahoe County, Colorado,
Public Highway Authority,
Capital Improvement Trust
Fund, Highway Revenue Bonds
(E-470 Project), Pre-Refunded to
8/31/2005 @ 103, MBIA
Insured, 7.00% ...................... 5,000,000 8/31/2026 5,962,150
</TABLE>
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------
Principal Maturity Value
Amount Date (Note 1)
- --------------------------------------------------------------------------------------
<S> <C> <C> <C>
Colorado Housing and Finance
Authority, Single Family
Program, 1996 Series B-2
Senior Bonds, 7.45% ................. $1,500,000 11/01/2027 $ 1,716,840
----------
12,976,330
----------
Connecticut 6.3%
State of Connecticut, Clean
Water Revenue Bonds, 1991
Series, Pre-Refunded to
1/1/2001 @ 102, 7.00% ............... 1,000,000 1/01/2011 1,099,920
State of Connecticut, Special
Tax Obligation Bonds,
Transportation Infrastructure
Purposes, 1991 Series A,
6.50% ............................... 1,500,000 10/01/2012 1,789,935
Connecticut Development
Authority, Pollution Control
Refunding Bonds, (Pfizer Inc.
Project-1982 Series), 6.55% ......... 2,500,000 2/15/2013 2,765,575
State of Connecticut Health
and Educational Facilities
Authority, Revenue Bonds,
University of Hartford Issue,
Series D, 6.80% ..................... 5,000,000 7/01/2022 5,319,250
State of Connecticut Health
and Educational Facilities
Authority, Revenue Bonds,
Quinnipiac College Issue,
Series D, 6.00% ..................... 4,465,000 7/01/2023 4,592,163
Connecticut Development
Authority, Aquarium Project
Revenue Bonds, (Mystic
Marinelife Aquarium Project-
1997 Series A), 7.00% ............... 1,700,000 12/01/2027 1,811,673
----------
17,378,516
----------
Florida 10.8%
Grand Haven Community
Development District (Flagler
County, Florida), Special
Assessment Bonds, Series
1997 A, 6.30% ....................... 2,800,000 5/01/2002 2,882,628
</TABLE>
The accompanying notes are an integral part of the financial statements.
61
<PAGE>
STATE STREET RESEARCH TAX-EXEMPT FUND
- --------------------------------------------------------------------------------
INVESTMENT PORTFOLIO (cont'd)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------
Principal Maturity Value
Amount Date (Note 1)
- --------------------------------------------------------------------------------------
<S> <C> <C> <C>
Florida (cont'd)
Heritage Harbor Development
District, (Hillsborough County,
Florida), Special Assessment
Revenue Bonds, Series 1997B,
6.00% ......................... $1,250,000 5/01/2003 $1,240,125
North Springs Improvement
District, (Broward County,
Florida), Special Assessment
Bonds, Series 1997B, (Parkland
Isles Project), 6.25% ......... 500,000 5/01/2005 504,905
Orlando Utilities Commission,
Water and Electric
Subordinated Revenue Bonds,
Series D, 6.75% ............... 5,000,000 10/01/2017 6,153,850
Grand Haven Community
Development District (Flagler
County, Florida), Special
Assessment Bonds, Series
1997 B, 6.90% ................. 750,000 5/01/2019 792,608
North Springs Improvement
District, (Broward County,
Florida), Special Assessment
Bonds, Series 1997, (Heron Bay
Project), 7.00% ............... 745,000 5/01/2019 765,264
Martin County, Florida,
Pollution Control Revenue
Refunding Bonds, (Florida
Power & Light Company
Project), Series 1990, MBIA
Insured, 7.30% ................ 1,250,000 7/01/2020 1,370,900
Orange County, Florida, Health
Facilities Authority, First
Mortgage Revenue Bonds,
Series 1996, (Orlando Lutheran
Towers, Inc.), 8.75% .......... 5,000,000 7/01/2026 5,895,200
Volusia County Educational
Facility Authority, Educational
Facilities Revenue Bonds,
(Embry-Riddle Aeronautical
University Project), Series
1996A, 6.125% ................. 5,000,000 10/15/2026 5,322,150
</TABLE>
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------
Principal Maturity Value
Amount Date (Note 1)
- --------------------------------------------------------------------------------------
<S> <C> <C> <C>
Northern Palm Beach County,
Florida, Improvement District,
Water Control and
Improvement Bonds, Unit of
Development No. 9A, Series
1996A, 7.30% .................. $3,000,000 8/01/2027 $3,281,580
Housing Authority of Lee
County, Florida, Single Family
Mortgage Revenue Bonds,
(Multi-County Program), Series
1996A, Subseries 2, Subject to
AMT, 7.50% .................... 1,265,000 9/01/2027 1,454,383
----------
29,663,593
----------
Georgia 4.2%
State of Georgia, General
Obligation Bonds, Series
1992B, 6.25% .................. 4,300,000 3/01/2011 4,957,169
State of Georgia, General
Obligation Bonds, Series 1994E,
6.75% ......................... 1,000,000 12/01/2012 1,214,220
Metropolitan Atlanta Rapid
Transit Authority, Georgia,
Sales Tax Revenue Bonds,
Refunding Series P, AMBAC
Insured, 6.25% ................ 4,700,000 7/01/2020 5,516,108
----------
11,687,497
----------
Hawaii 2.0%
State of Hawaii, Airports
System Revenue Bonds, Second
Series of 1991, MBIA Insured,
Subject to AMT, 7.00% ......... 5,000,000 7/01/2018 5,450,800
----------
Illinois 3.4%
City of Chicago, Illinois, Gas
Supply Revenue Bonds, 1985
Series B (The Peoples Gas
Light and Coke Company
Project), 7.50% ............... 3,000,000 3/01/2015 3,246,630
Illinois Health Facilities
Authority, Revenue Bonds,
Series 1997, (Holy Family
Medical Center), MBIA Insured,
5.00% ......................... 5,000,000 8/15/2027 4,784,000
</TABLE>
The accompanying notes are an integral part of the financial statements.
62
<PAGE>
STATE STREET RESEARCH TAX-EXEMPT FUND
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------
Principal Maturity Value
Amount Date (Note 1)
- --------------------------------------------------------------------------------------
<S> <C> <C> <C>
Illinois (cont'd)
City of Chicago, Collateralized
Single Family Mortgage
Revenue Bonds, Series 1997-B,
6.95% ............................. $1,200,000 9/01/2028 $ 1,350,060
----------
9,380,690
----------
Maine 1.5%
Finance Authority of Maine,
Revenue Obligation Securities,
(Huntington Common Project),
Series 1997A, 7.50% ............... 4,000,000 9/01/2027 4,179,680
----------
Maryland 2.0%
Howard County, Maryland,
Multifamily Mortgage
Refunding Bonds, Series 1994,
(Chase Glen Project),
Mandatory Put 7/1/2004 @
100, 7.00% ........................ 5,000,000 7/01/2024 5,566,200
----------
Massachusetts 4.6%
Massachusetts Industrial
Finance Agency, First Mortgage
Revenue Bonds, (Brookhaven
Retirement Community,
Lexington-1994 Issue),
Series A, 6.75% ................... 4,500,000 1/01/2001 4,756,725
Massachusetts Industrial
Finance Agency, First Mortgage
Revenue Bonds, (Berkshire
Retirement Community, Lenox-
1994 Issue) Series A, 6.375% ...... 1,500,000 7/01/2005 1,597,605
Massachusetts Bay
Transportation Authority,
General Transportation System
Bonds, 1994 Series A,
Refunding Bonds, 7.00% ............ 3,385,000 3/01/2014 4,163,076
Massachusetts Industrial
Finance Agency, (Marina Bay
LLC Project-1997 Issue), 7.50%..... 2,000,000 12/01/2027 2,008,300
----------
12,525,706
----------
Michigan 0.7%
State Building Authority, State
of Michigan, 1997 Revenue
Bonds, Series II (Facilities
Program), AMBAC Insured,
0.00% ............................. 2,000,000 10/15/2011 1,022,520
</TABLE>
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------
Principal Maturity Value
Amount Date (Note 1)
- --------------------------------------------------------------------------------------
<S> <C> <C> <C>
State Building Authority, State
of Michigan, 1997 Revenue
Bonds, Series II (Facilities
Program), AMBAC Insured,
0.00% ............................. $1,940,000 10/15/2012 $ 936,554
----------
1,959,074
----------
Minnesota 1.5%
Northern Municipal Power
Agency, (Minnesota), Electric
System Revenue Bonds,
Refunding Series 1998, FSA
Insured, 5.40%+ ................... 2,000,000 1/01/2015 2,037,400
Minnesota Housing Finance
Authority, Single Family
Mortgage Bonds, 1994
Series E, 5.90% ................... 2,085,000 7/01/2025 2,188,687
----------
4,226,087
----------
Nevada 5.0%
North Las Vegas, Nevada,
Local Special Improvements
District No. 707, 7.10%* .......... 3,500,000 6/01/2016 3,643,045
Clark County School District,
Nevada, General Obligation
(Limited Tax), Building and
Renovation Bonds, Series
1997B, FGIC Insured, 5.25% ........ 5,045,000 6/15/2017 5,097,317
State of Nevada, General
Obligation (Limited Tax) Bonds,
Nevada Municipal Bond Bank
Project Nos. 49 and 50, Series
November 1, 1995A, FGIC
Insured, 5.50% .................... 5,000,000 11/01/2025 5,147,350
----------
13,887,712
----------
New Hampshire 2.2%
New Hampshire Higher
Educational and Health
Facilities Authority, Revenue
Bonds, Dartmouth College
Issue, Series 1993, 5.375% ........ 5,000,000 6/01/2023 5,049,850
New Hampshire Higher
Educational and Health
Facilities Authority, Revenue
Bonds, New Hampshire College
Issue, Series 1997, 6.375% ........ 1,000,000 1/01/2027 1,057,050
----------
6,106,900
----------
</TABLE>
The accompanying notes are an integral part of the financial statements.
63
<PAGE>
STATE STREET RESEARCH TAX-EXEMPT FUND
- --------------------------------------------------------------------------------
INVESTMENT PORTFOLIO (cont'd)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------
Principal Maturity Value
Amount Date (Note 1)
- --------------------------------------------------------------------------------------
<S> <C> <C> <C>
New Jersey 2.8%
New Jersey Transportation
Trust Fund Authority,
Transportation System Bonds,
1996 Series B, 5.00% .............. $5,000,000 6/15/2017 $4,969,100
New Jersey Educational
Facilities Authority, Seton Hall
University Project Revenue
Bonds, 1991 Series D, 7.00% ....... 1,000,000 7/01/2021 1,074,090
New Jersey Health Care
Facilities Financing Authority,
Revenue and Refunding Bonds,
AHS Hospital Corporation
Issue, Series 1997 A, AMBAC
Insured, 5.00% .................... 1,750,000 7/01/2027 1,712,988
----------
7,756,178
----------
New Mexico 1.6%
City of Farmington, New
Mexico, Pollution Control
Revenue Refunding Bonds,
1997 Series D, (Public Service
Company of New Mexico San
Juan Project), 6.375% ............. 4,000,000 4/01/2022 4,307,400
----------
New York 8.3%
Port Authority of New York and
New Jersey, Special Project
Bonds, Series 4, KIAC Partners
Project, Subject to AMT,
6.75% ............................. 5,000,000 10/01/2011 5,583,200
The City of New York, General
Obligation Refunding Bonds,
Fiscal 1991, Series B, 7.75%* ..... 3,990,000 2/01/2012 4,507,503
New York Local Government
Assistance Corp., (A Public
Benefit Corporation of the
State of New York), Series
1993E Refunding Bonds, 6.00%....... 5,000,000 4/01/2014 5,622,500
Dormitory Authority of the
State of New York, Department
of Health of the State of New
York, Revenue Bonds, Series
1996, 5.75% ....................... 5,000,000 7/01/2017 5,166,950
</TABLE>
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------
Principal Maturity Value
Amount Date (Note 1)
- --------------------------------------------------------------------------------------
<S> <C> <C> <C>
Port Authority of New York and
New Jersey, Special Project
Bonds, Series 6, JFK
International Air Terminal LLC
Project, Subject to AMT, MBIA
Insured, 5.75% .................... $2,000,000 12/01/2022 $2,100,220
----------
22,980,373
----------
North Carolina 2.8%
North Carolina Housing Finance
Agency, Multifamily Revenue
Refunding Bonds, (1992
Refunding Bond Resolution),
Series B, 6.90% ................... 7,000,000 7/01/2024 7,584,780
----------
Ohio 3.8%
County of Miami, Ohio,
Hospital Facilities Revenue
Refunding and Improvement
Bonds, Series 1996A, (Upper
Valley Medical Center), 6.25%...... 2,500,000 5/15/2016 2,664,650
City of Cleveland, Ohio, Public
Power System Improvement
First Mortgage Revenue
Refunding Bonds, Series 1991
B, 7.00% .......................... 7,000,000 11/15/2017 7,754,530
----------
10,419,180
----------
Oklahoma 1.1%
Tulsa Industrial Authority,
Revenue and Refunding Bonds,
(The University Of Tulsa),
Series 1996A, MBIA Insured,
5.00% ............................. 3,000,000 10/01/2022 2,945,430
----------
Pennsylvania 5.7%
Montgomery County Industrial
Development Authority, Health
Facilities Revenue Bonds,
Series of 1993, (ECRI Project),
6.40% ............................. 680,000 6/01/2003 717,964
Montgomery County Higher
Education and Health Authority,
Pennsylvania, Northwestern
Corp., 6.50% ...................... 1,140,000 6/01/2004 1,235,498
</TABLE>
The accompanying notes are an integral part of the financial statements.
64
<PAGE>
STATE STREET RESEARCH TAX-EXEMPT FUND
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------
Principal Maturity Value
Amount Date (Note 1)
- --------------------------------------------------------------------------------------
<S> <C> <C> <C>
Pennsylvania (cont'd)
City of Philadelphia,
Pennsylvania, Airport Revenue
Refunding Bonds, (Philadelphia
Airport System), Series 1998A
(AMT), FGIC Insured, 6.00%+ ........ $2,750,000 6/15/2008 $ 3,037,458
Pennsylvania Economic
Development Financing
Authority, Resource Recovery
Revenue Bonds, (Northampton
Generating Project), Series
1994A, 6.40% ....................... 2,500,000 1/01/2009 2,653,750
Pennsylvania Economic
Development Financing
Authority, Resource Recovery
Revenue Bonds, (Colver
Project), Series 1994D, Subject
to AMT, 7.05% ...................... 1,000,000 12/01/2010 1,111,480
Scranton-Lackawanna Health
and Welfare Authority, City of
Scranton, Lackawanna County,
Pennsylvania, Hospital Revenue
Bonds (Moses Taylor Hospital
Project), Series of 1997, 6.20%..... 2,500,000 7/01/2017 2,667,300
Montgomery County Industrial
Development Authority,
Pollution Control Revenue
Refunding Bonds, 1991 Series
A, (Philadelphia Electric Co.
Project), Subject to AMT,
7.60% .............................. 1,000,000 4/01/2021 1,092,160
Philadelphia Authority for
Industrial Development,
Commercial Development
Revenue Refunding Bonds,
(Doubletree Guest Suites
Project), Series 1997A, 6.50% ...... 3,000,000 10/01/2027 3,167,100
----------
15,682,710
----------
Tennessee 2.1%
City of Memphis, Tennessee,
Electric System Revenue
Refunding Bonds, Series of
1992, 6.00% ........................ 2,250,000 1/01/2006 2,475,878
</TABLE>
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------
Principal Maturity Value
Amount Date (Note 1)
- --------------------------------------------------------------------------------------
<S> <C> <C> <C>
City of Memphis, Tennessee,
Water Division Revenue
Refunding Bonds, Series of
1992-A, 6.00% ...................... $3,000,000 1/01/2012 $ 3,225,300
----------
5,701,178
----------
Texas 8.0%
Texas Municipal Power Agency,
Refunding Revenue Bonds,
Series 1991A, AMBAC Insured,
6.75% .............................. 1,000,000 9/01/2012 1,100,840
Harris County, Texas, General
Obligation Unlimited Tax,
Refunding and Toll Road
Subordinate Lien, Revenue
Bonds, Series 1991, 6.75% .......... 5,750,000 8/01/2014 6,324,482
Texas Public Finance Authority,
State of Texas General
Obligation Refunding Bonds,
Series 1997, 0.00% ................. 5,000,000 10/01/2014 2,187,850
Denison Hospital Authority,
Hospital Revenue Bonds,
(Texoma Medical Center, Inc.
Project), Series 1997, 6.125% ...... 1,000,000 8/15/2017 1,061,620
Dallas-Fort Worth International
Airport, Facility Improvement
Corporation, American Airlines,
Inc., Revenue Bonds, Series
1990, 7.50% ........................ 5,250,000 11/01/2025 5,738,670
Alliance Airport Authority, Inc.,
Special Facilities Revenue
Bonds, Series 1990, (American
Airlines Inc. Project), 7.50% ...... 5,000,000 12/01/2029 5,477,100
----------
21,890,562
----------
Utah 1.0%
Intermountain Power Agency,
Utah, Power Supply Revenue
Refunding Bonds, 1996 Series
A, MBIA Insured, 6.15% ............. 2,500,000 7/01/2014 2,735,175
----------
</TABLE>
The accompanying notes are an integral part of the financial statements.
65
<PAGE>
STATE STREET RESEARCH TAX-EXEMPT FUND
- --------------------------------------------------------------------------------
INVESTMENT PORTFOLIO (cont'd)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------
Principal Maturity Value
Amount Date (Note 1)
- --------------------------------------------------------------------------------------
<S> <C> <C> <C>
Wisconsin 1.7%
Wisconsin Housing and
Economic Development
Authority, Home Ownership
Revenue Bonds, 1992 Series 2,
Subject to AMT, 6.875% ......... $4,250,000 9/01/2024 $ 4,554,895
-----------
Total Municipal Bonds (Cost $260,417,913)....................... 283,152,541
-----------
</TABLE>
<TABLE>
<S> <C> <C> <C>
SHORT-TERM OBLIGATIONS 0.4%
New York Local Government
Assistance Corp., (A Public
Benefit Corporation of the
State of New York), Series
1993B Refunding Bonds,
5.50% ............................. 100,000 3/01/2005[dbldag] 100,000
Lone Star Airport Improvement
Authority, Inc., Multiple Mode
Demand Revenue Bonds, Issue
of 1984, (American Airlines,
Inc. Project), 5.00% .............. 1,000,000 12/01/2014[dbldag] 1,000,000
---------
Total Short-Term Obligations (Cost $1,100,000)...................... 1,100,000
---------
Total Investments (Cost $261,517,913)--103.3%....................... 284,252,541
Cash and Other Assets, Less Liabilities--(3.3%) .................... (8,954,859)
------------
Net Assets--100.0% ................................................. $275,297,682
============
</TABLE>
<TABLE>
<S> <C>
Federal Income Tax Information:
At December 31, 1997, the net unrealized appreciation
of investments based on cost for Federal income tax
purposes of $261,517,913 was as follows:
Aggregate gross unrealized appreciation for all
investments in which there is an excess of value
over tax cost ...................................................... $22,734,628
Aggregate gross unrealized depreciation for all
investments in which there is an excess of tax
cost over value .................................................... --
-----------
$22,734,628
===========
</TABLE>
- --------------------------------------------------------------------------------
[ddag] Interest rates on these obligations may reset daily.
+ The delivery and payment of this security is beyond the normal settlement
time. The purchase price and interest rate are fixed at the trade date
although interest is not earned until settlement date.
* This security is being used to collateralize the delayed delivery
purchase noted above. The total market value of segregated securities
is $9,190,098.
The accompanying notes are an integral part of the financial statements.
66
<PAGE>
STATE STREET RESEARCH TAX-EXEMPT FUND
- --------------------------------------------------------------------------------
STATEMENT OF ASSETS AND LIABILITIES
- --------------------------------------------------------------------------------
December 31, 1997
<TABLE>
<S> <C>
Assets
Investments, at value (Cost $261,517,913) (Note 1) ................... $284,252,541
Cash ................................................................. 54,070
Interest receivable .................................................. 4,980,026
Receivable for securities sold ....................................... 3,269,510
Receivable for fund shares sold ...................................... 100,395
Other assets ......................................................... 22,070
------------
292,678,612
Liabilities
Payable for securities purchased ..................................... 16,399,680
Dividends payable .................................................... 298,682
Payable for fund shares redeemed ..................................... 173,274
Accrued management fee (Note 2) ...................................... 127,624
Accrued transfer agent and shareholder services
(Note 2) ........................................................... 123,172
Accrued distribution and service fees (Note 4) ....................... 91,950
Accrued trustees' fees (Note 2) ...................................... 22,606
Other accrued expenses ............................................... 143,942
------------
17,380,930
------------
Net Assets $275,297,682
============
Net Assets consist of:
Undistributed net investment income ................................. $ 487,464
Unrealized appreciation of investments .............................. 22,734,628
Accumulated net realized loss ....................................... (683,961)
Paid-in capital ..................................................... 252,759,551
------------
$275,297,682
============
Net Asset Value and redemption price per share of
Class A shares ($209,551,674 [divided by] 24,634,800 shares) $8.51
============
Maximum Offering Price per share of Class A shares
($8.51 [divided by] .955) .......................................... $8.91
============
Net Asset Value and offering price per share of
Class B shares ($54,093,140 [divided by] 6,359,801 shares)*......... $8.51
============
Net Asset Value and offering price per share of
Class C shares ($2,835,939 [divided by] 333,565 shares)* ........... $8.50
============
Net Asset Value, offering price and redemption price per share of
Class S shares ($8,816,929 [divided by] 1,038,945 shares)* ......... $8.49
============
</TABLE>
- --------------------------------------------------------------------------------
* Redemption price per share for Class B and Class C is equal to net asset value
less any applicable contingent deferred sales charge.
<TABLE>
- --------------------------------------------------------------------------------
STATEMENT OF OPERATIONS
- --------------------------------------------------------------------------------
For the year ended December 31, 1997
<S> <C>
Investment Income
Interest ........................................................... $16,428,006
Expenses
Management fee (Note 2) ............................................ 1,510,208
Transfer agent and shareholder services (Note 2) ................... 415,570
Custodian fee ...................................................... 144,959
Reports to shareholders ............................................ 70,924
Registration fees .................................................. 45,605
Audit fee .......................................................... 38,146
Service fee-Class A (Note 4) ....................................... 530,251
Distribution and service fees-Class B (Note 4) ..................... 510,821
Distribution and service fees-Class C (Note 4) ..................... 29,009
Trustees' fees (Note 2) ............................................ 27,703
Legal fees ......................................................... 7,089
Miscellaneous ...................................................... 11,498
-----------
3,341,783
-----------
Net investment income .............................................. 13,086,223
-----------
Realized and Unrealized Gain (Loss) on
Investments and Futures Contracts
Net realized gain on investments (Notes 1 and 3) ................... 3,899,015
Net realized loss on futures contracts (Note 1) .................... (114,912)
-----------
Total net realized gain ........................................... 3,784,103
Net unrealized appreciation of investments ......................... 8,918,360
-----------
Net gain on investments and futures contracts ...................... 12,702,463
-----------
Net increase in net assets resulting from operations ............... $25,788,686
===========
</TABLE>
The accompanying notes are an integral part of the financial statements.
67
<PAGE>
STATE STREET RESEARCH TAX-EXEMPT FUND
- --------------------------------------------------------------------------------
STATEMENT OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
December 31, 1997
<TABLE>
<CAPTION>
Years ended December 31
-----------------------------
1996 1997
- --------------------------------------------------------------------
<S> <C> <C>
Increase (Decrease) in Net Assets
Operations:
Net investment income ............ $ 14,218,877 $ 13,086,223
Net realized gain (loss) on
investments and futures
contracts ...................... (1,834,226) 3,784,103
Net unrealized appreciation
(depreciation) of
investments .................... (4,864,350) 8,918,360
------------ ------------
Net increase resulting from
operations ..................... 7,520,301 25,788,686
------------ ------------
Dividends from net investment income:
Class A ......................... (11,329,888) (10,117,491)
Class B ......................... (2,112,558) (2,053,700)
Class C ......................... (108,938) (116,036)
Class S ......................... (810,073) (427,971)
------------ ------------
(14,361,457) (12,715,198)
------------ ------------
Net decrease from fund share
transactions (Note 5) .......... (38,189,738) (24,771,115)
------------ ------------
Total decrease in net assets ..... (45,030,894) (11,697,627)
Net Assets
Beginning of year ................ 332,026,203 286,995,309
------------ ------------
End of year (including
undistributed net
investment income of
$118,283 and $487,464,
respectively) .................. $286,995,309 $275,297,682
============ ============
</TABLE>
- --------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
December 31, 1997
Note 1
State Street Research Tax-Exempt Fund (the "Fund"), is a series of State Street
Research 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 August, 1986. The Trust consists presently of two
separate funds: State Street Research Tax-Exempt Fund and State Street Research
New York Tax-Free Fund.
The investment objective of the Fund is to seek a high level of interest income
exempt from federal income taxes. In seeking to achieve its investment
objective, the Fund invests primarily in tax-exempt debt obligations which the
investment manager believes will not involve undue risk.
The Fund offers four classes of shares. Before November 1, 1997, Class C shares
were designated Class D and Class S shares were designated Class C. 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 subject to a contingent deferred sales charge of 1.00% on any
shares redeemed within one year of their purchase. Class C shares also pay
annual distribution and service fees of 1.00%. Class S shares are only offered
through certain retirement accounts, advisory accounts of State Street Research
& Management Company (the "Adviser"), an indirect wholly owned subsidiary of
Metropolitan Life Insurance Company ("Metropolitan"), and special programs. No
sales charge is imposed at the time of purchase or redemption of Class S shares.
Class S shares do not pay any distribution or service fees. 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 declare 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.
The accompanying notes are an integral part of the financial statements.
68
<PAGE>
STATE STREET RESEARCH TAX-EXEMPT FUND
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
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
between both 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.
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, 1997, the Fund had a capital
loss carryforward of $99,523 available, to the extent provided in regulations,
to offset future capital gains, if any, which expires on December 31, 2004. As
part of a merger that occurred December 15, 1995, the Fund acquired from State
Street Research Florida Tax-Free Fund and State Street Research Pennsylvania
Tax-Free Fund a capital loss carryforward of $379,027, of which $70,949 and
$308,078 expires on December 31, 2001 and 2002, respectively. The Fund's use of
such capital loss carryforward may be limited under current tax laws.
F. Futures Contracts
The Fund may enter into futures contracts as a hedge against unfavorable market
conditions and to enhance income. The Fund will not purchase any futures
contract if, after such purchase, more than one-third of net assets would be
represented by long futures contracts. The Fund will limit its risks by entering
into a futures position only if it appears to be a liquid investment.
Upon entering into a futures contract, the Fund deposits with the selling broker
sufficient cash or U.S. Government securities to meet the minimum "initial
margin" requirements. Thereafter, the Fund receives from or pays to the broker
cash or U.S. Government securities equal to the daily fluctuation in value of
the contract ("variation margin"), which is recorded as unrealized gain or loss.
When the contract is closed, the Fund records a realized gain or loss equal to
the difference between the value of the contract at the time it was opened and
the value at the time it was closed.
G. Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of income and expenses during the reporting period. Actual
results could differ from those estimates.
H. Securities Lending
The Fund may seek additional income by lending portfolio securities to qualified
institutions. The Fund will receive cash or securities as collateral in an
amount equal to at least 100% of the current market value of any loaned
securities plus accrued interest. If the borrower fails to return the securities
and the value of the collateral has declined during the term of the loan, the
Fund will bear the loss. During the year ended December 31, 1997, there were no
loaned securities.
Note 2
The Trust and the Adviser 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, 1997, the fees pursuant to such
agreement amounted to $1,510,208.
State Street Research Service Center, 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, 1997, the amount of such
expenses was $75,169.
The fees of the Trustees not currently affiliated with the Adviser amounted to
$27,703 during the year ended December 31, 1997.
Note 3
For the year ended December 31, 1997, purchases and sales of securities,
exclusive of short-term obligations, aggregated $168,797,458 and $185,685,527,
respectively.
Note 4
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 C shares. In addition, the Fund pays
annual distribution fees of 0.75% of average daily net assets for Class B and
Class C shares. The Distributor uses such payments for personal services and/or
the maintenance or servicing 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, 1997, fees pursuant to such plan amounted to
$530,251, $510,821 and $29,009 for Class A, Class B and Class C shares,
respectively.
The Fund has been informed that the Distributor and MetLife Securities, Inc., a
wholly owned subsidiary of Metropolitan, earned initial sales charges
aggregating $58,730 and $358,291, respectively, on sales of Class A shares of
the Fund during the year ended December 31, 1997, and that MetLife Securities,
Inc. earned commissions aggregating $250,218 on sales of Class B shares, and the
Distributor collected contingent deferred sales charges aggregating $163,953 and
$5,380 on redemptions of Class B and Class C shares, respectively, during the
same period.
69
<PAGE>
STATE STREET RESEARCH TAX-EXEMPT FUND
- --------------------------------------------------------------------------------
NOTES (cont'd)
- --------------------------------------------------------------------------------
Note 5
The Trustees have the authority to issue an unlimited number of shares of
beneficial interest, $.001 par value per share.
Share transactions were as follows:
<TABLE>
<CAPTION>
Years ended December 31
-----------------------------------------------------------------------
1996 1997
---------------------------------- ----------------------------------
Class A Shares Amount Shares Amount
- ----------------------------------------------- --------------- ---------------- --------------- ----------------
<S> <C> <C> <C> <C>
Shares sold ................................... 3,002,670 $ 23,933,082 2,065,831 $ 16,933,303
Issued upon reinvestment of dividends ......... 1,019,921 8,152,263 893,473 7,340,108
Shares repurchased ............................ (7,148,451) (57,087,469) (5,888,583) (48,161,322)
---------- ------------- ---------- -------------
Net decrease .................................. (3,125,860) $ (25,002,124) (2,929,279) $ (23,887,911)
========== ============= ========== =============
Class B Shares Amount Shares Amount
- ------------------------------------------------ ---------- ------------- ---------- -------------
Shares sold ................................... 1,380,510 $ 11,106,098 1,029,241 $ 8,463,587
Issued upon reinvestment of dividends ......... 183,701 1,368,769 187,485 1,540,633
Shares repurchased ............................ (1,461,750) (11,643,649) (1,237,297) (10,121,203)
---------- ------------- ---------- -------------
Net increase (decrease) ....................... 102,461 $ 831,218 (20,571) $ (116,983)
========== ============= ========== =============
Class C (Formerly Class D) Shares Amount Shares Amount
- ------------------------------------------------ ---------- ------------- ---------- -------------
Shares sold ................................... 252,936 $ 2,023,533 154,375 $ 1,262,199
Issued upon reinvestment of dividends ......... 5,443 44,400 7,270 59,643
Shares repurchased ............................ (408,733) (3,307,900) (184,791) (1,511,144)
---------- ------------- ---------- -------------
Net decrease .................................. (150,354) $ (1,239,967) (23,146) $ (189,302)
========== ============= ========== =============
Class S (Formerly Class C) Shares Amount Shares Amount
- ------------------------------------------------ ---------- ------------- ---------- -------------
Shares sold ................................... 573,749 $ 4,662,961 67,784 $ 567,802
Issued upon reinvestment of dividends ......... 49,208 392,454 34,030 279,608
Shares repurchased ............................ (2,257,037) (17,834,280) (174,445) (1,424,329)
---------- ------------- ---------- -------------
Net decrease .................................. (1,634,080) $ (12,778,865) (72,631) $ (576,919)
========== ============= ========== =============
</TABLE>
70
<PAGE>
STATE STREET RESEARCH TAX-EXEMPT FUND
- --------------------------------------------------------------------------------
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
For a share outstanding throughout each year:
<TABLE>
<CAPTION>
Class A
-----------------------------------------------------------
Years ended December 31
-----------------------------------------------------------
1993 1994 1995 1996 1997
----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Net asset value, beginning of year ($) 7.94 8.43 7.46 8.26 8.10
----- ----- ----- ------ -----
Net investment income ($) 0.40 0.40 0.39 0.39 0.40
Net realized and unrealized gain (loss) on
investments and futures contracts ($) 0.54 (0.98) 0.82 (0.16) 0.40
----- ------ ----- ------- -----
Total from investment operations ($) 0.94 (0.58) 1.21 0.23 0.80
----- ------ ----- ------- -----
Dividends from net investment income ($) (0.39) (0.38) (0.41) (0.39) (0.39)
Distributions from net realized gains ($) (0.06) (0.01) -- -- --
------ ------ ------ ------- ------
Total distributions ($) (0.45) (0.39) (0.41) (0.39) (0.39)
------ ------ ------ ------- ------
Net asset value, end of year ($) 8.43 7.46 8.26 8.10 8.51
====== ====== ====== ======= ======
Total return(2) (%) 12.11 (6.90) 16.58 2.93 10.17
Ratios/supplemental data:
Net assets at end of year ($ thousands) 302,845 238,097 253,402 223,407 209,552
Ratio of operating expenses to average net
assets (%) 1.20 1.20 1.13 1.04 1.08
Ratio of net investment income to average net
assets (%) 4.85 5.07 4.95 4.82 4.91
Portfolio turnover rate (%) 36.16 78.63 97.32 125.24 60.48
<CAPTION>
Class B
---------------------------------------------------------
Years ended December 31
---------------------------------------------------------
1993(1) 1994 1995 1996 1997
-------------- ---------- ---------- ---------- ---------
<S> <C> <C> <C> <C> <C>
Net asset value, beginning of year ($) 8.25 8.43 7.46 8.26 8.10
----- ----- ----- ------ -----
Net investment income ($) 0.19 0.34 0.33 0.32 0.34
Net realized and unrealized gain (loss) on
investments and futures contracts ($) 0.24 (0.97) 0.82 (0.15) 0.40
----- ------ ------ ------- -----
Total from investment operations ($) 0.43 (0.63) 1.15 0.17 0.74
----- ------ ----- ------- -----
Dividends from net investment income ($) (0.19) (0.33) (0.35) (0.33) (0.33)
Distributions from net realized gains ($) (0.06) (0.01) -- -- --
------ ------ ------ ------- ------
Total distributions ($) (0.25) (0.34) (0.35) (0.33) (0.33)
------ ------ ------ ------- ------
Net asset value, end of year ($) 8.43 7.46 8.26 8.10 8.51
====== ====== ====== ======= ======
Total return(2) (%) 5.20(3) (7.59) 15.72 2.15 9.35
Ratios/supplemental data:
Net assets at end of year ($ thousands) 27,695 35,338 51,827 51,710 54,093
Ratio of operating expenses to average net
assets (%) 1.95(4) 1.95 1.88 1.79 1.83
Ratio of net investment income to average net
assets (%) 3.93(4) 4.35 4.19 4.07 4.15
Portfolio turnover rate (%) 36.16 78.63 97.32 125.24 60.48
</TABLE>
<TABLE>
<CAPTION>
Class C (Formerly Class D)
------------------------------------------------------
Years ended December 31
------------------------------------------------------
1993(1) 1994 1995 1996 1997
-------------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Net asset value, beginning of year ($) 8.25 8.43 7.46 8.25 8.10
----- ----- ----- ------ -----
Net investment income ($) 0.19 0.34 0.33 0.32 0.34
Net realized and unrealized gain (loss) on
investments and futures contracts ($) 0.23 (0.97) 0.81 (0.14) 0.39
----- ------ ----- ------- -----
Total from investment operations ($) 0.42 (0.63) 1.14 0.18 0.73
----- ------ ----- ------- -----
Dividends from net investment income ($) (0.18) (0.33) (0.35) (0.33) (0.33)
Distributions from net realized gains ($) (0.06) (0.01) -- -- --
------ ------ ------ ------- ------
Total distributions ($) (0.24) (0.34) (0.35) (0.33) (0.33)
------ ------ ------ ------- ------
Net asset value, end of year ($) 8.43 7.46 8.25 8.10 8.50
====== ====== ====== ======= ======
Total return(2) (%) 5.19(3) (7.59) 15.58 2.28 9.23
Ratios/supplemental data:
Net assets at end of year ($ thousands) 1,115 958 4,183 2,889 2,836
Ratio of operating expenses to to average net
assets (%) 1.99(4) 1.95 1.88 1.79 1.83
Ratio of net investment income to average net
assets (%) 3.92(4) 4.31 4.13 4.06 4.16
Portfolio turnover rate (%) 36.16 78.63 97.32 125.24 60.48
<CAPTION>
Class S (Formerly Class C)
-------------------------------------------------------
Years ended December 31
-------------------------------------------------------
1993(1) 1994 1995 1996 1997
-------------- --------- ---------- --------- ---------
<S> <C> <C> <C> <C> <C>
Net asset value, beginning of year ($) 8.25 8.41 7.45 8.24 8.09
----- ----- ----- ------ -----
Net investment income ($) 0.23 0.42 0.40 0.39 0.42
Net realized and unrealized gain (loss) on
investments and futures contracts ($) 0.22 (0.96) 0.81 (0.13) 0.39
----- ------ ----- ------- -----
Total from investment operations ($) 0.45 (0.54) 1.21 0.26 0.81
----- ------ ----- ------- -----
Dividends from net investment income ($) (0.23) (0.41) (0.42) (0.41) (0.41)
Distributions from net realized gains ($) (0.06) (0.01) -- -- --
------ ------ ------ ------- ------
Total distributions ($) (0.29) (0.42) (0.42) (0.41) (0.41)
------ ------ ------ ------- ------
Net asset value, end of year ($) 8.41 7.45 8.24 8.09 8.49
====== ====== ====== ======= ======
Total return(2) (%) 5.54(3) (6.56) 16.76 3.30 10.33
Ratios/supplemental data:
Net assets at end of year ($ thousands) 477 334 22,614 8,990 8,817
Ratio of operating expenses to to average net
assets (%) 0.96(4) 0.95 0.88 0.79 0.83
Ratio of net investment income to average net
assets (%) 4.92(4) 5.26 4.85 5.04 5.15
Portfolio turnover rate (%) 36.16 78.63 97.32 125.24 60.48
</TABLE>
- --------------------------------------------------------------------------------
(1) June 7, 1993 (commencement of share class designations) to December 31,
1993.
(2) Does not reflect any front-end or contingent deferred sales charges.
(3) Not annualized.
(4) Annualized.
71
<PAGE>
- --------------------------------------------------------------------------------
REPORT OF INDEPENDENT ACCOUNTANTS
- --------------------------------------------------------------------------------
To the Trustees of State Street Research
Tax-Exempt Trust and the Shareholders of
State Street Research Tax-Exempt 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 Tax-Exempt
Fund (a series of State Street Research Tax-Exempt Trust, hereafter referred to
as the "Trust") at December 31, 1997, 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 at
December 31, 1997 by correspondence with the custodian and brokers, and the
application of alternative auditing procedures where confirmations from brokers
were not received, provide a reasonable basis for the opinion expressed above.
Price Waterhouse LLP
Boston, Massachusetts
February 6, 1998
72
<PAGE>
STATE STREET RESEARCH TAX-EXEMPT FUND
- --------------------------------------------------------------------------------
MANAGEMENT'S DISCUSSION OF FUND PERFORMANCE
- --------------------------------------------------------------------------------
State Street Research Tax-Exempt Fund had a strong year. Class A shares returned
+10.17% [without sales charge] for the 12 months ended December 31, 1997. This
total return performance was higher than that of the average general municipal
debt fund tracked by Lipper Analytical Services, which returned 9.11% for the
same period. The Lehman Brothers Municipal Bond Index gained 9.19% for the same
period.
The Fund invests primarily in tax-exempt debt obligations with an emphasis on
research to maximize return and manage risk.
A generally favorable economic environment helped the Fund's performance during
the year. The manager increased the Fund's investments in higher-yielding,
uninsured and zero coupon bonds and gradually lengthened the Fund's duration. As
interest rates came down during the year and the supply of new bonds remained
low, the Fund's return got a boost from capital appreciation.
With a favorable outlook for both the economy and inflation, the outlook for the
Fund remains positive for the period ahead.
December 31, 1997
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. Performance for a class may include periods prior to the
adoption of class designations in 1993, which resulted in new or increased 12b-1
fees of up to 1% per class thereafter and which will reduce subsequent
performance. "S" shares, offered without a sales charge, are available through
certain employee benefit plans and special programs. Performance reflects
maximum 4.5% "A" share front-end sales charge or 5% "B" share or 1% "C" share
contingent deferred sales charges where applicable. Before November 1, 1997,
Class C shares were designated Class D, and Class S shares were designated Class
C. The Lehman Brothers Municipal Bond Index is a commonly used measure of bond
market performance. The index is unmanaged and does not take sales charges into
consideration. Direct investment in the index is not possible; results are for
illustrative purposes only.
Change In Value Of $10,000 Based On The
Lehman Municipal Bond Index Compared To
Change In Value Of $10,000 Invested
In Tax-Exempt Fund
Class A Shares
Tax-Exempt Lehman Municipal
Fund Bond Index
12/87 9,550 10,000
12/88 10,838 11,016
12/89 11,881 12,205
12/90 12,455 13,094
12/91 13,924 14,684
12/92 15,222 15,979
12/93 17,006 17,942
12/94 15,888 17,014
12/95 18,522 19,984
12/96 19,065 20,869
12/97 21,004 22,787
Average Annual Total Return
- ------------------------------------------
1 Year 5 Years 10 Years
- ------------------------------------------
+5.21% +5.67% +7.70%
Class B Shares
Tax-Exempt Lehman Municipal
Fund Bond Index
12/87 10,000 10,000
12/88 11,349 11,016
12/89 12,441 12,205
12/90 13,042 13,094
12/91 14,580 14,684
12/92 15,939 15,979
12/93 17,796 17,942
12/94 16,445 17,014
12/95 19,029 19,984
12/96 19,438 20,869
12/97 21,256 22,787
Average Annual Total Return
- ------------------------------------------
1 Year 5 Years 10 Years
- ------------------------------------------
+4.35% +5.61% +7.83%
Class C Shares
Tax-Exempt Lehman Municipal
Fund Bond Index
12/87 10,000 10,000
12/88 11,349 11,016
12/89 12,441 12,205
12/90 13,042 13,094
12/91 14,580 14,684
12/92 15,939 15,979
12/93 17,794 17,942
12/94 16,433 17,014
12/95 19,004 19,984
12/96 19,437 20,869
12/97 21,231 22,787
Average Annual Total Return
1 Year 5 Years 10 Years
+8.23% +5.90% +7.82%
Class S Shares
Tax-Exempt Lehman Municipal
Fund Bond Index
12/87 10,000 10,000
12/88 11,349 11,016
12/89 12,441 12,205
12/90 13,042 13,094
12/91 14,580 14,684
12/92 15,939 15,979
12/93 17,854 17,942
12/94 16,682 17,014
12/95 19,477 19,984
12/96 20,120 20,869
12/97 22,200 22,787
Average Annual Total Return
- ------------------------------------------
1 Year 5 Years 10 Years
- ------------------------------------------
+10.33% +6.85% +8.30%
73
<PAGE>
STATE STREET RESEARCH NEW YORK TAX-FREE FUND
a Series of
STATE STREET RESEARCH TAX-EXEMPT TRUST
STATEMENT OF ADDITIONAL INFORMATION
May 1, 1998
TABLE OF CONTENTS
Page
INVESTMENT OBJECTIVE........................................................ 2
ADDITIONAL INVESTMENT POLICIES AND RESTRICTIONS............................. 2
NEW YORK MUNICIPAL OBLIGATIONS.............................................. 4
ADDITIONAL INFORMATION CONCERNING
CERTAIN INVESTMENT TECHNIQUES...................................... 19
DEBT INSTRUMENTS AND PERMITTED CASH INVESTMENTS............................. 28
THE TRUST, THE FUND AND ITS SHARES.......................................... 35
TRUSTEES AND OFFICERS....................................................... 37
INVESTMENT ADVISORY SERVICES................................................ 42
PURCHASE AND REDEMPTION OF SHARES........................................... 43
SHAREHOLDER ACCOUNTS........................................................ 48
NET ASSET VALUE............................................................. 52
PORTFOLIO TRANSACTIONS...................................................... 53
CERTAIN TAX MATTERS......................................................... 56
DISTRIBUTION OF SHARES OF THE FUND.......................................... 59
CALCULATION OF PERFORMANCE DATA............................................. 62
CUSTODIAN................................................................... 68
INDEPENDENT ACCOUNTANTS..................................................... 68
FINANCIAL STATEMENTS........................................................ 68
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, 1998, 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-980501(0699)SSR-LD NYTF-879D-598
<PAGE>
INVESTMENT OBJECTIVE
As set forth under "The Fund--Goal and Strategy--Fundamental Goal" in the
Prospectus of State Street Research New York Tax-Free Fund (the "Fund"), the
Fund's investment goal, which is to seek a high level of interest income exempt
from federal income taxes and New York State and New York City personal income
taxes, is fundamental and may not be changed by the Fund except by the
affirmative vote of a majority of the outstanding voting securities of the Fund,
as defined in the Investment Company Act of 1940, as amended (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 the
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.)
ADDITIONAL INVESTMENT POLICIES AND RESTRICTIONS
As set forth under "New York Tax-Free Fund--Portfolio Risks" and "Other
Securities and Risks" in the Fund's Prospectus, the Fund has adopted certain
investment restrictions, and those restrictions are either fundamental or not
fundamental. Fundamental restrictions may not be changed by the Fund except by
the affirmative vote of a majority of the outstanding voting securities of the
Fund. Restrictions that are not fundamental may be changed by a vote of a
majority of the Trustees of the Trust.
The Fund's fundamental investment restrictions are set forth below. Under
these restrictions, it is the Fund's policy:
(1) not to purchase a security of any one issuer (other than securities issued
or guaranteed as to principal or interest by the U.S. Government or its
agencies or instrumentalities or mixed-ownership Government corporations)
if such purchase would, with respect to 75% of the Fund's total assets,
cause more than 5% of the Fund's total assets to be invested in the
securities of such issuer or cause more than 10% of the voting securities
of such issuer to be held by the Fund;
(2) not to issue senior securities;
(3) 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;
(4) 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;
2
<PAGE>
(5) not to invest in physical commodities or physical commodity contracts or
options in excess of 10% of the Fund's total assets, except that
investments in essentially financial items or arrangements such as, but not
limited to, swap arrangements, hybrids, currencies, currency and other
forward contracts, delayed delivery and when-issued contracts, futures
contracts and options on futures contracts on securities, securities
indices, interest rates and currencies, shall not be deemed investments in
commodities or commodities contracts;
(6) 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);
(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); and
3
<PAGE>
(11) 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 are not fundamental. Under these
restrictions, it is the Fund's policy:
(1) not to purchase any security or enter into a repurchase agreement if as a
result more than 15% of its net assets would be invested in securities that
are illiquid (including repurchase agreements not entitling the holder to
payment of principal and interest within seven days);
(2) 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;
(3) not to purchase securities on margin or make short sales of securities or
maintain a short position except for short sales "against the box";
(4) 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);
(5) not to purchase a security issued by another investment company, except to
the extent permitted under the 1940 Act or except by purchases in the open
market involving only customary brokers' commissions, or securities
acquired as dividends or distributions or in connection with a merger,
consolidation or similar transaction or other exchange; and
(6) 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 of Additional Information, 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
4
<PAGE>
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. 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).
Municipal lease obligations, that is, lease obligations or installment
purchase contract obligations supported by lease payments made by a
municipality, may be issued by state and government authorities to obtain funds
to acquire a wide variety of equipment and facilities, such as fire and
sanitation vehicles, computer equipment, buildings and other capital assets.
Although municipal lease obligations do not normally constitute general
obligations of the municipality, a lease obligation is ordinarily based by the
municipality's agreement to make the payments due under the lease obligation.
However, certain lease obligations contain "non-appropriation" clauses which
provide that the municipality has no obligation to make lease or installment
purchase payments in later years unless money is appropriated in the future.
Municipal lease obligations are a relatively new form of financing instrument
and the market for such obligations is still developing.
5
<PAGE>
Depending on the development of such markets, such municipal lease
obligations may be deemed to be liquid as determined by or in accordance with
methods adopted by the Trustees. In determining the liquidity and appropriate
valuation of a municipal lease obligation, the following factors relating to the
security are considered, among others: (1) the frequency of trades and quotes;
(2) the number of dealers willing to purchase or sell the security; (3) the
willingness of dealers to undertake to make a market; (4) the nature of the
marketplace trades and (5) the likelihood that the obligation will continue to
be marketable based on the credit quality of the municipality or relevant
obligor. Municipal lease obligations initially deemed to be liquid could later
become illiquid.
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 Fund may invest in New York Municipal Obligations which have fixed
interest rates or variable or floating interest rates, including short-term
obligations which have daily adjustable rates. Variable or floating rates may be
adjusted in relation to market rates for other instruments, prime rates, indices
or similar indicators. Certain of these adjustable obligations may carry a
demand feature that permits the Fund to receive the par value of the security
upon demand prior to maturity. These obligations may also be subject to
prepayment without penalty at the option of the issuer.
The ratings of Standard & Poor's Corporation ("S&P") and Moody's Investors
Service, Inc. ("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.
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
6
<PAGE>
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
investments 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 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. State per capita
personal income has historically been significantly higher than the national
average, although the ratio has varied substantially. Moderate growth is
projected to continue in 1998 and 1999 for employment, wages, and personal
income, although the growth rates will lessen gradually during the course of the
two years. Overall employment growth is expected to continue at a modest rate,
reflecting the slowing growth in the national economy, continued spending
restraint in government, and restructuring in the health care, social service,
and banking sectors.
There can be no assurance that the State economy will not experience
worse-than-predicted results, with corresponding material and adverse effects on
the State's projections of receipts and disbursements.
State Budget. The State Constitution requires the governor (the "Governor") to
submit to the State legislature (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.
7
<PAGE>
The State's budget for the 1997-98 fiscal year was adopted by the
Legislature on August 4, 1997, more than four 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 necessary appropriations for State-supported debt
service. The State Financial Plan for the 1997-98 fiscal year was formulated on
August 11, 1997 and was based on the State's budget as enacted by the
Legislature, as well as actual results for the first quarter of the current
fiscal year (the "1997-98 State Financial Plan"). In recent years, the State has
failed to adopt a budget prior to the beginning of its fiscal year. There can be
no assurance that State budgets in future fiscal years will be adopted by the
April 1 statutory deadline.
The Governor is required by law to propose a balanced budget each year. In
order to address any potential remaining budget gap, the Governor is expected to
make additional proposals to bring receipts in line with disbursements. The
State has closed projected budget gaps of $5.0 billion, $3.9 billion and $2.3
billion in its 1995-96, 1996-97 and 1997-98 fiscal years, respectively.
The 1997-98 General Fund Financial Plan is projected to be balanced on a
cash basis, with a projected cash surplus of $1.83 billion. As compared to the
Governor's Executive Budget as amended in February 1997, the State's adopted
budget for 1997-98 increased General Fund spending by $1.7 billion, primarily
from increases for local assistance ($1.3 billion). Resources used to fund these
additional expenditures include increased revenues projected for the 1997-98
fiscal year, increased resources produced in the 1996-97 fiscal year that will
be utilized in 1997- 98, re-estimates of social service, fringe benefit and
other spending, and certain non-recurring resources.
The 1997-98 adopted budget includes multi-year reductions, including a
State funded property and local income tax reduction program, estate tax relief,
utility gross receipts tax reductions, permanent reductions in the State sales
tax on clothing, and elimination of assessments on medical providers. These
reductions are intended to reduce the overall level of State and local taxes in
New York and to improve the State's competitive position vis-a-vis other states.
The various elements of the State and local tax and assessments reductions have
little or no impact on the 1997-98 State Financial Plan, and do not begin to
materially affect the outyear projections until the State's 1999-2000 fiscal
year.
Other actions taken in the 1997-98 adopted budget add further pressure to
future budget balance in New York State. For example, the fiscal effects of tax
reductions adopted in the 1997-98 budget are projected to grow more
substantially beyond the 1998-99 fiscal year, with incremental costs averaging
in excess of $1.3 billion annually over the last three years of the tax
reduction program. These incremental costs reflect the phase-in of State-funded
school property tax and local income tax relief, the phase-out of the
assessments on medical providers, and reductions in estate and gift levies,
utility gross receipts taxes, and the State sales tax on clothing. The full
annual cost of the enacted tax reduction package is estimated at approximately
$4.8 billion when fully effective in State fiscal year 2001-02. In addition, the
1997-98 budget included multi-year commitments for school aid and
pre-kindergarten early learning programs which could add as much as $1.4 billion
in costs when fully annualized in fiscal year 2001-02. These spending
commitments are subject to annual appropriation.
8
<PAGE>
On September 11, 1997, the New York State Comptroller issued a report which
noted that the ability to deal with future budget gaps could become a
significant issue in the State's 2000-2001 fiscal year, when the cost of tax
cuts increases by $1.9 billion. The report contained projections that, based on
current economic conditions and current law for taxes and spending, showed a gap
in the 2000-2001 State fiscal year of $5.6 billion and of $7.4 billion in the
2001- 2002 State fiscal year. The report noted that these gaps would be smaller
if recurring spending reductions produce savings in earlier years. The State
Comptroller has also stated that if Wall Street earnings moderate and the State
experiences a moderate recession, the gap for the 2001- 2002 State fiscal year
could grow to nearly $12 billion.
The Governor presented his 1998-99 Executive Budget to the Legislature on
January 20, 1998. The Executive Budget contains financial projections for the
State's 1997-98 through 2000-01 fiscal years, detailed estimates of receipts
and a proposed Capital Program and Financing Plan for the 1997-98 through
2002-03 fiscal years. It is expected that the Governor will prepare amendments
to his Executive Budget as permitted under law and that these amendments will be
reflected in a revised Financial Plan. There can be no assurance that the
Legislature will enact into law the Executive Budget as proposed by the
Governor, or that the State's adopted budget projections will not differ
materially and adversely from the projections set forth therein.
The 1998-99 Financial Plan is projected to be balanced on a cash basis in
the General Fund. Total General Fund receipts, including transfers from other
funds, are projected to be $36.22 billion, an increase of $1.02 billion over
projected receipts in the current fiscal year. Total General Fund disbursements,
including transfers to other funds, are projected to be $36.18 billion, an
increase of $1.02 billion over the projected expenditures (including
pre-payments), for the current fiscal year. As compared to the 1997-98 State
Financial Plan, the Executive Budget proposes year-to-year growth in General
Fund spending of 2.89 percent. State Funds spending (i.e., General Fund plus
other dedicated funds, with the exception of federal aid) is projected to grow
by 8.5 percent. Spending from All Governmental Funds (excluding transfers) is
proposed to increase by 7.6 percent from the prior fiscal year.
The forecast of General Fund receipts in 1998-99 incorporates several
Executive Budget tax proposals that, if enacted, would further reduce receipts
otherwise available to the General Fund by approximately $700 million during
1998-99. The Executive Budget proposes accelerating school tax relief for senior
citizens under STAR, which is projected to reduce General Fund receipts by $537
million in 1998-99. The proposed reduction supplements STAR tax reductions
already scheduled in law, which are projected at $187 million in 1998-99. The
Budget also proposes several new tax-cut initiatives and other funding changes
that are projected to further reduce receipts available to the General Fund by
over $200 million. These initiatives include reducing the fee to register
passenger motor vehicles and earmarking a larger portion of such fees to
dedicated funds and other purposes; extending the number of weeks in which
certain clothing purchases are exempt from sales taxes; more fully conforming
State law to reflect recent Federal changes in estate taxes; continuing lower
pari-mutuel tax rates; and accelerating scheduled property tax relief for
farmers from 1999 to 1998. In addition to the specific tax and fee reductions
discussed above, the Executive Budget also proposes establishing a reserve of
$100 million to permit the acceleration into 1998-99 of other tax reductions
that are otherwise scheduled in law for implementation in future fiscal years.
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The Division of the Budget estimates that the 1998-99 Financial Plan
includes approximately $62 million in non-recurring resources, comprising less
than two-tenths of one percent of General Fund disbursements. The non-recurring
resources projected for use in 1998-99 consist of $27 million in retroactive
federal welfare reimbursements for family assistance recipients with HIV/AIDS,
$25 million in receipts from the Housing Finance Agency that were originally
anticipated in 1997-98, and $10 million in other measures, including $5 million
in asset sales.
Disbursements from Capital Projects funds in 1998-99 are estimated at $4.82
billion, or $1.07 billion higher than 1997-98. The proposed spending plan
includes: $2.51 billion in disbursements for transportation purposes, including
the State and local highway and bridge program; $815 million for environmental
activities; $379 million for correctional services; $228 million for the State
University of New York ("SUNY") and the City University of New York ("CUNY");
$290 million for mental hygiene projects; and $375 million for CEFAP.
Approximately 28 percent of capital projects are proposed to be financed by
"pay-as-you-go" resources. State-supported bond issuances finance 46 percent of
capital projects, with federal grants financing the remaining 26 percent.
The economic and financial condition of the State may be affected by
various financial, social, economic and political factors. Those factors can be
very complex, may vary from fiscal year to fiscal year, and are frequently the
result of actions taken not only by the State and its agencies and
instrumentalities, but also by entities, such as the federal government, that
are not under the control of the State. In addition, the financial plan is based
upon forecasts of national and State economic activity. Economic forecasts have
frequently failed to predict accurately the timing and magnitude of changes in
the national and the State economies. Actual results, however, could differ
materially and adversely from the projections set forth in a financial plan, and
those projections may be changed materially and adversely from time to time.
In the past, the State has taken management actions and made use of
internal sources to address potential State financial plan shortfalls, and the
Division of Budget believes it could take similar actions should variances occur
in its projections for the current fiscal year.
Recent Financial Results. The General Fund is the principal 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.
The State ended the first six months of its 1997-98 fiscal year with an
unaudited General Fund cash balance of $3.2 billion, or $254 million above the
August Financial Plan estimate. Total unaudited receipts, including transfers
from other funds, totaled $18.8 billion, or $340 million higher than expected.
The additional receipts reflected higher-than-anticipated tax revenues of $244
million and miscellaneous receipts of $93 million. Unaudited General Fund
spending for the same period equaled $16.0 billion, or $86 million above the
cashflow projections published in the August Financial Plan. For fiscal year
1997-98, total General Fund receipts were projected at $35.09 billion, an
increase of $2.05 billion from 1996-97 results. Total disbursements, including
transfers to capital projects, debt service and other funds, were projected at
$34.60 billion, or 5.2 percent higher than disbursements in 1996-97.
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The mid-year update projected a closing balance in the General Fund of $927
million, which was composed of a $530 million reserve for future needs, a $332
million balance in the Tax Stabilization Reserve Fund ("TSRF"), and a $65
million balance in the Contingency Reserve Fund ("CRF").
As part of the 1997-98 Adopted Budget Report, the State also issued its
update to the GAAP-basis Financial Plan for the State's 1997-98 fiscal year,
based on the cash-basis 1997-98 State Financial Plan completed in August. The
GAAP-basis update projected a General Fund operating deficit of $959 million,
primarily reflecting the use of a portion of the 1996-97 cash surplus to fund
1997-98 liabilities, offset by the $530 million reserve for future needs.
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 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 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 of New York.
The State 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 and
rehabilitation 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") to restructure the way the State makes certain
local aid payments.
In February 1997, the Job Development Authority ("JDA") issued
approximately $85 million of State-guaranteed bonds to refinance certain of its
outstanding bonds and notes in order to restructure and improve JDA's capital
structure. Due to concerns regarding the economic viability of its programs,
JDA's loan and loan guarantee activities had been suspended since the Governor
took office in 1995. As a result of the structural imbalances in JDA's capital
structure, and defaults in its loan portfolio and loan guarantee program
incurred between 1991
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and 1996, JDA would have experienced a debt service cash flow shortfall had it
not completed its recent refinancing. JDA anticipates that it will transact
additional refinancings in 1999, 2000 and 2003 to complete its long-term plan of
finance and further alleviate cash flow imbalances which are likely to occur in
future years. The State does not anticipate that it will be called upon to make
any payments pursuant to the State guarantee in the 1997-98 fiscal year. JDA
recently resumed its lending activities under a revised set of lending programs
and underwriting guidelines.
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 New York State's annual seasonal borrowing. The legislation empowered
LGAC to issue its bonds and notes in an amount to yield net proceeds not in
excess of $4.7 billion (exclusive of certain refunding bonds). Over a period of
years, the issuance of these long-term obligations, which were to be amortized
over no more than 30 years, was expected to eliminate the need for continued
short-term seasonal borrowing. The legislation also dedicated revenues equal to
one-quarter of the four cent State sales and use tax to pay debt service on
these bonds. 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 the need for additional
borrowing and provided a schedule for reducing it to the cap. If borrowing above
the cap was thus permitted in any fiscal year, it was required by law to be
reduced to the cap by the fourth fiscal year after the limit was first exceeded.
As of June 1995, LGAC had issued bonds to provide net proceeds of $4.7 billion,
completing the program.
On January 13, 1992, S&P reduced its ratings on the State's general
obligation bonds from A to A- and, in addition, reduced its ratings on the
State's moral obligation, lease purchase, guaranteed and contractual obligation
debt. On August 28, 1997, S&P revised its ratings on the State's general
obligation bonds from A- to A and revised its ratings on the State's moral
obligation, lease purchase, guaranteed and contractual obligation debt. 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 the 1997-98 fiscal year. The State
expects to issue $605 million in general obligation bonds (including $140
million for purposes of redeeming outstanding bond anticipation notes) and $140
million in general obligation commercial paper. The Legislature has also
authorized the issuance of $311 million in certificates of participation
(including costs of issuance, reserve funds and other costs) during the State's
1997-98 fiscal year for equipment purchases. The projection of State borrowings
for the 1997-98 fiscal year is subject to change as market conditions, interest
rates and other factors vary throughout the fiscal year.
The proposed 1997-98 through 2002-03 Capital Program and Financing Plan was
released with the 1998-99 Executive Budget on January 20, 1998. As a part of
that Plan, changes were proposed to the State's 1997-98 borrowing plan,
including: the delay in the issuance of COPs to finance welfare information
systems until 1998-99 to permit a thorough assessment of needs; and
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the elimination of issuances for the CEFAP to reflect the proposed conversion of
that bond-financed program to pay-as-you-go financing.
As a result of these changes, the State's 1997-98 borrowing plan now
reflects: $501 million in general obligation bonds (including $140 million for
purposes of redeeming outstanding BANs) and $140 million in general obligation
commercial paper; the issuance of $83 million in COPs for equipment purchases;
and approximately $1.8 billion in borrowings by public authorities pursuant to
lease-purchase and contractual-obligation financings for capital programs of the
State, including costs of issuance, reserve funds, and other costs, net of
anticipated refundings and other adjustments for 1997-98 capital projects. The
projection of State borrowings for the 1997-98 fiscal year is subject to change
as market conditions, interest rates and other factors vary through the end of
the fiscal year.
New York 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 New York State or its officers or
employees could have a substantial or long-term adverse effect on New York 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 New York State of certain land in central and upstate New
York; (2) certain aspects of New York State's Medicaid policies, including its
rates, regulations and procedures; (3) action against New York State and New
York City officials alleging inadequate shelter allowances to maintain proper
housing; (4) challenges to the practice of reimbursing certain Office of Mental
Health patient care expenses from the client's Social Security benefits; (5)
alleged responsibility of New York State officials to assist in remedying racial
segregation in the City of Yonkers; (6) challenges to regulations promulgated by
the Superintendent of Insurance establishing certain excess medical malpractice
premium rates; (7) challenges to certain aspects of petroleum business taxes;
(8) action alleging damages resulting from the failure by the State's Department
of Environmental Conservation to timely provide certain data; (9) challenges to
the constitutionality of Public Health Law 2807-d, which imposes a gross
receipts tax from certain patient care services; (10) an action seeking
reimbursement from the State for certain costs arising out of the provision of
pre-school services and programs for children with handicapped conditions; (11)
action seeking enforcement of certain sales and excise taxes and tobacco
products and motor fuel sold to non-Indian consumers on Indian reservations; and
(12) a challenge to the constitutionality of Clean Water/Clean Air Bond Act.
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 Comptroller developed a
plan to restore the State's retirement systems to prior funding levels. Such
funding is expected to exceed prior levels by $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
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executed in connection with the action, the State was required to make aggregate
payments of $351.4 million. 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.
Litigation challenging the constitutionality of the treatment of certain moneys
held in a reserve fund was settled in June 1996 and certain amounts in a
Supplemental Reserve Fund previously credited by the State against prior State
and local pension contributions will be paid in 1998.
The legal proceedings noted above involve State finances, State programs
and miscellaneous cure rights, tort, real property and contract claims in which
the State is a defendant and the monetary damages sought are substantial,
generally in excess of $100 million. These proceedings could affect adversely
the financial condition of the State in the 1997-98 fiscal year or thereafter.
Adverse developments in these proceedings, other proceedings for which there are
unanticipated, unfavorable and material judgments, or the initiation of new
proceedings could affect the ability of the State to maintain a balanced
financial plan. An adverse decision in any of these proceedings could exceed the
amount of the reserve established in the State's financial plan for the payment
of judgments and, therefore, could affect the ability of the State to maintain a
balanced financial plan. In its audited financial statements for the 1996-97
fiscal year, the State reported its estimated liability for awarded and
anticipated unfavorable judgments to be $364 million, of which $134 million is
expected to be paid during the 1997-98 fiscal year.
Although other litigation is pending against New York State, except as
described herein, no current litigation involves New York State's authority, as
a matter of law, to contract indebtedness, issue its obligations, or pay such
indebtedness when it matures, or affects New York 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 New York 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 is
State-supported or State-related.
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, New York
State has provided financial assistance through appropriations, in some cases of
a recurring nature, to certain of the 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. 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
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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 of New York
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 depends on State aid both to
enable the City to balance its budget and to meet its cash requirements. There
can be no assurance that there will not be reductions in State aid to the City
from amounts currently projected or that State budgets will be adopted by the
April 1 statutory deadline or that any such reductions or delays will not have
adverse effects on the City's cash flow or expenditures. In addition, the
Federal budget negotiation process could result in a reduction in or a delay in
the receipt of Federal grants which could have additional adverse effects on the
City's cash flow or revenues.
In 1975, New York 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 the 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&Ps.
On July 2, 1985, S&P revised its rating of City bonds upward to BBB+ and on
November 19, 1987, to A-. 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 February
3, 1998, S&P placed a BBB+ rating on the City's general obligation debt on
CreditWatch with positive implications.
New York City is heavily dependent on New York 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. Since its
creation, MAC has provided, among other things, financing assistance to the City
by refunding maturing City short-term debt and transferring to the City funds
received from sales of MAC bonds and notes. 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, subject to certain prior claims,
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 acceleration of the maturity of all or a portion of MAC's debt.
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. As of June
30, 1997, MAC had outstanding an aggregate of approximately $4.267 billion of
its bonds. MAC is authorized to issue bonds and notes to refunds its outstanding
bonds and notes and to fund certain reserves, without limitation as to principal
amount, and to finance certain capital commitments to the Transit Authority and
the New York City School Construction Authority through the 1997 fiscal year in
the event the City fails to provide such financing.
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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.
On June 10, 1997, the City submitted to the Control Board the Financial
Plan (the "1998-2001 Financial Plan") for the 1998 through 2001 fiscal years,
relating to the City, the Board of Education ("BOE") and CUNY and reflected the
City's expense and capital budgets for the 1998 fiscal year, which were adopted
on June 6, 1997. The 1998-2001 Financial Plan projected revenues and
expenditures for the 1998 fiscal year balanced in accordance with GAAP. The
1998-99 Financial Plan projects General Fund receipts (including transfers from
other funds) of $36.22 billion, an increase of $1.02 billion over the estimated
1997-987 level. Recurring growth in the State General Fund tax base is projected
to be approximately six percent during 1998-99, after adjusting for tax law and
administrative changes. This growth rate is lower than the rates for 1996-97 or
currently estimated for 1997-98, but roughly equivalent to the rate for 1995-96.
The 1998-99 forecast for user taxes and fees also reflects the impact of
scheduled tax reductions that will lower receipts by $38 million, as well as the
impact of two Executive Budget proposals that are projected to lower receipts by
an additional $79 million. The first proposal would divert $30 million in motor
vehicle registration fees from the General Fund to the Dedicated Highway and
Bridge Trust Fund; the second would reduce fees for motor vehicle registrations,
which would further lower receipts by $49 million. The underlying growth of
receipts in this category is projected at 4 percent, after adjusting for these
scheduled and recommended changes.
In comparison to the current fiscal year, business tax receipts are
projected to decline slightly in 1998-99, falling from $4.98 million to $4.96
billion. The decline in this category is largely attributable to scheduled tax
reductions. In total, collections for corporation and utility taxes and the
petroleum business tax are projected to fall by $107 million from 1997-98. The
decline in receipts in these categories is partially offset by growth in the
corporation franchise, insurance and bank taxes, which are projected to grow by
$88 million over the current fiscal year.
The Financial Plan is projected to show a GAAP-basis surplus of $131
million for 1997-98 and a GAAP-basis deficit of $1.3 billion for 1998-99 in the
General Fund, primarily as a result of the use of the 1997-98 cash surplus. In
1998-99, the General Fund GAAP Financial Plan shows total revenues of $34.68
billion, total expenditures of $35.94 billion, and net other financing sources
and uses of $42 million.
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Since the preparation of the 1998-2001 Financial Plan, the State has
adopted its budget for the 1997-1998 fiscal year. The State budget enacted a
smaller sales tax reduction than the tax reduction program assumed by the City
in the financial plan, which will increase projected City sales tax revenues;
provided for State aid to the City which was less than assumed in the financial
plan; and enacted a State funded tax relief program which begins a year later
than reflected in the financial plan. In addition, the net effect of tax law
changes made in the Federal Balanced Budget Act of 1997 are expected to increase
tax revenues in the 1998 fiscal year.
Although the City has maintained balanced budgets in each of its last
sixteen fiscal years and is projected to achieve balanced operating results for
the 1997 fiscal year, there can be no assurance that the gap-closing actions
proposed in the 1998-2001 Financial Plan can be successfully implemented or that
the City will maintain a balanced budget in future years without additional
State aid, revenue increases or expenditure reductions. Additional tax increases
and reductions in essential City services could adversely affect the City's
economic base.
The projections set forth in the 1998-2001 Financial Plan were based on
various assumptions and contingencies which are uncertain and which may not
materialize. Changes in major assumptions could significantly affect the City's
ability to balance its budget as required by State law and to meet its annual
cash flow and financing requirements. Such assumptions and contingencies include
the condition of the regional and local economies, the impact on real estate tax
revenues of the real estate market, wage increases for City employees consistent
with those assumed in the 1998-2001 Financial Plan, employment growth, the
ability to implement proposed reductions in City personnel and other cost
reduction initiatives, the ability of the Health and Hospitals Corporation and
the BOE to take actions to offset reduced revenues, the ability to complete
revenue generating transactions, provision of State and Federal aid and mandate
relief and the impact on City revenues and expenditures of Federal and State
welfare reform and any future legislation affecting Medicare or other
entitlements.
Implementation of the 1998-2001 Financial Plan is also dependent upon the
City's ability to market its securities successfully. The City's financing
program for fiscal years 1998 through 2001 contemplates the issuance of $5.7
billion of general obligation bonds and $5.7 billion of bonds to be issued by
the proposed New York City Transitional Finance Authority (the "Finance
Authority") to finance City capital projects. The Finance Authority, was created
as part of the City's effort to assist in keeping the City's indebtedness within
the forecast level of the constitutional restrictions on the amount of debt the
City is authorized to incur. Despite this additional financing mechanism, the
City currently projects that, if no further action is taken, it will reach its
debt limit in City fiscal year 1999-2000. Indebtedness subject to the
constitutional debt limit includes liability on capital contracts that are
expected to be funded with general obligation bonds, as well as general
obligation bonds. On June 2, 1997, an action was commenced seeking a declaratory
judgment declaring the legislation establishing the Transitional Finance
Authority to be unconstitutional. If such legislation were voided, projected
contracts for the City capital projects would exceed the City's debt limit
during fiscal year 1997-98. Future developments concerning the City or entities
issuing debt for the benefit of the City, and public discussion of such
developments, as well as prevailing market conditions and securities credit
ratings, may affect the ability or cost to sell securities issued by the City or
such entities and may also affect the market for their outstanding securities.
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The City Comptroller and other agencies and public officials have issued
reports and made public statements which, among other things, state that
projected revenues and expenditures may be different from those forecast in the
City's financial plans. It is reasonable to expect that such reports and
statements will continue to be issued and to engender public comment.
The City since 1981 has fully satisfied its seasonal financing needs in the
public credit markets, repaying all short-term obligations within their fiscal
year of issuance. Although the City's current financial plan projects $2.4
billion of seasonal financing for the 1998 fiscal year, the City expects to
undertake only approximately $1.4 billion of seasonal financing. The City issued
$2.4 billion of short-term obligations in fiscal year 1997. Seasonal financing
requirements for the 1996 fiscal year increased to $2.4 billion from $2.2
billion and $1.75 billion in the 1995 and 1994 fiscal years, respectively.
Seasonal financing requirements were $1.4 billion in the 1993 fiscal year. The
delay in the adoption of the State's budget in certain past fiscal years has
required the City to issue short-term notes in amounts exceeding those expected
early in such fiscal years.
Certain localities, in addition to the City, have experienced financial
problems and have requested and received additional New York State assistance
during the last several State fiscal years. The potential impact on the State of
any future requests by localities for additional assistance is not included in
the State's projections of its receipts and disbursements for the 1997-98 fiscal
year.
Fiscal difficulties experienced by the City of Yonkers ("Yonkers") resulted
in the re-establishment 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
State to assist Yonkers could result in increased State expenditures for
extraordinary local assistance.
Beginning in 1990, the City of Troy experienced a series of budgetary
deficits that resulted in the establishment of a Supervisory Board for the City
of Troy in 1994. The Supervisory Board's powers were increased in 1995, when
Troy MAC was created to help Troy avoid default on certain obligations. The
legislation creating Troy MAC prohibits the city of Troy from seeking federal
bankruptcy protection while Troy MAC bonds are outstanding. Troy MAC has issued
bonds to effect a restructuring of the City of Troy's obligations.
Eighteen municipalities received extraordinary assistance during the 1996
legislative session through $50 million in special appropriations targeted for
distressed cities, and that was largely continued in 1997. Twenty-eight
municipalities are scheduled to share in more than $32 million in targeted
unrestricted aid allocated in the 1997-98 budget. An additional $21 million will
be dispersed among all cities, towns and villages, a 3.97% increase in General
Purpose State Aid.
Municipalities and school districts have engaged in substantial short-term
and long-term borrowings. In 1995, the total indebtedness of all localities in
New York State other than New York City was approximately $19 billion. A small
portion (approximately $102.3 million) of that indebtedness represented
borrowing to finance budgetary deficits and was issued pursuant to
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enabling New York State legislation. State law requires the comptroller to
review and make recommendations concerning the budgets of those local government
units other than New York City authorized by State law to issue debt to finance
deficits during the period that such deficit financing is outstanding. Eighteen
localities had outstanding indebtedness for deficit financing at the close of
their fiscal year ending in 1995.
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
New York State, New York 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 New
York State could be adversely affected. Localities also face anticipated and
potential problems resulting from certain pending litigation, judicial decisions
and long-range economic trends. Long-range potential problems of declining urban
population, increasing expenditures and other economic trends could adversely
affect localities and require increasing New York State assistance in the
future.
Certain Limitations Relating to New York Municipal Obligations
The Fund reserves the right to invest more than 25% of its total assets in
tax-exempt industrial development revenue bonds. The Fund may invest up to 25%
of its total assets in securities issued in connection with the financing of
projects with similar characteristics, such as toll road revenue bonds, housing
revenue bonds or electric power project revenue bonds, or in industrial
development revenue bonds which are based, directly or indirectly, on the credit
of private entities in any one industry. This may make the Fund more susceptible
to economic, political or regulatory occurrences affecting a particular industry
or sector and increase the potential for fluctuation of net asset value.
Investments in industrial development revenue bonds which may result in federal
alternative minimum taxes will under present policy be limited to 20% of the
Fund's net assets.
ADDITIONAL INFORMATION CONCERNING
CERTAIN INVESTMENT TECHNIQUES
Derivatives
The Fund may buy and sell certain types of derivatives, such as options,
futures contracts, options on futures contracts, and swaps under circumstances
in which such instruments are expected by State Street Research & Management
Company (the "Investment Manager") to aid in achieving the Fund's investment
objective. The Fund 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 or a currency at a
future time) and which, therefore, possess the risks of both futures and
securities investments.
Derivatives, such as options, futures contracts, options on futures
contracts, and swaps enable the Fund to take both "short" positions (positions
which anticipate a decline in the market value of a particular asset or index)
and "long" positions (positions which anticipate an increase
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in the market value of a particular asset or index). The Fund may also use
strategies which involve simultaneous short and long positions in response to
specific market conditions, such as where the Investment Manager anticipates
unusually high or low market volatility.
The Investment Manager may enter into derivative positions for the Fund for
either hedging or non-hedging purposes. The term hedging is applied to defensive
strategies designed to protect the Fund from an expected decline in the market
value of an asset or group of assets that the Fund owns (in the case of a short
hedge) or to protect the Fund from an expected rise in the market value of an
asset or group of assets which it intends to acquire in the future (in the case
of a long or "anticipatory" hedge). Non-hedging strategies include strategies
designed to produce incremental income (such as the option writing strategy
described below) or "speculative" strategies which are undertaken to profit from
an expected decline in the market value of an asset or group of assets which the
Fund does not own or expected increases in the market value of an asset which it
does not plan to acquire. Information about specific types of instruments is
provided below.
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.
Futures Contracts. Futures contracts are publicly traded contracts to buy
or sell an underlying asset or group of assets, such as a currency, 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 an equity security or an index of
equity 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. The Fund will initially be required to deposit with the Trust's
custodian or the broker effecting the futures transaction an amount of "initial
margin" in cash or securities, as permitted under applicable regulatory
policies.
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
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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 instrument
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 the
Fund's 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.
In transactions establishing a long position in a futures contract, assets
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, assets 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 utilize such
assets and methods of cover as appropriate under applicable exchange and
regulatory policies.
Options. The Fund may use options to implement its investment strategy.
There are two basic types of options: "puts" and "calls." Each type of option
can establish either a long or a short position, depending upon whether the Fund
is the purchaser or the writer of the option. 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. 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, that is, 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. In general, a purchased put increases in value
as the value of the underlying security falls and a purchased call increases in
value as the value of the underlying security rises.
The principal reason to write options is to generate extra income (the
premium paid by the buyer). 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,
that is, 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, that is, 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.
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<PAGE>
The obligation of the writer of an option continues until the writer
effects a closing purchase transaction or until the option expires. To secure
its 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.
Among the options which the Fund may enter are options on securities
indices. In general, options on indices of securities are similar to options on
the securities themselves except that delivery requirements are different. For
example, a put option on an index of securities does not give the holder the
right to make actual delivery of a basket of securities but instead 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. As with options on equity securities, or futures contracts,
a 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.
A securities index assigns relative values to the securities included in
the index and the index options are based on a broad market index. In connection
with the use of such options, the Fund may cover its position by identifying
assets having a value equal to the aggregate face value of the option position
taken.
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.
Limitations and Risks of Options and Futures Activity. 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. The Fund applies a
similar policy to options that are not commodities.
As noted above, the Fund may engage in both hedging and nonhedging
strategies. Although effective hedging can generally capture the bulk of a
desired risk adjustment, no hedge is completely effective. The Fund's ability to
hedge effectively through transactions in futures and options depends on the
degree to which price movements in its holdings correlate with price movements
of the futures and options.
Nonhedging strategies typically involve special risks. The profitability of
the Fund's non-hedging strategies will depend on the ability of the Investment
Manager to analyze both the applicable derivatives market and the market for the
underlying asset or group of assets. Derivatives markets are often more volatile
than corresponding securities markets and a relatively small change in the price
of the underlying asset or group of assets can have a magnified effect upon the
price of a related derivative instrument.
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<PAGE>
Derivatives markets also are often less liquid than the market for the
underlying asset or group of assets. 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 to effectively carry out their derivative
strategies and might, in some cases, require the Fund to deposit cash to meet
applicable margin requirements. The Fund will enter into an option or futures
position only if it appears to be a liquid investment.
Swaps. The Fund may enter into various forms of swap arrangements with
counterparties with respect to interest rates, currency 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 a currency
swap the Fund would agree with the other party to exchange cash flows based on
the relative differences in values of a notional amount of two (or more)
currencies; 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.
The Fund may enter credit protection swap arrangements involving the sale
by the Fund of a put option on a debt security which is exercisable by the buyer
upon certain events, such as a default by the referenced creditor on the
underlying debt or a bankruptcy event of the creditor.
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.
These arrangements will be made primarily for hedging purposes, to preserve
the return on an investment or on a portion of the Fund's portfolio. However,
the Fund may, as noted above, enter into such arrangements for income purposes
to the extent permitted by the Commodities 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
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<PAGE>
become illiquid to the extent that nonstandard 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 forecasts 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 forecasts, there is a risk that the swap position may correlate
imperfectly with the price of the asset or liability being hedged.
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 net assets, except that
repurchase agreements extending for more than seven days when combined with any
other illiquid securities held by the Fund will be limited to 15% of the Fund's
net assets.
Reverse Repurchase Agreements
The Fund may enter into reverse repurchase agreements. However, the Fund
has no present intention of engaging in reverse repurchase agreements in excess
of 5% of the Fund's total assets. 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 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.
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
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<PAGE>
few days to months, or over a year 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. Securities transactions involving
delayed deliveries or forward commitments are frequently characterized as when-
issued transactions and are similarly treated by the Fund.
Restricted Securities
It is the Fund's policy not to make an investment in restricted securities,
including restricted securities sold in accordance with Rule 144A under the
Securities Act of 1933 ("Rule 144A Securities") if, as a result, more than 35%
of the Fund's total assets are invested in restricted securities, provided not
more than 10% of the Fund's total assets are invested in restricted securities
other than 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, 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, market making
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 a market for them. Restricted securities that are not resalable under Rule
144A may be subject to risks of illiquidity and subjective valuations to a
greater degree than Rule 144A Securities.
Lower Quality Debt Securities ("Junk Bonds")
Lower quality convertible or nonconvertible debt securities generally
involve more credit risk than higher rated securities and are considered by S&P
and Moody's to be speculative with respect to capacity to pay interest and repay
principal in accordance with the terms of the obligation. Further, such
securities may be subject to greater market fluctuations and risk of loss of
income and principal than lower yielding, higher rated debt securities. Risk of
lower quality debt securities, commonly known as "junk bonds," include (i)
limited liquidity and secondary market support; (ii) substantial market price
volatility resulting from changes in prevailing interest rates and/or investor
perceptions; (iii) subordination to the prior claims of banks and other senior
lenders; (iv) the operation of mandatory sinking fund or call/redemption
provisions during periods of declining interest rates when the Fund may be
required to reinvest premature redemption proceeds in lower yielding portfolio
securities; (v) the possibility that earnings of the
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<PAGE>
issuer may be insufficient to meet its debt service; and (vi) the issuer's low
creditworthiness and potential for insolvency during period of rising interest
rates and economic downturn. For further information concerning the rating
categories of debt securities, see the Appendix to this Statement of Additional
Information.
For the fiscal year ended December 31, 1997, the percentage of the Fund's
total investments on an average annual basis invested in debt securities of any
particular rating category or its equivalent as determined by the Investment
Manager, was as follows:
27% AAA
17% AA
11% A
34% BBB
11% BB,
on a dollar weighted basis, comprising 100% of total investments. Of these
bonds, 82% were rated by a nationally recognized statistical rating organization
and 18% were unrated but considered to be equivalent as determined by the
Investment Manager.
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.
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 any loaned securities plus accrued interest. Collateral
received by the Fund will generally be held in the form tendered, although cash
may be invested in unaffiliated mutual funds with quality short-term portfolios,
securities issued or guaranteed by the U.S. Government or its agencies or
instrumentalities or certain unaffiliated mutual funds, irrevocable stand-by
letters of credit issued by a bank, or repurchase agreements, or other similar
investments. 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 rights to dividends, interest or other distributions,
on the loaned securities. Voting rights pass with the lending, 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 or its agents to be of good financial standing.
Short-Term Trading
The Fund may engage in short-term trading of securities and reserves full
freedom with respect to portfolio turnover. In periods where there are rapid
changes in economic conditions and security price levels or when reinvestment
strategy changes significantly, portfolio turnover may be higher than during
times of economic and market price stability or when investment strategy remains
relatively constant. The Fund's portfolio turnover rate may involve greater
transaction costs relative to other funds in general, and may have tax and other
consequences.
Temporary and Defensive Investments
The Fund may hold up to 100% of its assets in cash or short-term debt
securities for temporary defensive purposes. The Fund will adopt a temporary
defensive position when, in the opinion of the Investment Manager, such a
position is more likely to provide protection against adverse market conditions
than adherence to the Fund's other investment policies. The types of
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<PAGE>
short-term instruments in which the Fund may invest for such purposes include
short-term New York Municipal Obligations, short-term money market securities,
such as repurchase agreements, and securities issued or guaranteed by the U.S.
Government or its agencies or instrumentalities, certificates of deposit, time
deposits and bankers' acceptances of certain qualified financial institutions
and corporate commercial paper, which at the time of purchase are rated at least
within the "A" major rating category by S&P or the "Prime" major rating category
by Moody's, or, if not rated, issued by companies having an outstanding
long-term unsecured debt issued rated at least within the "A" category by S&P or
Moody's.
The Fund intends that short-term securities acquired for temporary purposes
will be exempt from federal income taxes and New York State and New York City
personal income taxes. However, if suitable short-term securities are not
available or if securities are available only on a when-issued basis or in the
event of an emergency, the Fund may invest up to 100% of its total assets in
short-term securities which may not be exempt from taxes.
Industry Classifications
In determining how much of the Fund's portfolio is invested in a given
industry, the following industry classifications are currently used. Securities
issued or guaranteed as to principal or interest by the U.S. Government or its
agencies or instrumentalities or mixed-ownership Government corporations or
sponsored enterprises (including repurchase agreements involving U.S. Government
securities to the extent excludable under relevant regulatory interpretations)
are excluded. Securities issued by foreign governments are also excluded.
Companies engaged in the business of financing may be classified according to
the industries of their parent or sponsor companies or industries that otherwise
most affect such financing companies. Issuers of asset-backed pools will be
classified as separate industries based on the nature of the underlying assets,
such as mortgages and credit card receivables. "Asset-backed-Mortgages"
includes private pools of nongovernment backed mortgages.
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<PAGE>
<TABLE>
<S> <C> <C>
Aerospace Electric Equipment Oil Refining & Marketing
Airline Electronic Components Oil Service
Asset-backed--Mortgages Electronic Equipment Paper Products
Asset-backed--Credit Card Entertainment Personal Care
Receivables Financial Service Photography
Automotive Food & Beverage Plastics
Automotive Parts Forest Products Printing & Publishing
Bank Gaming & Lodging Railroad
Building Gas Real Estate & Building
Business Service Gas Transmission Recreation
Cable Grocery Retail Trade
Capital Goods & Equipment Healthcare & Hospital Savings & Loan
Chemical Management Shipping & Transportation
Computer Software & Service Hospital Supply Technology & Communications
Conglomerate Hotel & Restaurant Telephone
Consumer Goods & Services Insurance Textile & Apparel
Container Machinery Tobacco
Cosmetics Media Truckers
Diversified Metal & Mining Trust Certificates -
Drug Office Equipment Government Related Lending
Electric Oil Production
</TABLE>
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.
DEBT INSTRUMENTS AND PERMITTED CASH INVESTMENTS
The Fund may invest in long-term and short-term debt securities. Certain
debt securities and money market instruments in which the Fund may invest are
described below.
Managing Volatility. In administering the Fund's portfolio, the Investment
Manager attempts to manage volatility in part by managing the duration and
weighted average maturity of the Fund's bond position.
Duration is an indicator of the expected volatility of a bond position in
response to changes in interest rates. In calculating duration, the Fund
measures the average time required to receive all cash flows associated with
those debt securities held in the Fund's portfolio -- representing payments of
principal and interest -- by considering the timing, frequency and amount of
payment expected from each portfolio security. The higher the
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<PAGE>
duration, the greater the gains and losses when interest rates change. Duration
generally is a more accurate measure of potential volatility with a portfolio
composed of high-quality debt securities, such as U.S. government securities,
municipal securities and high-grade U.S. corporate bonds, than with lower-grade
securities.
The Investment Manager may use several methods to manage the duration of
the Fund's bond position in order to increase or decrease its exposure to
changes in interest rates. First, the Investment Manager may adjust portfolio
duration by adjusting the mix of debt securities held by the Fund. For example,
if the Investment Manager intends to shorten the duration, it may sell debt
instruments that individually have a long duration and purchase other debt
instruments that individually have a shorter duration. Among the factors that
will affect a debt security's duration are the length of time to maturity, the
timing of interest and principal payments, and whether the terms of the security
give the issuer of the security the right to call the security prior to
maturity. Second, the Investment Manager may adjust bond portfolio duration
using derivative transactions, especially with interest rate futures and options
contracts. For example, if the Investment Manager wants to lengthen the duration
of the Fund's bond position, it could purchase interest rate futures contracts
instead of buying longer-term bonds or selling shorter-term bonds. Similarly,
during periods of lower interest rate volatility, the Investment Manager may use
a technique to extend duration in the event rates rise by writing an out-of-the-
money put option and receiving premium income with the expectation that the
option could be exercised. In managing duration, the use of such derivatives may
be faster and more efficient than trading specific portfolio securities.
Weighted average maturity is another indicator of potential volatility used
by the Investment Manager with respect to the Fund's bond portfolio, although
for certain types of debt securities, such as high quality debt securities, it
is not as accurate as duration in quantifying potential volatility. Weighted
average maturity is the average of all maturities of the individual debt
securities held by the Fund, weighted by the market value of each security.
Generally, the longer the weighted average maturity, the more bond prices will
vary in response to changes in interest rates.
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:
[bullet] direct obligations of the U.S. Treasury, i.e., U.S. Treasury bills,
notes, certificates and bonds;
[bullet] obligations of U.S. Government agencies or instrumentalities, such as
the Federal Home Loan Banks, the Federal Farm Credit Banks, the Federal
National Mortgage Association, the Government National Mortgage
Association and the Federal Home Loan Mortgage Corporation; and
[bullet] obligations of mixed-ownership Government corporations such as
Resolution Funding Corporation.
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<PAGE>
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, 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 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-related 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.
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
30
<PAGE>
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 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 within the "A" major rating category by S&P or within the
"Prime" major rating category by Moody's, or, if not rated, issued by companies
having an outstanding long-term unsecured debt issue rated at least within the
"A" category 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 within the "A"
category by S&P or within the "Prime" category by Moody's.
Commercial paper rated within the "A" category (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 within the "A" category or better,
although in some cases credits within the "BBB" category 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
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<PAGE>
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 category 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.
In the event the lowering of ratings of debt instruments held by the Fund
by applicable rating agencies results in a material decline in the overall
quality of the Fund's portfolio, the Trustees of the Trust will review the
situation and take such action as they deem in the best interests of the Fund's
shareholders, including, if necessary, changing the composition of the
portfolio.
Unrated and Split-Rated Securities. The Fund may invest up to 25% of its
total assets in unrated securities considered by the Investment Manager to be of
equivalent investment quality to comparable rated securities in which the Fund
may invest. Many issuers of tax-exempt securities choose not to have their
obligations rated. Although unrated securities usually provide a higher yield
than rated securities, they may also involve a greater degree of risk. Medium
and lower rated or unrated tax-exempt bonds are frequently traded in markets in
which liquidity may be limited. This factor might limit the ability to sell such
securities at the fair value either to meet redemption requests or to respond to
changes in the economy or the financial markets. The Fund will purchase unrated
securities only when the Investment Manager believes that the issuers of such
securities are in financial circumstances similar to the financial circumstances
of issuers of securities rated within the BB or Ba categories or above and the
securities themselves are otherwise similar in quality to those rated within the
BB or Ba categories or above.
The Fund may invest in debt instruments which are split rated; for example,
rated investment grade by one rating agency, but lower than investment grade by
the other. Where an investment is split rated, the Fund may invest on the basis
of the higher rating. Where an investment is rated by only one rating agency,
the Fund may invest on the basis of the one rating or on the basis of a higher
rating derived from its own analysis.
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.
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<PAGE>
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
outweighted by large uncertainties or major risk exposures to adverse
conditions.
BB: Debt rated BB has less near-term vulnerability to default than other
speculative issues. However, it faces major ongoing uncertainties or exposure to
adverse business, financial or economic conditions which could lead to
inadequate capacity to meet timely interest and principal payments. The BB
rating category is also used for debt subordinated to senior debt that is
assigned an actual or implied BBB- rating.
B: Debt rated B has a greater vulnerability to default but currently has
the capacity to meet interest payments and principal repayments. Adverse
business, financial or economic conditions will likely impair capacity or
willingness to pay interest and repay principal. The B rating category is also
used for debt subordinated to senior debt that is assigned an actual or implied
BB or BB- rating.
CCC: Debt rated CCC has a currently identifiable vulnerability to default,
and is dependent upon favorable business, financial and economic conditions to
meet timely payment of interest and repayment of principal. In the event of
adverse business, financial or economic conditions, it is not likely to have the
capacity to pay interest and repay principal. The CCC rating category is also
used for debt subordinated to senior debt that is assigned an actual or implied
B or B- rating.
CC: 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 CC 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.
CI: The rating CI is reserved for income bonds on which no interest is
being paid.
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<PAGE>
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 rating 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.
SP-3: Notes rated SP-3 have a speculative 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 protected nor poorly secured. Interest payments and
principal security appear adequate for the present, but certain protective
elements may be lacking or may be
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<PAGE>
characteristically unreliable over any great length of time. Such bonds lack
outstanding investment characteristics and in fact have speculative
characteristics as well.
Ba: Bonds which are rated Ba are judged to have speculative elements; their
future cannot be considered as well assured. Often the protection of interest
and principal payments may be very moderate, and thereby not well safeguarded
during 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.
1, 2 or 3: The ratings from Aa through B may be modified by the addition of
a numeral indicating a bond's rank within its rating category.
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 of
protection ample although not so large as in the preceding group.
THE TRUST, THE FUND AND ITS SHARES
State Street Research Tax-Exempt Trust is currently comprised of the
following series: State Street Research Tax-Exempt Fund and State Street
Research New York Tax-Free Fund. 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. The Trustees also 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. 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 authorized shares of the Fund to be issued in four
classes: Class A, Class B, Class C and Class S shares. Prior to November 1,
1997, the Fund's current Class C shares were designated as Class D shares and
the Fund's current Class S shares were designated as Class C shares.
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<PAGE>
Each share of each class of shares represents an identical legal interest
in the same portfolio of investments of the Fund, has the same rights and is
identical in all respects, except that Class A, Class B and Class C shares bear
the expenses of the deferred sales arrangement and any expenses (including the
higher service and distribution fees) resulting from such sales arrangement, and
certain other incremental expenses related to a class. Each class will have
exclusive voting rights with respect to provisions of the Rule 12b-1
distribution plan pursuant to which the service and distribution fees, if any,
are paid. Although the legal rights of holders of each class of shares are
identical, it is likely that the different expenses borne by each class will
result in different net asset values and dividends. The different classes of
shares of the Fund also have different exchange privileges. Except for those
differences between classes of shares described above, in the Fund's Prospectus
and otherwise this Statement of Additional Information, each share of the Fund
has equal dividend, redemption and liquidation rights with other shares of the
Fund, and when issued, is fully paid and nonassessable by the Fund.
The rights of holders of shares may be modified by the Trustees at any
time, so long as such modifications do not have a material, adverse effect on
the rights of any shareholder. On any matter submitted to the shareholders, the
holder of a Fund share is entitled to one vote per share (with proportionate
voting for fractional shares) regardless of the relative net asset value
thereof.
Under the Master Trust Agreement, no annual or regular meeting of
shareholders is required. Thus, there ordinarily will be no shareholder meetings
unless required by the 1940 Act. Except as otherwise provided under the 1940
Act, the Board of Trustees will be a self-perpetuating body until fewer than
two-thirds of the Trustees serving as such are Trustees who were elected by
shareholders of the Trust. In the event less than a majority of the Trustees
serving as such were elected by shareholders of the Trust, a meeting of
shareholders will be called to elect Trustees. Under the Master Trust Agreement,
any Trustee may be removed by vote of two-thirds of the outstanding Trust
shares; holders of 10% or more of the outstanding shares of the Trust can
require that the Trustees call a meeting of shareholders for purposes of voting
on the removal of one or more Trustees. In connection with such meetings called
by shareholders, shareholders will be assisted in shareholder communications to
the extent required by applicable law.
Under Massachusetts law, the shareholders of the Trust could, under certain
circumstances, be held personally liable for the obligations for the Trust.
However, the Master Trust Agreement of the Trust disclaims shareholder liability
for acts or obligations of the Trust and provides for indemnification for all
losses and expenses of any shareholder of the Fund held personally liable for
the obligations of the Trust. Thus, the risk of a shareholder incurring
financial loss on account of shareholder liability is limited to circumstances
in which the Fund would be unable to meet its obligations. The Investment
Manager believes that, in view of the above, the risk of personal liability to
shareholders is remote.
TRUSTEES AND OFFICERS
The Trustees and principal officers of the Trust, their addresses, and
their principal occupations and positions with certain affiliates of the
Investment Manager are set forth below.
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<PAGE>
*Paul J. Clifford, Jr., One Financial Center, Boston, MA 02111, serves as
Vice President of the Trust. He is 35. 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.
+Steve A. Garban, The Pennsylvania State University, 210 Old Main,
University Park, PA 16802, serves as Trustee of the Trust. He is 60. He is
retired and was formerly Senior Vice President for Finance and Operations and
Treasurer of The Pennsylvania State University.
+Malcolm T. Hopkins, 14 Brookside Road, Biltmore Forest, Asheville, NC
28803, serves as Trustee of the Trust. He is 70. He is engaged principally in
private investments. Previously, he was Vice Chairman of the Board and Chief
Financial Officer of St. Regis Corp.
*+John H. Kallis, One Financial Center, Boston, MA 02111 serves as Vice
President of the Trust. He is 57. 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 71. He is engaged principally in private investments
and civic affairs, and is an author of business history. Previously, he was with
an affiliate of J.P. Morgan & Co. in New York.
+Robert A. Lawrence, Saltonstall & Co., 175 Federal Street, Boston, MA
02110, serves as Trustee of the Trust. He is 71. He is retired and was formerly
a Partner in Saltonstall & Co., a private investment firm.
*+Gerard P. Maus, One Financial Center, Boston, MA 02111, serves as
Treasurer of the Trust. He is 47. His principal occupation is currently, and
during the past five years has been, Executive Vice President, Treasurer, Chief
Financial Officer and Director of State Street Research & Management Company.
Mr. Maus's other principal business affiliations include Executive Vice
President, Treasurer, Chief Financial Officer and Director of State Street
Research Investment Services, Inc. and Executive Vice President, Chief Financial
Officer, Administrative Officer and Director, GFM International, Inc.
*+Francis J. McNamara, III, One Financial Center, Boston, MA 02111, serves
as Secretary and General Counsel of the Trust. He is 42. His principal
occupation is Executive Vice President, General Counsel and Secretary of State
Street Research & Management Company. During the past five years he has also
served as Senior Vice President of State Street Research & Management Company
and as Senior Vice President, General Counsel and Assistant Secretary of The
Boston Company, Inc., Boston Safe Deposit and Trust Company and The Boston
Company Advisors, Inc. Mr. McNamara's other principal business affiliations
include Senior Vice President, Clerk and General Counsel of State Street
Research Investment Services, Inc. and Executive Vice President and General
Counsel, GFM International Investors, Inc.
- ------------------
* or +, see footnotes on page 38.
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<PAGE>
+Dean O. Morton, 3200 Hillview Avenue, Palo Alto, CA 94304, serves as
Trustee of the Trust. He is 66. He is retired, and was formerly Executive Vice
President, Chief Operating Officer and Director of Hewlett-Packard Company.
+Toby Rosenblatt, 3409 Pacific Avenue, San Francisco, CA 94118, serves as
Trustee of the Trust. He is 59. 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 Investments Ltd.
+Michael S. Scott Morton, Massachusetts Institute of Technology, 77
Massachusetts Avenue, Cambridge, MA 02139, serves as Trustee of the Trust. He is
60. 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 43. His principal occupation is Executive Vice
President and Director of State Street Research & Management Company. During the
past five years he has also served as Senior Vice President of State Street
Research & Management Company. Mr. Shively's other principal business
affiliation is 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 55. His principal occupation is currently, and during the past five
years has been, Chairman of the Board, President, Chief Executive Officer and
Director of State Street Research & Management Company. Mr. Verni's other
principal business affiliations include Chairman of the Board and Director of
State Street Research Investment Services, Inc. and (until February, 1996, prior
positions as President and Chief Executive Officer of that company) and Chairman
of the Board, President, Chief Executive Officer and Director of GFM
International Investors, Inc.
- -----------------
* 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/Director and/or officer of one or more of the following
investment companies, each of which has an advisory relationship with the
Investment Manager or its parent, Metropolitan Life Insurance Company
("Metropolitan"): State Street Research Equity Trust, State Street Research
Financial Trust, State Street Research Income Trust, State Street Research
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.
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<PAGE>
As of January 31, 1998, the Trustees and principal officers of the Trust as
a group owned none of the Fund's outstanding shares.
Record ownership of shares of the Fund as of January 31, 1998 was as
follows:
% of
Class Holder Class
- ----- ------ -----
B Merrill Lynch 6.8
C (1) Metropolitan Life 60.3
Merrill Lynch 18.8
M.M. Rousseau 9.2
S.T. & R. Iovino 6.1
The full name and address of the above institutions are:
Merrill Lynch, Pierce, Fenner & Smith, Inc.(2)
4800 Deerlake Drive E.
Jacksonville, FL 32246
Metropolitan Life Insurance Company(3)
One Madison Avenue
New York, NY 10010
M.M. Rouseau
c/o State Street Research Service Center
One Financial Center
Boston, MA 02111
S.T. & R. Iovino
c/o State Street Research Service Center
One Financial Center
Boston, MA 02111
- -------------------
(1) Prior to November 1, 1997, the Fund's current Class C shares were
designated as Class D shares and the Fund's current Class S shares were
designated as Class C shares.
(2) The Fund believes that Merrill Lynch does not have beneficial ownership of
such shares.
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<PAGE>
(3) Metropolitan was the record and/or beneficial owner, directly or
indirectly through its subsidiaries or affiliates, of such shares.
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.
The Trustees were compensated as follows:
Total
Compensation
Aggregate From Trust and
Name of Compensation Complex Paid
Trustee From Trust(a) to Trustees(b)
------- ------------- --------------
Steve A. Garban $ 4,738 $ 75,899
Malcolm T. Hopkins $ 5,183 $ 78,499
Edward M. Lamont $ 5,900 $ 68,741
Robert A. Lawrence $ 6,100 $ 93,125
Dean O. Morton $ 6,500 $ 97,125
Toby Rosenblatt $ 5,900 $ 68,741
Michael S. Scott Morton $ 7,100 $103,625
Ralph F. Verni $ 0 $ 0
(a) For the Fund's fiscal year ended December 31, 1997. Includes compensation
received from multiple series of the Trust. See "The Trust, the Fund and
its Shares" in this Statement of Additional Information for a listing of
series.
(b) Includes compensation on behalf of all series of 12 investment companies
for which the Investment Manager or its parent, Metropolitan, served as
investment adviser. "Total Compensation from Trust and Complex Paid to
Trustees" for the 12 months ended December 31, 1997. The Trust does not
provide any pension or retirement benefits for the Trustees.
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<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 Investment
Manager was founded by Paul Cabot, Richard Saltonstall and Richard Paine to
serve as investment adviser to one of the nation's first mutual funds, presently
known as State Street Research Investment Trust, which they had formed in 1924.
Their investment management philosophy emphasized comprehensive fundamental
research and analysis, including meetings with the management of companies under
consideration for investment. The Investment Manager's portfolio management
group has extensive investment industry experience managing equity and debt
securities. In managing debt securities, if any, for a portfolio, the Investment
Manager may consider yield curve positioning, sector rotation and duration,
among other factors.
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.
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 regular trading on 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 advisory fees paid by the Fund to the Investment Manager for the last
three fiscal years, prior to the assumption of fees or expenses, were as
follows: 1997, $382,777; 1996, $391,693; and 1995, $404,069.
The Distributor and its affiliates have from time to time and in varying
amounts voluntarily assumed some portion of fees or expenses relating to the
Fund. The voluntary reduction of fees or assumption of expenses for the same
periods were as follows: 1997, $113,047; 1996, $120,150; and 1995, $156,963.
The Advisory Agreement provides that it shall continue in effect from year
to year with respect to the Fund 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 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.
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<PAGE>
Under the Fund's Administration Agreement between the Investment Manager
and the Distributor, the Distributor provides assistance to the Investment
Manager in performing certain fund administration services for the Trust, such
as assistance in determining the daily net asset value of shares of each 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, such as employee benefit
plans, through or under which the Fund's shares may be purchased.
Under the Code of Ethics of the Investment Manager, investment management
personnel are only permitted to engage in personal securities transactions in
accordance with certain conditions relating to such person's position, the
identity of the security, the timing of the transaction, and similar factors.
Such personnel 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 State Street Research Investment
Services, Inc., 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 S 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 C shares). General
information on how to buy shares of the Fund, as well as sales charges involved,
are set forth under "Your Account" in the Prospectus. The following supplements
that information.
Public Offering Price. The public offering price for each class of shares
is based on their net asset value determined as of the close of regular trading
on the NYSE on the day the purchase order is received by State Street Research
Service Center (the "Service Center"), provided that the order is received prior
to the close of regular trading on 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 the Service
Center in order to permit the 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.
Class A Shares--Reduced Sales Charges. The reduced sales charges set forth
under "Your Account--Class A Sales Charge Reductions and Waivers" in the Fund's
Prospectus apply to purchases made at any one time by any "person," which
includes: (i) an individual, or an
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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"
(which include the Fund and other funds as designated by the Distributor from
time to time) 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 S 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 the right is determined on the amount arrived at
by combining the dollar amount of the 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 S 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.
Other Programs Related to Class A Shares. Class A shares of the Fund may be
sold or issued in an exchange at a reduced sales charge or without sales charge
pursuant to certain sponsored arrangements, which include programs under which a
company, employee benefit
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plan or other organization makes recommendations to, or permits group
solicitation of, its employees, members or participants, except any organization
created primarily for the purpose of obtaining shares of the Fund at a reduced
sales charge or without a sales charge. Sales without a sales charge, or with a
reduced sales charge, may also be made through brokers, registered investment
advisers, financial planners, institutions, and others, under managed fee-based
programs (e.g., "wrap fee" or similar programs) which meet certain requirements
established from time to time by the Distributor. Information on such
arrangements and further conditions and limitations is available from the
Distributor.
In addition, no sales charge is imposed in connection with the sale of
Class A shares of the Fund to the following entities and person: (A) the
Investment Manager, Distributor or any affiliated entities, including any direct
or indirect parent companies and other subsidiaries of such parents
(collectively "Affiliated Companies"); (B) employees, officers, sales
representatives or current or retired directors or trustees of the Affiliated
Companies or any investment company managed by any of the Affiliated Companies,
any relatives of any such individuals whose relationship is directly verified by
such individuals to the Distributor, or any beneficial account for such
relatives or individuals; and (C) employees, officers, sales representatives or
directors of dealers and other entities with a selling agreement with the
Distributor to sell shares of any aforementioned investment company, any spouse
or child of such person, or any beneficial account for any of them. The purchase
must be made for investment and the shares purchased may not be resold except
through redemption. This purchase program is subject to such administrative
policies, regarding the qualification of purchasers and any other matters, as
may be adopted by the Distributor from time to time.
Conversion of Class B Shares to Class A Shares. A shareholder's Class B
shares of the Fund, including all shares received as dividends or distributions
with respect to such shares, will automatically convert to Class A shares of the
Fund at the end of eight years following the issuance of such Class B shares;
consequently, they will no longer be subject to the higher expenses borne by
Class B shares. The conversion rate will be determined on the basis of the
relative per share net asset values of the two classes and may result in a
shareholder receiving either a greater or fewer number of Class A shares than
the Class B shares so converted. As noted above, holding periods for Class B
shares received in exchange for Class B shares of other Eligible Funds will be
counted toward the eight-year period.
Contingent Deferred Sales Charges. The amount of any contingent deferred
sales charge paid on Class A shares (on sales of $1 million or more and which do
not involve an initial sales charge) or on Class B or Class C shares of the Fund
will be paid to the Distributor. The Distributor will pay dealers at the time of
sale a 4% commission for selling Class B shares and a 1% commission for selling
Class C shares. In certain cases, a dealer may elect to waive the 4% commission
on Class B shares and receive in lieu thereof a 1% annual fee with respect to
such outstanding shares until the shares convert to Class A shares. The proceeds
of the contingent deferred sales charges and the distribution fees are used to
offset distribution expenses and thereby permit the sale of Class B and Class C
shares without an initial sales charge.
In determining the applicability and rate of any contingent deferred sales
charge of Class B or Class C shares, it will be assumed that a redemption of the
shares is made first of those shares having the greatest capital appreciation,
next of shares representing reinvestment of
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dividends and capital gains distributions and finally of remaining shares held
by shareholder for the longest period of time. Class B shares that are redeemed
within a five-year period after their purchase, and Class C shares that are
redeemed within a one-year period after their purchase, will not be subject to a
contingent deferred sales charge to the extent that the value of such shares
represents (1) capital appreciation of Fund assets or (2) reinvestment of
dividends or capital gains distributions. The holding period for purposes of
applying a contingent deferred sales charge for a particular class of shares of
the Fund acquired through an exchange from another Eligible Fund will be
measured from the date that such shares were initially acquired in the other
Eligible Fund, and shares of the same class being redeemed will be considered to
represent, as applicable, capital appreciation or dividend and capital gains
distribution reinvestments in such other Eligible Fund. These determinations
will result in any contingent deferred sales charge being imposed at the lowest
possible rate. For federal income tax purposes, the amount of the contingent
deferred sales charge will reduce the gain or increase the loss, as the case may
be, on the amount realized on redemption.
Contingent Deferred Sales Charge Waivers. With respect to Class A shares
(on sales of $1 million or more and which do not involve an initial sales
charge), and Class B and Class C shares of the Fund, the contingent deferred
sales charge does not apply to exchanges or to redemptions under a systematic
withdrawal plan which meets certain conditions. In addition, the contingent
deferred sales charge will be waived for: (i) redemptions made within one year
of the death or total disability, as defined by the Social Security
Administration, of all shareholders of an account; (ii) redemptions made after
attainment of a specific age in an amount which represents the minimum
distribution required at such age under Section 401(a)(9) of the Internal
Revenue Code of 1986, as amended, for retirement accounts or plans (e.g., age 70
1/2 for Individual Retirement Accounts and Section 403(b) plans), calculated
solely on the basis of assets invested in the Fund or other Eligible Funds; and
(iii) a redemption resulting from a tax-free return of an excess contribution to
an Individual Retirement Account. (The foregoing waivers do not apply to a
tax-free rollover or transfer of assets out of the Fund). The Fund may modify or
terminate the waivers at any time; for example, the Fund may limit the
application of multiple waivers and establish other conditions for employee
benefit plans.
Class S Shares. Class S shares are currently available to certain employee
benefit plans such as qualified retirement plans which meet criteria relating to
number of participants, service arrangements, or similar factors; insurance
companies; investment companies; advisory accounts of the Investment Manager;
endowment funds of nonprofit organizations with substantial minimum assets
(currently a minimum of $10 million); and other similar institutional investors.
Class S shares may be acquired through programs or products sponsored by
Metropolitan, its affiliates, or both for which Class S shares have been
designated. In addition, Class S shares are available through programs under
which, for example, investors pay an asset-based fee and/or a transaction fee to
intermediaries. Class S share availability is determined by the Distributor and
intermediaries based on the overall direct and indirect costs of a particular
program, expected assets, account sizes and similar considerations.
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, the Fund may issue its shares at net asset value (or
more) to such entities or to their security holders.
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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.
Systematic Withdrawal Plan. A shareholder who owns noncertificated Class A
or Class S shares with a value of $5,000 or more, or Class B or Class C shares
with a value of $10,000 or more, may elect, by participating in the Fund's
Systematic Withdrawal Plan, to have periodic checks issued for specified
amounts. These amounts may not be less than certain minimums, depending on the
class of shares held. The Plan provides that all income dividends and capital
gains distributions of the Fund shall be credited to participating shareholders
in additional shares of the Fund. Thus, the withdrawal amounts paid can only be
realized by redeeming shares of the Fund under the Plan. To the extent such
amounts paid exceed dividends and distributions from the Fund, a shareholder's
investment will decrease and may eventually be exhausted.
In the case of shares otherwise subject to contingent deferred sales
charges, no such charges will be imposed on withdrawals of up to 8% annually of
either (a) the value, at the time the Systematic Withdrawal Plan is initiated,
of the shares then in the account or (b) the value, at the time of a withdrawal,
of the same number of shares as in the account when the Systematic Withdrawal
Plan was initiated, whichever is higher.
Expenses of the Systematic Withdrawal Plan are borne by the Fund. A
participating shareholder may withdraw from the Systematic Withdrawal Plan, and
the Fund may terminate the Systematic Withdrawal Plan at any time on written
notice. Purchase of additional shares while a shareholder is receiving payments
under a Systematic Withdrawal Plan is ordinarily disadvantageous because of
duplicative sales charges. For this reason, a shareholder may not participate in
the Investamatic Program (see "Your Account--Investor Services--Investamatic
Program" in the Fund's Prospectus) and the Systematic Withdrawal Plan at the
same time.
Request to Dealer to Repurchase. For the convenience of shareholders, the
Fund has authorized the Distributor as its agent to accept orders from dealers
by wire or telephone for the repurchase of shares by the Distributor from the
dealer. The Fund may revoke or suspend this authorization at any time. The
repurchase price is the net asset value for the applicable shares next
determined following the time at which the shares are offered for repurchase by
the dealer to the Distributor. The dealer is responsible for promptly
transmitting a shareholder's order to the Distributor.
Signature Guarantees. Signature guarantees are required for, among other
things: (1) written requests for redemptions for more than $100,000; (2) written
requests for redemptions for any amount if the proceeds are transmitted to other
than the current address of record (unchanged in the past 30 days); (3) written
requests for redemptions for any amount submitted by corporations and certain
fiduciaries and other intermediaries; and (4) requests to transfer the
registration of shares to another owner. Signatures must be guaranteed by a
bank, a member
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firm of a national stock exchange, or other eligible guarantor institution. The
Transfer Agent will not accept guarantees (or notarizations) from notaries
public. The above requirements may be waived in certain instances.
Dishonored Checks. If a purchaser's check is not honored for its full
amount, the purchaser could be subject to additional charges to cover collection
costs and any investment loss, and the purchase may be canceled.
Processing Charges. Purchases and redemptions processed through securities
dealers may be subject to processing charges imposed by the securities dealer in
addition to sales charges that may be imposed by the Fund or the Distributor.
SHAREHOLDER ACCOUNTS
General information on shareholder accounts is included in the Fund's
Prospectus under "Your Account." The following supplements that information.
Maintenance Fees and Involuntary Redemption. Because of the relatively high
cost of maintaining small shareholder accounts, the Fund reserves the right to
redeem at its option any shareholder account which remains below $1,500 for a
period of 60 days after notice is mailed to the applicable shareholder, or to
impose a maintenance fee on such account after 60 days' notice. Such
involuntarily redemptions will be subject to applicable sales charges, if any.
The Fund may increase such minimum account value above such amount in the future
after notice to affected shareholders. Involuntarily redeemed shares will be
priced at the net asset value on the date fixed for redemption by the Fund, and
the proceeds of the redemption will be mailed to the affected shareholder at the
address of record. Currently, the maintenance fee is $18 annually, which is paid
to the Transfer Agent. The fee does not apply to certain retirement accounts or
if the shareholder has more than an aggregate $50,000 invested in the Fund and
other Eligible Funds combined. Imposition of a maintenance fee on a small
account could, over time, exhaust the assets of such account.
To cover the cost of additional compliance administration, a $20 fee will
be charged against any shareholder account that has been determined to be
subject to escheat under applicable state laws.
The Fund may not suspend the right of redemption or postpone the date of
payment of redemption proceeds for more than seven days, except that (a) it may
elect to suspend the redemption of shares or postpone the date of payment of
redemption proceeds: (1) during any period that the NYSE is closed (other than
customary weekend and holiday closings) or trading on the NYSE is restricted;
(2) during any period in which an emergency exists as a result of which disposal
of portfolio securities is not reasonably practicable or it is not reasonably
practicable to fairly determine the Fund's net asset values; or (3) during such
other periods as the Securities and Exchange Commission (the "SEC") may by order
permit for the protection of investors; and (b) the payment of redemption
proceeds may be postponed as otherwise provided under "Purchase and Redemption
of Shares" in this Statement of Additional Information.
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The Open Account System. Under the Open Account System full and fractional
shares of the Fund owned by shareholders are credited to their accounts by the
Transfer Agent, State Street Bank and Trust Company, 225 Franklin Street,
Boston, Massachusetts 02110. Certificates representing Class B or Class C shares
will not be issued, while certificates representing Class A or Class S shares
will only be issued if specifically requested in writing and, in any case, will
only be issued for full shares, with any fractional shares to be carried on the
shareholder's account. Shareholders will receive periodic statements of
transactions in their accounts.
The Fund's Open Account System provides the following options:
1. Additional purchases of shares of the Fund may be made through dealers, by
wire or by mailing a check payable to "State Street Research Funds" under
the terms set forth above under "Purchase and Redemption of Shares" in this
Statement of Additional Information.
2. The following methods of receiving dividends from investment income and
distributions from capital gains generally are available:
(a) All income dividends and capital gains distributions reinvested in
additional shares of the Fund.
(b) All income dividends and capital gains distributions in cash.
(c) All income dividends and capital gains distributions invested in any one
available Eligible Fund designated by the shareholder as described below.
See "--Dividend Allocation Plan" herein.
Dividend and distribution selections should be made on the Application
accompanying the initial investment. If no selection is indicated on the
Application, that account will be automatically coded for reinvestment of all
dividends and distributions in additional shares of the same class of the Fund.
Selections may be changed at any time by telephone or written notice to the
Service Center. Dividends and distributions are reinvested at net asset value
without a sales charge.
Exchange Privileges. Shareholders of the Fund may exchange their shares for
available shares with corresponding characteristics of any of the other Eligible
Funds at any time on the basis of the relative net asset values of the
respective shares to be exchanged, subject to compliance with applicable
securities laws. Exchanges into the Fund are available only to investors who
meet the Funds minimum investment and eligibility standards. Prior to making an
exchange, shareholders should obtain the Prospectus of the Eligible Fund into
which they are exchanging. Under the Direct Program, subject to certain
conditions, shareholders may make arrangements for regular exchanges from the
Fund into other Eligible Funds. To effect an exchange, Class A, Class B and
Class C shares may be redeemed without the payment of any contingent deferred
sales charge that might otherwise be due upon an ordinary redemption of such
shares. The State Street Research Money Market Fund issues Class E shares which
are sold without any sales charge. Exchanges of State Street Research Money
Market Fund Class E shares into Class A shares of the Fund or any other Eligible
Fund are subject to the initial sales
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charge or contingent deferred sales charge applicable to an initial investment
in such Class A shares, unless a prior Class A sales charge has been paid
directly or indirectly with respect to the shares redeemed. For purposes of
computing the contingent deferred sales charge that may be payable upon
disposition of any acquired Class A, Class B and Class C shares, the holding
period of the redeemed shares is "tacked" to the holding period of any acquired
shares. No exchange transaction fee is currently imposed on any exchange.
Shares of the Fund may also be acquired or redeemed in exchange for shares
of the Summit Cash Reserves Fund ("Summit Cash Reserves") by customers of
Merrill Lynch, Pierce, Fenner & Smith Incorporated (subject to completion of
steps necessary to implement the program). The Fund and Summit Cash Reserves are
related mutual funds for purposes of investment and investor services. Upon the
acquisition of shares of Summit Cash Reserves by exchange for redeemed shares of
the Fund, (a) no sales charge is imposed by Summit Cash Reserves, (b) no
contingent deferred sales charge is imposed by the Fund on the Fund shares
redeemed, and (c) any applicable holding period of the Fund shares redeemed is
"tolled," that is, the holding period clock stops running pending further
transactions. Upon the acquisition of shares of the Fund by exchange for
redeemed shares of Summit Cash Reserves, (a) the acquisition of Class A shares
shall be subject to the initial sales charges or contingent deferred sales
charges applicable to an initial investment in such Class A shares, unless a
prior Class A sales charge has been paid indirectly, and (b) the acquisition of
Class B or Class C shares of the Fund shall restart any holding period
previously tolled, or shall be subject to the contingent deferred sales charge
applicable to an initial investment in such shares.
The exchange privilege may be terminated or suspended or its terms changed
at any time, subject, if required under applicable regulations, to 60 days'
prior notice. New accounts established for investments upon exchange from an
existing account in another fund will have the same telephone privileges with
respect to the Fund (see "Your Account--Account Policies--Telephone Requests" in
the Fund's Prospectus and "--Telephone Privileges," below) as the existing
account unless the Service Center is instructed otherwise. Related
administrative policies and procedures may also be adopted with regard to a
series of exchanges, street name accounts, sponsored arrangements and other
matters.
The exchange privilege is not designed for use in connection with
short-term trading or market timing strategies. To protect the interests of
shareholders, the Fund reserves the right to temporarily or permanently
terminate the exchange privilege for any person who makes more than six
exchanges out of or into the Fund per calendar year. Accounts under common
ownership or control, including accounts with the same taxpayer identification
number, may be aggregated for purposes of the six exchange limit.
Notwithstanding the six exchange limit, the Fund reserves the right to refuse
exchanges by any person or group if, in the Investment Manager's judgment, the
Fund would be unable to invest effectively in accordance with its investment
objective and policies, or would otherwise potentially be adversely affected.
Exchanges may be restricted or refused if the Fund receives or anticipates
simultaneous orders affecting significant portions of the Fund's assets. In
particular, a pattern of exchanges that coincides with a "market timing"
strategy may be disruptive to the Fund. The Fund may impose these restrictions
at any time. The exchange limit may be modified for accounts in certain
institutional retirement plans because of plan exchange limits, Department of
Labor regulations or administrative and other considerations. Subject to the
foregoing, if an exchange request in
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good order is received by the Service Center and delivered by the Service Center
to the Transfer Agent by 12 noon Boston time on any business day, the exchange
usually will occur that day. For further information regarding the exchange
privilege, shareholders should contact the Service Center.
Reinvestment Privilege. A shareholder of the Fund who has redeemed shares
or had shares repurchased at his or her request may reinvest all or any portion
of the proceeds (plus that amount necessary to acquire a fractional share to
round off his or her reinvestment to full shares) in shares, of the same class
as the shares redeemed, of the Fund or any other Eligible Fund at net asset
value and without subjecting the reinvestment to an initial sales charge,
provided such reinvestment is made within 120 calendar days after a redemption
or repurchase. Upon such reinvestment, the shareholder will be credited with any
contingent deferred sales charge previously charged with respect to the amount
reinvested. The redemption of shares is, for federal income tax purposes, a sale
on which the shareholder may realize a gain or loss. If a redemption at a loss
is followed by a reinvestment within 30 days, the transaction may be a "wash
sale" resulting in a denial of the loss for federal income tax purposes.
Any reinvestment pursuant to the reinvestment privilege will be subject to
any applicable minimum account standards imposed by the fund into which the
reinvestment is made. Shares are sold to a reinvesting shareholder at the net
asset value thereof next determined following timely receipt by the Service
Center of such shareholder's written purchase request and delivery of the
request by the Service Center to the Transfer Agent. A shareholder may exercise
this reinvestment privilege only once per 12-month period with respect to his or
her shares of the Fund.
Dividend Allocation Plan. The Dividend Allocation Plan allows shareholders
to elect to have all their dividends and any other distributions from the Fund
or any Eligible Fund automatically invested at net asset value in one other such
Eligible Fund designated by the shareholder, provided the account into which the
dividends and distributions are directed is initially funded with the requisite
minimum amount.
Telephone Privileges. A shareholder with the telephone privileges that are
offered with his or her Account (see "Your Account--Account Policies--Telephone
Requests") is deemed to authorize the Service Center and the Transfer Agent to:
(1) act upon the telephone instructions of any person purporting to be the
shareholder or the shareholder's financial professional to exchange, or to
redeem with the shareholder's permission, shares from any account; and (2) honor
any written instructions for a change of address regardless of whether such
request is accompanied by a signature guarantee. All telephone calls will be
recorded. Neither the Fund, the other Eligible Funds, the Transfer Agent, the
Investment Manager nor the Distributor will be liable for any loss, expense or
cost arising out of any request, including any fraudulent or unauthorized
requests. Shareholders assume the risk to the full extent of their accounts that
telephone requests may be unauthorized. Reasonable procedures will be followed
to confirm that instructions communicated by telephone are genuine. The
shareholder will not be liable for any losses arising from unauthorized or
fraudulent instructions if such procedures are not followed.
Alternative Means of Contacting the Fund. It is unlikely, even during
periods of extraordinary market conditions, that a shareholder will have
difficulty in reaching the Service Center. In that
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event, however, the shareholder should contact the Service Center at
1-800-562-0032, 1-617-357-7800 or otherwise at its main office at One Financial
Center, Boston, Massachusetts 02111-2690.
NET ASSET VALUE
The net asset value of the shares of the Fund is determined once daily as
of the close of regular trading on 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, Martin
Luther King, Jr. Day, Presidents Day, Good Friday, Memorial Day, Independence
Day, Labor Day, Thanksgiving Day and Christmas Day.
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 as provided below, the
Trustees utilize one or more pricing services in lieu of market quotations for
certain securities which are not readily available on a daily basis. Such
services utilize information with respect to market transactions, quotations
from dealers and various relationships among securities in determining value and
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 New York or 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 New York or 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, Inc.'s (the "NASD") NASDAQ 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 with the use of such pricing services as may be deemed appropriate or
methodologies approved by the Trustees.
The Trustees have authorized the use of the amortized cost method to value
short-term debt instruments issued with a maturity of one year or less and
having a remaining maturity of 60 days or less when the value obtained is fair
value, 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. 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
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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.
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 Fund's portfolio turnover rates for the fiscal years ended
December 31, 1996 and 1997, respectively, were as follows: 89.14% and 50.92%.
The Investment Manager believes that the portfolio turnover rate was
significantly lower in 1997 than for the previous fiscal year because in 1996,
the Fund restructured its portfolio to adjust portfolio duration and sensitivity
to volatility.
Brokerage Allocation
The Investment Manager's policy is to seek for its clients, including the
Fund, what in the Investment Manager's judgment will be the best overall
execution of purchase or sale orders and the most favorable net prices in
securities transactions consistent with its judgment as to the business
qualifications of the various broker or dealer firms with whom the Investment
Manager may do business, and the Investment Manager may not necessarily choose
the broker offering the lowest available commission rate. Decisions with respect
to the market where the transaction is to be completed, to the form of
transaction (whether principal or agency), 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 their
proven integrity and financial responsibility, their demonstrated execution
experience and capabilities both generally and with respect to particular
markets or securities, the competitiveness of their commission rates in agency
transactions (and their net prices in principal transactions), their willingness
to commit capital, and their clearance and settlement capability. The Investment
Manager makes every effort to keep informed of commission rate structures and
prevalent bid/ask spread characteristics of the markets and securities in which
transactions for the Fund occur. Against this background, the Investment Manager
evaluates the reasonableness of a commission or a net price with respect to a
particular transaction by considering such factors as difficulty of execution or
security positioning by the executing firm. The Investment Manager may or may
not solicit competitive bids based on its judgment of the expected benefit or
harm to the execution process for that transaction.
When it appears that a number of firms could satisfy the required standards
in respect of a particular transaction, consideration may also be given to
services other than execution services which certain of such firms have provided
in the past or may provide in the future. Negotiated commission rates and
prices, however, are based upon the Investment Manager's judgment of the rate
which reflects the execution requirements of the transaction without regard to
whether the broker provides services in addition to execution. Among such other
services are the supplying of supplemental investment research; general
economic, political and business
52
<PAGE>
information; analytical and statistical data; relevant market information,
quotation equipment and services; reports and information about specific
companies, industries and securities; purchase and sale recommendations for
stocks and bonds; portfolio strategy services; historical statistical
information; market data services providing information on specific issues and
prices; financial publications; proxy voting data and analysis services;
technical analysis of various aspects of the securities markets, including
technical charts; computer hardware used for brokerage and research purposes;
computer software and databases (including those contained in certain trading
systems and used for portfolio analysis and modeling and also including software
providing investment personnel with efficient access to current and historical
data from a variety of internal and external sources); portfolio evaluation
services and data relating to the relative performance of accounts.
In the case of the Fund and other registered investment companies advised
by the Investment Manager or its affiliates, the above services may include data
relating to performance, expenses and fees of those investment companies and
other investment companies; this information is used by the Trustees or
Directors of the investment companies to fulfill their responsibility to oversee
the quality of the Investment Manager's advisory contracts between the
investment companies and the Investment Manager. The Investment Manager
considers these investment company services only in connection with the
execution of transactions on behalf of its investment company clients and not
its other clients.
The Investment Manager regularly reviews and evaluates the services
furnished by broker-dealers. The Investment Manager's investment management
personnel conduct internal surveys and use other methods to evaluate the quality
of the research and other services provided by various broker-dealer firms, and
the results of these efforts are made available to the equity trading department
which uses this information as consideration to the extent described above in
the selection of brokers to execute portfolio transactions.
Some services furnished by broker-dealers may be used for research and
investment decision-making purposes, and also for marketing or administrative
purposes. Under these circumstances, the Investment Manager allocates the cost
of such services to determine the appropriate proportion of the cost which is
allocable to research or investment decision-making and the proportion allocable
to other purposes. The Investment Manager pays directly from its own funds for
that portion allocable to uses other than research or investment
decision-making. Some research and execution services may benefit the Investment
Manager's clients as a whole, while others may benefit a specific segment of
clients. Not all such services will necessarily be used exclusively in
connection with the accounts which pay the commissions to the broker-dealer
producing the services.
53
<PAGE>
The Investment Manager has no fixed agreements or understandings with any
broker-dealer as to the amount of brokerage business which the firm may expect
to receive for services supplied to the Investment Manager 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 brokerage business. These understandings are
honored to the extent possible in accordance with the policies set forth above.
It is not the Investment Manager's policy to intentionally pay a firm a
brokerage commission higher than that which another firm would charge for
handling the same transaction in recognition of services (other than execution
services) provided. However, the Investment Manager is aware that this is an
area where differences of opinion as to fact and circumstances may exist, and in
such circumstances, if any, relies on the provisions of Section 28(e) of the
Securities Exchange Act of 1934, to the extent applicable. During the fiscal
years ended December 31, 1995, 1996 and 1997, the Fund paid no brokerage
commissions in secondary trading.
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.
In the case of the purchase of fixed income securities in underwriting
transactions, the Investment Manager follows any instructions received from its
clients as to the allocation of new issue discounts, selling commissions and
designations to brokers or dealers which provide the client with research,
performance evaluation, master trustee and other services. In the absence of
instructions from the client, the Investment Manager may make such allocations
to broker-dealers which have provided the Investment Manager with research and
brokerage services.
In some instances, certain clients of the Investment Manager request it to
place all or part of the orders for their account with certain brokers or
dealers, which in some cases provide services to those clients. The Investment
Manager generally agrees to honor these requests to the extent practicable.
Clients may condition their requests by requiring that the Investment Manager
only effect transactions with the specified broker-dealers if the broker-dealers
are competitive as to price and execution. In other cases, the Investment
Manager may be unable to negotiate commissions or obtain volume discounts or
best execution. In addition, a disparity may exist among the commissions charged
to clients who request the Investment Manager to use particular brokers or
dealers, and also between those clients and those who do not make such requests.
A client who requests the use of a particular broker-dealer should understand
that it may lose the possible advantage which non-requesting clients derive from
aggregation of orders for several clients as a single transaction for the
purchase or sale of a particular security. Among other reasons why best
execution may not be achieved with directed brokerage is that, in an effort to
achieve orderly execution of transactions, execution of orders that have
designated particular brokers may, at the discretion of the trading desk, be
delayed until execution of other non-designated orders has been completed.
When more than one client of the Investment Manager is seeking to buy or
sell the same security, the sale or purchase is carried out in a manner which is
considered fair and equitable to all accounts. In allocating investments among
various clients (including in what sequence orders for trades are placed), the
Investment Manager will use its best business judgment and will take into
account such factors as the investment objectives of the clients, the amount of
investment funds available to each, the size of the order, the amount already
committed for each client to a specific investment and the relative risks of the
investments, all in order to provide on balance a fair and equitable result to
each client over time. Although sharing in large transactions may sometimes
affect price or volume of shares acquired or sold, overall it is believed there
may be an advantage in execution. The Investment Manager may follow the practice
of grouping orders of various clients for execution to get the benefit of lower
prices or commission rates. In certain cases where the aggregate order may be
executed in a series of transactions at various prices, the transactions are
allocated as to amount and price in a manner considered equitable to each so
that each receives, to the extent practicable, the average price of such
transactions. Exceptions may be made based on such factors as the size of the
account and the size of the trade. For example, the Investment Manager may not
aggregate trades where it believes that it is in the best interests of clients
not to do so, including situations where aggregation might result in a large
number of small transactions with consequent increased custodial and other
transactional costs which may
54
<PAGE>
disproportionately impact smaller accounts. Such disaggregation, depending on
the circumstances, may or may not result in such accounts receiving more or less
favorable execution relative to other clients.
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) satisfy certain diversification
requirements; and (c) in order to be entitled to utilize the dividends paid
deduction, distribute annually at least 90% of its investment company taxable
income (determined without regard to the deduction for dividends paid).
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 or
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 to the extent thereof. Any distribution in excess of a shareholder's basis
in the shareholder's shares would be taxable as gain realized from the sale of
such shares.
The Fund will be liable for a nondeductible 4% excise tax on amounts not
distributed (or deemed 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 (or be deemed to have distributed) 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. For that purpose, any
income or gain retained by the Fund that is subject to corporate tax will be
considered to have been distributed by year-end. 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
55
<PAGE>
treated for federal income tax purposes as income 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 may 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 federal
income tax purposes. In the case of any debt security 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 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 or
continued 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 include original issue discount in income, it will be more difficult
for the Fund to make the distributions required for the Fund to maintain its
status as a regulated investment company under Subchapter M of the Code or 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 income for purposes of the 90% 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, any dividend declared in October, November or December and
made payable to shareholders of record in any such month is treated as received
by such shareholder on December 31, provided that the Fund pays the dividend
during January of the following calendar 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 taxable distribution. The price of shares
purchased at that time includes the amount of any forthcoming
56
<PAGE>
distribution. Those investors purchasing shares just prior to a taxable
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, a
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 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.
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<PAGE>
DISTRIBUTION OF SHARES OF THE FUND
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 C shares). The Distributor may reallow all or
portions of such sales charges as concessions to dealers.
Total sales charges on Class A shares paid to the Distributor for the last
three fiscal years were as follows: 1997, $120,364; 1996, $140,433; and 1995,
$129,732.
For the same periods, the Distributor retained the following amounts after
reallowance of concessions to dealers: 1997, $14,177; 1996, $17,248; and 1995,
$15,287.
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, managed fee-based programs and
so-called "mutual fund supermarkets," among other programs, the amount of the
sales charge reduction will similarly reflect the anticipated reduction in sales
expenses associated with such arrangements. The reductions in sales expenses,
and therefore the reduction in sales charges, will vary depending on factors
such as the size and other characteristics of the organization or program, and
the nature of its membership or the participants. 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
or similar programs 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 based on the aggregate of such sales. 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 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
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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 A, Class B and Class C shares of the Fund
and paid initial commissions to securities dealers for sales of such Class A,
Class B and Class C shares as follows:
<TABLE>
<CAPTION>
Fiscal Year Ended Fiscal Year Ended Fiscal Year Ended
December 31, 1997 December 31, 1996 December 31, 1995
----------------- ----------------- -----------------
Contingent Commissions Contingent Commissions Contingent Commissions
Deferred Paid to Deferred Paid to Deferred Paid to
Sales Charges Dealers Sales Charges Dealers Sales Charges Dealers
------------- ------- ------------- ------- ------------- -------
<S> <C> <C> <C> <C> <C> <C>
Class A $ 0 $106,187 $ 0 $123,185 $ 0 $114,445
Class B $43,278 $102,457 $38,918 $154,234 $109,751 $117,596
Class C $ 0 $ 1,197 $ 0 $ 171 $ 5 $ 300
</TABLE>
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 C 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 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 the servicing of shareholder accounts including
payments to securities dealers and others in consideration of the provision of
personal service to investors and/or the maintenance or servicing of shareholder
accounts and expenses associated with the provision of personal service 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.
Some or all of the service fees are used to pay or reimburse dealers
(including dealers that are affiliates of the Distributor) or others for
personal services and/or the maintenance of shareholder accounts. A portion of
any initial commission paid to dealers for the sale of shares of the Fund
represents payment for personal services and/or the maintenance or servicing of
shareholder accounts by such dealers. Dealers who have sold Class A shares are
eligible for further reimbursement commencing as of the time of such sale.
Dealers who have sold Class B
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<PAGE>
and Class C shares are eligible for further reimbursement after the first year
during which such shares have been held of record by such dealer as nominee for
its clients (or by such clients directly). Any service fees received by the
Distributor and not allocated to dealers may be applied by the Distributor in
reduction of expenses incurred by it directly for personal services and the
maintenance or servicing of shareholder accounts.
The distribution fees are used primarily to offset initial and ongoing
commissions paid to dealers for selling such shares. Any distribution fees
received by the Distributor and not allocated to dealers may be applied by the
Distributor in connection with sales or marketing efforts, including special
promotional fees and cash and noncash incentives based upon sales by dealers.
The Distributor provides distribution services on behalf of other funds
having distribution plans and receives similar payments from, and incurs similar
expenses on behalf of, such other funds. When expenses of the Distributor cannot
be identified as relating to a specific fund, the Distributor allocates expenses
among the funds in a manner deemed fair and equitable to each fund.
Commissions and other cash and noncash incentives and payments to dealers,
to the extent payable out of the general profits, revenues or other sources of
the Distributor (including the advisory fees paid by the Fund), have also been
authorized pursuant to the Distribution Plan.
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 C shares, an annual rate of 0.75% of the
average daily value of the net assets represented by such Class B or Class C
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 C shares (as the case may be) to make payments for personal
services and/or the maintenance or servicing of shareholder accounts. The
distribution and servicing expenses of a particular class will be borne solely
by that class. In addition, a rule of the NASD limits annual expenditures that
the Fund may incur under the Distribution Plan to 1%, of which 0.75% may be used
to pay distribution expenses and 0.25% may be used to pay shareholder service
fees. The NASD rule also limits the aggregate amount that the Fund may pay for
such distribution costs to 6.25% of gross share sales of a class since the
inception of any asset-based sales charge plus interest at the prime rate plus
1% on unpaid amounts thereof (less any contingent deferred sales charges). Such
limitation does not apply to shareholder service fees. Payments to the
Distributor or to dealers funded under the Distribution Plan may be discontinued
at any time.
The Distributor may pay certain dealers and other intermediaries additional
compensation for sales and administrative services. The Distributor may provide
cash and noncash incentives to intermediaries who, for example, sell significant
amounts of shares or develop particular distribution channels. The Distributor
may compensate dealers with clients who maintain their investments in the Fund
over a period of years. The incentives can include merchandise and trips to, and
attendance at, sales seminars at resorts. The Distributor may pay for
administrative services, such as technological and computer systems support for
the maintenance of pension plan participant records, for subaccounting, and for
distribution through mutual fund supermarkets or similar arrangements.
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<PAGE>
During the fiscal year ended December 31, 1997, 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 C
-------- -------- -------
Advertising $ 21 $ 0 $1,110
Printing and mailing of prospectuses
to other than current shareholders $ 6 $ 0 $ 335
Compensation to dealers $49,326 $167,726 $2,161
Compensation to sales personnel $ 45 $ 0 $2,389
Interest $ 0 $ 0 $ 0
Carrying or other financing charges $ 0 $ 0 $ 0
Other expenses: marketing; general $ 23 $ 0 $1,128
------- -------- ------
Total Fees $49,421 $167,726 $7,123
======= ======== ======
The Distributor may have also used additional resources of its own for
further expenses on behalf of the Fund.
No interested 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
From time to time, in advertisements or in communications to shareholders
or prospective investors, the Fund may compare the performance of its Class A,
Class B, Class C or Class S shares to the performance of other mutual funds with
similar investment objectives, to certificates of deposit, to taxable debt
instruments, such as Treasury bonds, as may be included in the Merrill Lynch
Treasury Master Index, and/or to other financial alternatives. The Fund may also
compare its performance to appropriate indices, such as the Lehman Brothers
Municipal Bond Index, the Merrill Lynch Revenue Index, the Merrill Lynch 500
Municipal Index, the Lehman Brothers New York Bond Index, or the Bond Buyer
Revenue Bond Index
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<PAGE>
and/or to appropriate rankings and averages such as those compiled by Lipper
Analytical Services, Inc., Morningstar, Inc., Money Magazine, Business Week,
Forbes Magazine, The Wall Street Journal and Investor's Daily. For example, the
performance of the Fund might be compared to the Lipper New York Municipal Debt
Funds Average.
The average annual total return ("standard total return") and yield of the
Class A, Class B, Class C and Class S 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. On June 7, 1993, when designations
were assigned based on the pricing and Rule 12b-1 fees applicable to shares sold
thereafter. The application of the additional Rule 12b-1 fees, if any, of up to
1% will, for periods after June 7, 1993, adversely affect Fund performance
results. Thus, performance data or rankings for a given class of shares should
be interpreted carefully by investors who hold or may invest in a different
class of shares.
The performance data below reflect Rule 12b-1 fees and, where applicable,
sales charges as follows:
<TABLE>
<CAPTION>
Rule 12b-1 Fees Sales Charges
--------------- -------------
Class Amount Period
- ----- ------ ------
<S> <C> <C> <C>
A 0.25% June 7, 1993 to present; fee will Maximum 4.5% sales charge reflected
reduce performance for periods
after June 7, 1993
B 1.00% June 7, 1993 to present; fee will 1- and 5-year periods reflect a 5% and a
reduce performance for periods 2% contingent deferred sales charge,
after June 7, 1993 respectively
C* 1.00% June 7, 1993 to present; fee will 1-year period reflects a 1% contingent
reduce performance for periods deferred sales charge
after June 7, 1993
S* None Since commencement of None
operations to present
</TABLE>
- ------------
* Prior to November 1, 1997, the Fund's current Class C shares were
designated as Class D shares and the Fund's current Class S shares were
designated as Class C shares.
All calculations of performance data in this section reflect the voluntary
measures, if any, by the Fund's affiliates to reduce fees or expenses relating
to the Fund; see "--Accrued Expenses and Recurring Charges" later in this
section.
62
<PAGE>
Total Return
The Fund's standard average annual total returns ("standard total return")
of each class of shares were as follows:
<TABLE>
<CAPTION>
Commencement of
Operations Five Years One Year
(July 5, 1989) Ended Ended
Fund to December 31, 1997 December 31, 1997 December 31, 1997
- ---- -------------------- ----------------- -----------------
<S> <C> <C> <C>
Class A 6.65% 5.77% 4.31%
Class B 6.80% 5.71% 3.41%
Class C* 6.81% 6.04% 7.53%
Class S* 7.38% 7.01% 9.48%
</TABLE>
- ------------
* Prior to November 1, 1997, the Fund's current Class C shares were
designated as Class D shares and the Fund's current Class S shares were
designated as Class C shares.
Standard total return is computed separately for each class of shares 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 in accordance with 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 highest
applicable initial or contingent deferred sales charge 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.
63
<PAGE>
Yield
The annualized yield of each class of shares of the Fund based on the month
of December 1997 was as follows:
Class A 4.28%
Class B 3.74%
Class C* 3.73%
Class S* 4.73%
- ------------
* Prior to November 1, 1997, the Fund's current Class C shares were
designated as Class D shares and the Fund's current Class S shares were
designated as Class C shares.
Yield for each of the Fund's Class A, Class B, Class C and Class S shares
is computed by dividing the net investment income per share earned during a
recent month or other specified 30-day period by the maximum offering price per
share on the last day of the period and annualizing the result in accordance
with the following formula:
YIELD = 2[(a-b + 1)6 -1]
---
cd
Where: a = dividends and interest earned during the period
b = expenses accrued for the period (net of 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
64
<PAGE>
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, as applicable, a maximum sales charge of 4.5%.
All accrued expenses and recurring charges are taken into account as
described later herein.
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 often are insured and/or 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, 1997 assuming a combined federal and state maximum effective
marginal income tax rate of 46.27% was as follows:
Class A 7.97%
Class B 6.96%
Class C* 6.94%
Class S* 8.80%
- ------------
* Prior to November 1, 1997, the Fund's current Class C shares were
designated as Class D shares and the Fund's current Class S shares were
designated as Class C shares.
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 46.27% (or other relevant rate) and adding the result to that
portion, if any, of the yield of the Fund that is not tax-
65
<PAGE>
exempt. The complement, for example, of a tax rate of 46.27% is 53.73%, that is
[1.00 - .4627 = .5373].
Accrued Expenses and Recurring Charges
Accrued expenses include all recurring charges 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.
Nonstandardized Total Return
The Fund may provide the above described standard total return results for
Class A, Class B, Class C and Class S 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 the result may or may not be annualized, and as
noted any applicable sales charge 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 returns for the six months ended December 31, 1997,
without taking sales charges into account, were as follows:
Class A 5.99%
Class B 5.59%
Class C* 5.59%
Class S* 6.11%
- ------------
* Prior to November 1, 1997, the Fund's current Class C shares were
designated as Class D shares and the Fund's current Class S shares were
designated as Class C shares.
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 to which the distribution relates. 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
66
<PAGE>
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.
The distribution rate of each class of the Fund, based on the month ended
December 31, 1997 was as follows:
Class A 4.49%
Class B 3.95%
Class C* 3.95%
Class S* 4.95%
- ------------
* Prior to November 1, 1997, the Fund's current Class C shares were
designated as Class D shares and the Fund's current Class S shares were
designated as Class C shares.
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) audits of the Fund's annual financial statements, (2) assistance
and consultation in connection with SEC 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 financial reports may be made available from time to
time through electronic or other media. Shareholders with substantial holdings
in one or more State Street Research Funds
67
<PAGE>
may also receive reports and other information which reflect or analyze their
positions in a consolidated manner. For more information, call State Street
Research Service Center.
The following financial statements are for the Fund's fiscal year ended
December 31, 1997:
DOCSC\359869.9
68
<PAGE>
STATE STREET RESEARCH NEW YORK TAX-FREE FUND
- --------------------------------------------------------------------------------
INVESTMENT PORTFOLIO
- --------------------------------------------------------------------------------
December 31, 1997
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------
Principal Maturity Value
Amount Date (Note 1)
- -------------------------------------------------------------------------------------
<S> <C> <C> <C>
MUNICIPAL BONDS 101.8%
General Obligation 18.4%
City of New York, General
Obligation Bonds, Fiscal 1992
Series H, 7.00% ..................... $ 450,000 2/01/2005 $ 495,958
City of New York, General
Obligation Bonds, Fiscal 1995
Series F, 6.375% .................... 2,000,000 2/15/2006 2,218,540
County of Onondaga, New
York, General Improvement
(Serial) Bonds, 1992, 5.70% ......... 2,000,000 4/01/2007 2,198,660
City of New York, Tax-Exempt
Capital Appreciation Bonds,
Fiscal 1998 Series F, 0.00% ......... 2,500,000 8/01/2008 1,501,825
County of Nassau, New York,
General Obligation Refunding
Bonds, Series G, MBIA
Insured, 5.45% ...................... 1,000,000 1/15/2015 1,064,190
Commonwealth of Puerto
Rico, General Obligation
Public Improvement Refunding
Bonds, Series 1995A, MBIA
Insured, 5.65% ...................... 1,000,000 7/01/2015 1,092,340
County of Monroe, New York,
Public Improvement Refunding
Bonds, Series A, 6.00% .............. 1,535,000 3/01/2017 1,743,131
City of New York, General
Obligation Refunding Bonds,
Series H, 6.00% ..................... 1,500,000 8/01/2017 1,583,565
County of Orange, New York,
Various Purposes Serial
Bonds-1997, 5.125% .................. 1,000,000 9/01/2019 1,010,870
-----------
12,909,079
-----------
Airport 3.3%
Port Authority of New York
and New Jersey, Special
Project Bonds, Series 6, JFK
International Air Terminal LLC
Project, MBIA Insured, Subject
to AMT, 5.75% ....................... 1,000,000 12/01/2022 1,050,110
</TABLE>
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------
Principal Maturity Value
Amount Date (Note 1)
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C>
City of New York, Industrial
Development Agency, Special
Facility Revenue Bonds, 1997
Northwest Airlines, Inc.
Project, 6.00% ...................... $1,245,000 6/01/2027 $ 1,299,282
-----------
2,349,392
-----------
Certificates of Participation 1.8%
City of Syracuse, New York,
(Syracuse Hancock Inter-
national Airport), Certificates
of Participation, Series 1992,
Subject to AMT, 6.60% ............... 1,185,000 1/01/2006 1,298,819
-----------
College & University 8.4%
Dormitory Authority of the
State of New York, Mt. Sinai
School of Medicine, Series B,
MBIA Insured, 5.70% ................. 1,000,000 7/01/2011 1,086,510
Dormitory Authority of the
State of New York, Canisius
College, Revenue Bonds,
Series 1995, CapMAC Insured,
0.00% ............................... 1,550,000 7/01/2013 708,458
Dormitory Authority of the
State of New York, Montefiore
Medical Center, FHA-Insured
Mortgage Hospital Revenue
Bonds, Series 1996, AMBAC
Insured, 5.25% ...................... 2,000,000 2/01/2015 2,014,940
Dormitory Authority of the
State of New York, City
University System
Consolidated, Series A,
AMBAC Insured, 5.625% ............... 1,000,000 7/01/2016 1,087,480
Dormitory Authority of the
State of New York, Insured
Revenue Bonds, (853 Schools
Program Issue), The Center for
Developmental Disabilities,
Inc., Series 1997A, AMBAC
Insured, 5.00% ...................... 1,000,000 7/01/2017 986,510
-----------
5,883,898
-----------
</TABLE>
The accompanying notes are an integral part of the financial statements.
69
<PAGE>
STATE STREET RESEARCH NEW YORK TAX-FREE FUND
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------
Principal Maturity Value
Amount Date (Note 1)
- ----------------------------------------------------------------------------------------
<S> <C> <C> <C>
Escrowed Bonds 1.8%
Dormitory Authority of the
State of New York, Judicial
Facilities Lease Revenue
Bonds, (Suffolk County Issue)
Series 1986, 7.375% ................ $1,000,000 7/01/2016 $ 1,245,350
-----------
Hospital/Health Care 3.8%
Dormitory Authority of the
State of New York, Nyack
Hospital Revenue Bonds,
Series 1996, 6.00% ................. 1,500,000 7/01/2006 1,597,350
New York State Medical Care
Facilities Finance Agency,
Mental Health Services
Facilities Improvement,
Revenue Bonds, 1990 Series
A, 7.75% ........................... 60,000 8/15/2010 65,248
Dormitory Authority of the
State of New York, Mental
Health Services Facilities
Improvement Revenue Bonds,
Series 1997B, 5.50% ................ 1,000,000 8/15/2017 1,012,370
-----------
2,674,968
-----------
Industrial Development & Pollution Control 6.2%
Herkimer County Industrial
Development Agency,
Industrial Development
Revenue Bonds, (Burrows
Paper Corporation Solid
Waste Disposal Facility),
Series 1993, Subject to AMT,
8.00% .............................. 4,000,000 1/01/2009 4,366,120
-----------
Lease 14.2%
Dormitory Authority of the
State of New York, Judicial
Facilities Lease Revenue
Bonds, (Suffolk County Issue),
Series 1991A, 9.25% ................ 1,500,000 4/15/2006 1,655,130
Lyons Community Health
Initatives Corp., Facility
Revenue Bonds, Series 1994,
6.55% .............................. 470,000 9/01/2009 514,720
</TABLE>
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------
Principal Maturity Value
Amount Date (Note 1)
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C>
New York State Thruway
Authority, Service Contract
Revenue Bonds, 6.25% ............... $1,000,000 4/01/2014 $ 1,083,290
Dormitory Authority of the
State of New York, State
University Educational
Facilities, Revenue Bonds,
Series 1993 A, 5.50% ............... 2,500,000 5/15/2019 2,612,350
Lyons Community Health
Initiatives Corp., (New York),
Facility Revenue Bonds, Series
1994, 6.80% ........................ 940,000 9/01/2024 1,026,941
State of New York, Urban
Development Corporation,
Correctional Capital Facilities,
Series 6, FSA Insured,
5.375% ............................. 2,000,000 1/01/2025 2,028,520
Oswego County Industrial
Development Agency, (Oswego
New York), Civic Facility
Revenue Bonds, Series 1997A,
(FHA Insured Mortgage-Seneca
Hill Manor Inc. Project), 5.65%..... 1,000,000 8/01/2037 1,023,850
-----------
9,944,801
-----------
Life Care 6.6%
Orange County Industrial
Development Agency,(The
Glen Arden Inc. Project), Life
Care Community, Revenue
Bonds, Series 1994, 8.25%* ......... 2,000,000 1/01/2002 2,068,060
Tompkins County Industrial
Development Agency, Life
Care Community Revenue
Bonds, 1994 (Kendal at Ithaca
Inc., Project), 7.70% .............. 1,430,000 6/01/2011 1,530,615
Tompkins County Industrial
Development Agency, Life
Care Community Revenue
Bonds, 1994 (Kendal at Ithaca
Inc., Project), 7.875% ............. 1,000,000 6/01/2024 1,061,620
-----------
4,660,295
-----------
</TABLE>
The accompanying notes are an integral part of the financial statements.
70
<PAGE>
STATE STREET RESEARCH NEW YORK TAX-FREE FUND
- --------------------------------------------------------------------------------
INVESTMENT PORTFOLIO (cont'd)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------
Principal Maturity Value
Amount Date (Note 1)
- ----------------------------------------------------------------------------------------
<S> <C> <C> <C>
Multi-Family Housing 1.5%
New York State Housing
Finance Agency, Multi-Family
Housing Revenue Bonds,
(Secured Mortgage Program),
1992 Series F, Subject to
AMT, 6.625% ....................... $1,000,000 8/15/2012 $ 1,075,720
-----------
Power 1.9%
Power Authority of the State
of New York, General Purpose
Bonds, Series W, 6.50% ............ 1,150,000 1/01/2008 1,319,395
-----------
Pre-Refunded Bonds 5.6%
City of New York, General
Obligation Bonds, Fiscal 1992,
Current Interest Bonds, Series
H, Pre-Refunded to 2/1/2002
@ 101.5%, 7.00% ................... 810,000 2/01/2005 904,252
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% ............ 1,000,000 1/01/2010 1,100,550
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% ......... 350,000 5/15/2012 385,385
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% .................... 600,000 6/15/2016 664,146
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% ..................... 800,000 10/01/2026 887,104
-----------
3,941,437
-----------
</TABLE>
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------
Principal Maturity Value
Amount Date (Note 1)
- ----------------------------------------------------------------------------------------
<S> <C> <C> <C>
Single-Family Housing 5.5%
State of New York Mortgage
Agency, Homeowner
Mortgage Revenue Bonds,
Series 45, 7.20% .................. $2,000,000 10/01/2017 $ 2,205,340
State of New York Mortgage
Agency, Homeowner
Mortgage Revenue Bonds,
Series 55, 5.95% .................. 1,550,000 10/01/2017 1,636,180
-----------
3,841,520
-----------
Special/Sales Tax 1.4%
New York City Transitional
Finance Authority, Future Tax
Secured Bonds, Fiscal 1998
Series A, 5.00% ................... 1,000,000 8/15/2027 972,840
-----------
Structured Financings 6.4%
Port Authority of New York
and New Jersey, Special
Project Bonds, Series 4, KIAC
Partners Project, Subject to
AMT, 6.75% ........................ 3,000,000 10/01/2011 3,349,920
New York City Industrial
Development Agency,
Industrial Development
Revenue Bonds, (Brooklyn
Navy Yard Cogeneration
Partners, L.P. Project), Series
1997, 6.20% ....................... 1,000,000 10/01/2022 1,114,260
-----------
4,464,180
-----------
Toll Roads/Turnpike Authorities 5.4%
Triborough Bridge and Tunnel
Authority, General Purpose
Revenue Bonds, Series 1994
A, 6.00% .......................... 2,500,000 1/01/2010 2,814,775
New York State Thruway
Authority, Local Highway and
Bridge Service Contract
Bonds, Series 1997, 5.00% ......... 1,000,000 4/01/2017 968,690
-----------
3,783,465
-----------
</TABLE>
The accompanying notes are an integral part of the financial statements.
71
<PAGE>
STATE STREET RESEARCH NEW YORK TAX-FREE FUND
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------
Principal Maturity Value
Amount Date (Note 1)
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C>
Transit/Highway 1.4%
Metropolitan Transportation
Authority, Commuter Facilities
Service Contract Bonds, Series
R, AMBAC Insured, 5.50%+ ........... $1,000,000 7/01/2011 $ 1,009,890
-----------
Water & Sewer 8.2%
City of Niagara Falls, Niagara
County, New York, Water
Treatment Plant Bonds, 1994
(AMT), MBIA Insured, 8.50% ......... 1,000,000 11/01/2006 1,303,760
New York State Environmental
Facilities Corporation, State
Water Pollution Control,
Revolving Fund Revenue
Bonds, Series 1994 D, (Pooled
Loan Issue), 6.70% ................. 2,000,000 11/15/2009 2,290,340
Commonwealth of Puerto
Rico, Aqueduct and Sewer
Authority, General Revenue
Bonds, 6.25% ....................... 1,000,000 7/01/2012 1,155,800
New York City Municipal
Water Finance Authority,
Water and Sewer System
Revenue Bonds, Fiscal 1998
Series B, FGIC Insured,
5.125% ............................. 1,000,000 6/15/2030 983,650
-----------
5,733,550
-----------
Total Municipal Bonds and Investments
(Cost $65,877,653)--101.8%.................................. 71,474,719
Cash and Other Assets, Less Liabilities--(1.8%) ............. (1,291,021)
-----------
Net Assets--100.0% .......................................... $70,183,698
===========
<S> <C>
Federal Income Tax Information:
At December 31, 1997, the net unrealized
appreciation of investments based on cost for Federal
income tax purposes of $65,877,653 was as follows:
Aggregate gross unrealized appreciation for all
investments in which there is an excess of value over
tax cost .................................................................. $ 5,597,066
Aggregate gross unrealized depreciation for all
investments in which there is an excess of tax cost
over value ................................................................ --
-----------
$ 5,597,066
===========
</TABLE>
- --------------------------------------------------------------------------------
+ The delivery and payment of this security is beyond the normal settlement
time. The purchase price and interest rate are fixed at the trade date
although interest is not earned until settlement date.
* A portion of this security is being used to collateralize the delayed delivery
purchase noted above. The total market value of segregated securities is
$1,034,028.
The accompanying notes are an integral part of the financial statements.
72
<PAGE>
STATE STREET RESEARCH NEW YORK TAX-FREE FUND
- --------------------------------------------------------------------------------
STATEMENT OF ASSETS AND LIABILITIES
- --------------------------------------------------------------------------------
December 31, 1997
<TABLE>
<S> <C>
Assets
Investments, at value (Cost $65,877,653) (Note 1)..................... $71,474,719
Cash ................................................................. 20,867
Interest receivable .................................................. 1,347,803
Receivable for fund shares sold ...................................... 49,802
Receivable from Distributor (Note 3) ................................. 24,919
Other assets ......................................................... 3,579
-----------
72,921,689
Liabilities
Payable for securities purchased ..................................... 2,466,355
Dividends payable .................................................... 64,672
Accrued transfer agent and shareholder services
(Note 2) ........................................................... 33,085
Accrued management fee (Note 2) ...................................... 32,591
Payable for fund shares redeemed ..................................... 27,249
Accrued distribution and service fees (Note 5) ....................... 19,583
Accrued trustees' fees (Note 2) ...................................... 6,096
Other accrued expenses ............................................... 88,360
-----------
2,737,991
-----------
Net Assets $70,183,698
===========
Net Assets consist of:
Undistributed net investment income ................................. $ 94,763
Unrealized appreciation of investments .............................. 5,597,066
Accumulated net realized loss ....................................... (132,986)
Paid-in capital ..................................................... 64,624,855
-----------
$70,183,698
===========
Net Asset Value and redemption price per share of
Class A shares ($20,193,432 [divided by] 2,381,068 shares) ......... $8.48
=====
Maximum Offering Price per share of Class A shares
($8.48 [divided by] .955)........................................... $8.88
=====
Net Asset Value and offering price per share of Class
B shares ($17,426,202 [divided by] 2,055,032 shares) ............... $8.48
=====
Net Asset Value and offering price per share of Class
C shares ($805,190 [divided by] 94,893 shares) ..................... $8.49
=====
Net Asset Value, offering price and redemption price per share of
Class S shares ($31,758,874 [divided by] ,741,482 shares) .......... $8.49
=====
</TABLE>
- --------------------------------------------------------------------------------
* Redemption price per share for Class B and Class C is equal to net asset value
less any applicable contingent deferred sales charge.
<TABLE>
- --------------------------------------------------------------------------------
STATEMENT OF OPERATIONS
- --------------------------------------------------------------------------------
For the Year Ended December 31, 1997
<S> <C>
Investment Income
Interest ..................................................... $4,156,586
Expenses
Management fee (Note 2) ...................................... 382,777
Transfer agent and shareholder services (Note 2) ............. 113,074
Custodian fee ................................................ 98,109
Reports to shareholders ...................................... 38,945
Audit fee .................................................... 19,586
Trustees' fees (Note 2) ...................................... 18,401
Registration fees ............................................ 10,145
Legal fees ................................................... 8,529
Service fee--Class A (Note 5) ................................ 49,421
Distribution and service fees--Class B (Note 5) .............. 167,726
Distribution and service fees--Class C (Note 5) .............. 7,123
Miscellaneous ................................................ 11,700
----------
925,536
Expenses borne by the Distributor (Note 3) ................... (113,047)
----------
812,489
----------
Net investment income ........................................ 3,344,097
----------
Realized and Unrealized Gain (Loss)
on Investments and Futures Contracts
Net realized gain on investments (Notes 1 and 4) ............. 563,259
Net realized loss on futures contracts (Note 1) .............. (31,167)
----------
Total net realized gain .................................... 532,092
Net unrealized appreciation of investments ................... 2,315,876
----------
Net gain on investments and futures contracts ................ 2,847,968
----------
Net increase in net assets resulting from operations ......... $6,192,065
==========
</TABLE>
The accompanying notes are an integral part of the financial statements.
73
<PAGE>
STATE STREET RESEARCH NEW YORK TAX-FREE FUND
- --------------------------------------------------------------------------------
STATEMENT OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Years ended December 31
-----------------------------
1996 1997
- ----------------------------------------------------------------------
<S> <C> <C>
Increase (Decrease) in Net Assets
Operations:
Net investment income ................ $ 3,358,438 $ 3,344,097
Net realized gain on
investments and futures
contracts .......................... 36,115 532,092
Net unrealized appreciation
(depreciation) of
investments ........................ (908,453) 2,315,876
----------- -----------
Net increase resulting from
operations.......................... 2,486,100 6,192,065
----------- -----------
Dividends from net investment income:
Class A ............................. (943,352) (937,424)
Class B ............................. (635,153) (668,573)
Class C ............................. (25,084) (28,327)
Class S ............................. (1,809,871) (1,615,010)
----------- -----------
(3,413,460) (3,249,334)
----------- -----------
Net decrease from fund share
transactions (Note 7) .............. (2,475,362) (3,890,647)
----------- -----------
Total decrease in net assets ......... (3,402,722) (947,916)
Net Assets
Beginning of year .................... 74,534,336 71,131,614
----------- -----------
End of year (including
undistributed net
investment income of
$0 and $94,763,
respectively) ...................... $71,131,614 $70,183,698
=========== ===========
</TABLE>
- --------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
December 31, 1997
Note 1
State Street Research New York Tax-Free Fund (the "Fund"), is a series of State
Street Research 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. The Trust consists
presently of two separate funds: State Street Research New York Tax-Free Fund
and State Street Research Tax-Exempt Fund.
The investment objective of the Fund is to seek a high level of interest income
exempt from federal income taxes and New York State and New York City personal
income taxes. To achieve its investment objective, the Fund intends to invest
primarily in securities which are issued by or on behalf of New York State or
its political subdivisions and by other governmental entities.
The Fund offers four classes of shares. Before November 1, 1997, Class C shares
were designated Class D and Class S shares were designated Class C. 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 subject to a contingent deferred sales charge of 1.00% on any
shares redeemed within one year of their purchase. Class C shares also pay
annual distribution and service fees of 1.00%. Class S shares are only offered
through certain retirement accounts, advisory accounts of State Street Research
& Management Company (the "Adviser"), an indirect wholly owned subsidiary of
Metropolitan Life Insurance Company ("Metropolitan"), and special programs. No
sales charge is imposed at the time of purchase or redemption of Class S shares.
Class S shares do not pay any distribution or service fees. 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 declare 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.
The accompanying notes are an integral part of the financial statements.
74
<PAGE>
STATE STREET RESEARCH NEW YORK TAX-FREE FUND
- --------------------------------------------------------------------------------
NOTES (cont'd)
- --------------------------------------------------------------------------------
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
between both 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.
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, 1997, the Fund had a capital
loss carryforward of $132,986 available, to the extent provided in regulations,
to offset future capital gains, if any, which expires on December 31, 2002.
F. Futures Contracts
The Fund may enter into futures contracts as a hedge against unfavorable market
conditions and to enhance income. The Fund will not purchase any futures
contract if, after such purchase, more than one-third of net assets would be
represented by long futures contracts. The Fund will limit its risks by entering
into a futures position only if it appears to be a liquid investment.
Upon entering into a futures contract, the Fund deposits with the selling broker
sufficient cash or U.S. Government securities to meet the minimum "initial
margin" requirements. Thereafter, the Fund receives from or pays to the broker
cash or U.S. Government securities equal to the daily fluctuation in value of
the contract ("variation margin"), which is recorded as unrealized gain or loss.
When the contract is closed, the Fund records a realized gain or loss equal to
the difference between the value of the contract at the time it was opened and
the value at the time it was closed.
G. Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of income and expenses during the reporting period. Actual
results could differ from those estimates.
H. Securities Lending
The Fund may seek additional income by lending portfolio securities to qualified
institutions. The Fund will receive cash or securities as collateral in an
amount equal to at least 100% of the current market value of any loaned
securities plus accrued interest. If the borrower fails to return the securities
and the value of the collateral has declined during the term of the loan, the
Fund will bear the loss. During the year ended December 31, 1997, there were no
loaned securities.
Note 2
The Trust and the Adviser 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, 1997, the fees pursuant to such
agreement amounted to $382,777.
State Street Research Service Center, 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, 1997, the amount of such
expenses was $23,644.
The fees of the Trustees not currently affiliated with the Adviser amounted to
$18,401 during the year ended December 31, 1997.
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, 1997, the amount of such expenses assumed by the
Distributor and its affiliates was $113,047.
Note 4
For the year ended December 31, 1997, purchases and sales of securities,
exclusive of short-term obligations, aggregated $35,170,591 and $36,319,324,
respectively.
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 C shares. In addition, the Fund pays
annual distribution fees of 0.75% of average daily net assets for Class B and
Class C shares. The Distributor uses such payments for personal services and/or
the maintenance or servicing 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, 1997, fees pursuant to such plan amounted to
$49,421, $167,726 and $7,123 for Class A, Class B and Class C shares,
respectively.
75
<PAGE>
STATE STREET RESEARCH NEW YORK TAX-FREE FUND
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
The Fund has been informed that the Distributor and MetLife Securities, Inc., a
wholly owned subsidiary of Metropolitan, earned initial sales charges
aggregating $14,177 and $106,188, respectively, on sales of Class A shares of
the Fund during the year ended December 31, 1997, and that MetLife Securities,
Inc. earned commissions aggregating $102,457 on sales of Class B shares, and
that the Distributor collected contingent deferred sales charges aggregating
$43,278 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.
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, 1997, the
Distributor owned 59,031 Class S shares of the Fund.
Share transactions were as follows:
<TABLE>
<CAPTION>
Years ended December 31
-----------------------------------------------------------------
1996 1997
------------------------------- -------------------------------
Class A Shares Amount Shares Amount
- ----------------------------------------------- ------------- --------------- ------------- ---------------
<S> <C> <C> <C> <C>
Shares sold ................................... 598,718 $ 4,808,712 582,598 $ 4,780,960
Issued upon reinvestment of dividends ......... 93,925 754,768 90,168 742,070
Shares repurchased ............................ (713,493) (5,744,887) (707,169) (5,809,807)
-------- ------------ -------- ------------
Net decrease .................................. (20,850) $ (181,407) (34,403) $ (286,777)
======== ============ ======== ============
Class B Shares Amount Shares Amount
- ------------------------------------------------ -------- ------------ -------- ------------
Shares sold ................................... 504,073 $ 4,044,795 368,649 $ 3,022,966
Issued upon reinvestment of dividends ......... 61,038 490,585 60,770 499,904
Shares repurchased ............................ (328,785) (2,628,310) (444,087) (3,640,568)
-------- ------------ -------- ------------
Net increase (decrease) ....................... 236,326 $ 1,907,070 (14,668) $ (117,698)
======== ============ ======== ============
Class C (Formerly Class D) Shares Amount Shares Amount
- ------------------------------------------------ -------- ------------ -------- ------------
Shares sold ................................... 2,131 $ 17,119 21,486 $ 177,283
Issued upon reinvestment of dividends ......... 597 4,804 789 6,513
Shares repurchased ............................ (5,330) (42,575) (3,813) (31,241)
-------- ------------ -------- ------------
Net increase (decrease) ....................... (2,602) $ (20,652) 18,462 $ 152,555
======== ============ ======== ============
Class S (Formerly Class C) Shares Amount Shares Amount
- ------------------------------------------------ -------- ------------ -------- ------------
Shares sold ................................... 3,913 $ 31,610 30,543 $ 251,985
Issued upon reinvestment of dividends ......... 169,712 1,369,640 147,584 1,215,141
Shares repurchased ............................ (694,720) (5,581,623) (621,522) (5,105,853)
-------- ------------ -------- ------------
Net decrease .................................. (521,095) $ (4,180,373) (443,395) $ (3,638,727)
======== ============ ======== ============
</TABLE>
76
<PAGE>
STATE STREET RESEARCH NEW YORK TAX-FREE FUND
- --------------------------------------------------------------------------------
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
For a share outstanding throughout each year:
<TABLE>
<CAPTION>
Class A
----------------------------------------------------------
Years ended December 31
----------------------------------------------------------
1993(1) 1994 1995 1996 1997
-------------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Net asset value, beginning of year ($) 8.20 8.43 7.53 8.23 8.13
----- ----- ------ ----- -----
Net investment income ($)* 0.22 0.40 0.40 0.38 0.39
Net realized and unrealized gain (loss) on investments
and futures contracts ($) 0.25 (0.90) 0.71 (0.09) 0.35
----- ------ ------ ------ -----
Total from investment operations ($) 0.47 (0.50) 1.11 0.29 0.74
----- ------ ------ ------ -----
Dividends from net investment income ($) (0.22) (0.39) (0.41) (0.39) (0.39)
Distributions from net realized gains ($) (0.02) (0.01) -- -- --
------ ------ ------- ------ ------
Total distributions ($) (0.24) (0.40) (0.41) (0.39) (0.39)
------ ------ ------- ------ ------
Net asset value, end of year ($) 8.43 7.53 8.23 8.13 8.48
====== ====== ======= ====== ======
Total return(2) (%) 5.79(3) (6.04) 15.11 3.68 9.22
Ratios/supplemental data:
Net assets at end of year ($ thousands) 15,175 18,214 20,043 19,636 20,193
Ratio of operating expenses to average net assets (%)* 1.10(4) 1.10 1.10 1.10 1.10
Ratio of net investment income to average net assets (%)* 4.68(4) 5.07 5.07 4.76 4.88
Portfolio turnover rate (%) 33.11 64.80 109.74 89.14 50.92
* Reflects voluntary assumption of fees or expenses per
share in each year (Note 3) ($) 0.01 0.03 0.02 0.01 0.01
<CAPTION>
Class B
---------------------------------------------------------
Years ended December 31
---------------------------------------------------------
1993(1) 1994 1995 1996 1997
-------------- ---------- ---------- ---------- ---------
<S> <C> <C> <C> <C> <C>
Net asset value, beginning of year ($) 8.20 8.43 7.53 8.23 8.13
----- ----- ------ ----- -----
Net investment income ($)* 0.19 0.34 0.34 0.32 0.33
Net realized and unrealized gain (loss) on investments
and futures contracts ($) 0.25 (0.90) 0.71 (0.09) 0.35
----- ------ ------ ------ -----
Total from investment operations ($) 0.44 (0.56) 1.05 0.23 0.68
----- ------ ------ ------ -----
Dividends from net investment income ($) (0.19) (0.33) (0.35) (0.33) (0.33)
Distributions from net realized gains ($) (0.02) (0.01) -- -- --
------ ------ ------- ------ ------
Total distributions ($) (0.21) (0.34) (0.35) (0.33) (0.33)
------ ------ ------- ------ ------
Net asset value, end of year ($) 8.43 7.53 8.23 8.13 8.48
====== ====== ======= ====== ======
Total return(2) (%) 5.35(3) (6.74) 14.26 2.91 8.41
Ratios/supplemental data:
Net assets at end of year ($ thousands) 7,567 12,131 15,084 19,824 17,426
Ratio of operating expenses to average net assets (%)* 1.85(4) 1.85 1.85 1.85 1.85
Ratio of net investment income to average net assets (%)* 3.93(4) 4.34 4.32 4.01 4.12
Portfolio turnover rate (%) 33.11 64.80 109.74 89.14 50.92
* Reflects voluntary assumption of fees or expenses per
share in each year (Note 3) ($) 0.01 0.03 0.02 0.01 0.01
</TABLE>
<TABLE>
<CAPTION>
Class C (Formerly Class D)
------------------------------------------------------
Years ended December 31
------------------------------------------------------
1993(1) 1994 1995 1996 1997
-------------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Net asset value, beginning of year ($) 8.20 8.44 7.53 8.23 8.13
----- ----- ------ ----- -----
Net investment income ($)* 0.19 0.34 0.35 0.32 0.34
Net realized and unrealized gain (loss) on investments
and futures contracts ($) 0.25 (0.91) 0.70 (0.09) 0.35
----- ------ ------ ------ -----
Total from investment operations ($) 0.44 (0.57) 1.05 0.23 0.69
----- ------ ------ ------ -----
Dividends from net investment income ($) (0.18) (0.33) (0.35) (0.33) (0.33)
Distributions from net realized gains ($) (0.02) (0.01) -- -- --
------ ------ ------- ------ ------
Total distributions ($) (0.20) (0.34) (0.35) (0.33) (0.33)
------ ------ ------- ------ ------
Net asset value, end of year ($) 8.44 7.53 8.23 8.13 8.49
====== ====== ======= ====== ======
Total return(2) (%) 5.46(3) (6.86) 14.25 2.90 8.53
Ratios/supplemental data:
Net assets at end of year ($ thousands) 821 774 651 622 805
Ratio of operating expenses to average net assets (%)* 1.85(4) 1.85 1.85 1.85 1.85
Ratio of net investment income to average net assets (%)* 3.94(4) 4.31 4.35 4.03 4.11
Portfolio turnover rate (%) 33.11 64.80 109.74 89.14 50.92
* Reflects voluntary assumption of fees or expenses per
share in each year (Note 3) ($) 0.01 0.03 0.02 0.01 0.01
<CAPTION>
Class S (Formerly Class C)
-----------------------------------------------------
Years ended December 31
-----------------------------------------------------
1993 1994 1995 1996 1997
---------- ---------- ---------- ---------- ---------
<S> <C> <C> <C> <C> <C>
Net asset value, beginning of year ($) 7.84 8.44 7.54 8.24 8.14
----- ----- ------ ----- -----
Net investment income ($)* 0.42 0.42 0.42 0.40 0.43
Net realized and unrealized gain (loss) on investments
and futures contracts ($) 0.62 (0.90) 0.71 (0.09) 0.33
----- ------ ------ ------ -----
Total from investment operations ($) 1.04 (0.48) 1.13 0.31 0.76
----- ------ ------ ------ -----
Dividends from net investment income ($) (0.42) (0.41) (0.43) (0.41) (0.41)
Distributions from net realized gains ($) (0.02) (0.01) -- -- --
------ ------ ------- ------ ------
Total distributions ($) (0.44) (0.42) (0.43) (0.41) (0.41)
------ ------ ------- ------ ------
Net asset value, end of year ($) 8.44 7.54 8.24 8.14 8.49
====== ====== ======= ====== ======
Total return(2) (%) 13.46 (5.79) 15.37 3.93 9.48
Ratios/supplemental data:
Net assets at end of year ($ thousands) 56,515 40,750 38,757 34,050 31,759
Ratio of operating expenses to average net assets (%)* 0.85 0.85 0.85 0.85 0.85
Ratio of net investment income to average net assets (%)* 5.10 5.29 5.33 5.01 5.13
Portfolio turnover rate (%) 33.11 64.80 109.74 89.14 50.92
* Reflects voluntary assumption of fees or expenses per
share in each year (Note 3) ($) 0.01 0.03 0.02 0.01 0.01
</TABLE>
- --------------------------------------------------------------------------------
(1) June 7, 1993 (commencement of share class designations) to December 31,
1993.
(2) 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.
(3) Not annualized.
(4) Annualized.
77
<PAGE>
- --------------------------------------------------------------------------------
REPORT OF INDEPENDENT ACCOUNTANTS
- --------------------------------------------------------------------------------
To the Trustees of State Street Research
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 State Street Research Tax-Exempt Trust, hereafter
referred to as the "Trust") at December 31, 1997, 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 at
December 31, 1997 by correspondence with the custodian and brokers, and the
application of alternative auditing procedures where confirmations from brokers
were not received, provide a reasonable basis for the opinion expressed above.
Price Waterhouse LLP
Boston, Massachusetts
February 6, 1998
78
<PAGE>
STATE STREET RESEARCH NEW YORK TAX-FREE FUND
- --------------------------------------------------------------------------------
MANAGEMENT'S DISCUSSION OF FUND PERFORMANCE
- --------------------------------------------------------------------------------
State Street Research New York Tax-Free Fund had a strong year. Class A shares
returned +9.22% [without sales charge] for the 12 months ended December 31,
1997. This performance was higher than that of the average New York municipal
debt fund tracked by Lipper Analytical Services, which returned 8.99% for the
same period. The Lehman Brothers Municipal Bond Index gained 9.19% for the same
period.
The Fund invests primarily in tax-exempt debt obligations issued by or on behalf
of New York state, New York City or the political subdivisions and other
governmental agencies of either.
A generally favorable economic environment helped the Fund's performance during
the year. To the extent that it was possible, the manager increased the Fund's
investments in higher-yielding, uninsured and zero coupon bonds and gradually
lengthened the Fund's duration. As interest rates came down during the year and
the supply of newly-issued New York bonds remained low, the Fund's return got a
boost from capital appreciation.
With a favorable outlook for both the local and national economy and continued
demand for tax-free income from investors in the highest income tax brackets,
the outlook for the Fund remains positive for the period ahead.
December 31, 1997
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. Performance for a class may include periods prior to the
adoption of class designations in 1993, which resulted in new or increased 12b-1
fees of up to 1% per class thereafter and which will reduce subsequent
performance. "S" shares, offered without a sales charge, are available through
certain employee benefit plans and special programs. Performance reflects
maximum 4.5% "A" share front-end sales charge or 5% "B" share or 1% "C" share
contingent deferred sales charges where applicable. Before November 1, 1997,
Class C shares were designated Class D and Class S shares were designated Class
C. The Lehman Brothers Municipal Bond Index is a commonly used measure of bond
market performance. The index is unmanaged and does not take sales charges into
consideration. Direct investment in the index is not possible; results are for
illustrative purposes only. Performance results for the Fund are increased by
the voluntary reduction of Fund fees and expenses; without subsidization,
performance would have been lower.
Change In Value Of $10,000 Based On
The Lehman Municipal Bond Index Compared To
Change In Value Of $10,000
Invested In Tax-Exempt Fund
Class A Shares
Tax-Exempt Lehman Municipal
Fund Bond Index
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 13,256 14,485
12/95 15,259 17,014
12/96 15,820 17,767
12/97 17,279 19,400
Average Annual Total Return
- ------------------------------------------
1 Year 5 Years 10 Years
- ------------------------------------------
+4.31% +5.77% +6.65%
Class B Shares
Tax-Exempt Lehman Municipal
Fund Bond Index
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
12/95 15,675 17,014
12/96 16,131 17,767
12/97 17,487 19,400
Average Annual Total Return
- ------------------------------------------
1 Year 5 Years 10 Years
- ------------------------------------------
+3.41% +5.71% +6.80%
Class C Shares
Tax-Exempt Lehman Municipal
Fund Bond Index
12/89 10,172 10,391
12/90 10,509 11,148
12/91 11,967 12,502
12/92 13,052 13,504
12/93 14,726 15,275
12/94 13,717 14,485
12/95 15,671 17,014
12/96 16,126 17,767
12/97 17,502 19,400
Average Annual Total Return
- ------------------------------------------
1 Year 5 Years 10 Years
- ------------------------------------------
+7.53% +6.04% +6.81%
Class S Shares
Tax-Exempt Lehman Municipal
Fund Bond Index
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
12/95 16,097 17,014
12/96 16,729 17,767
12/97 18,315 19,400
Average Annual Total Return
- ------------------------------------------
1 Year 5 Years 10 Years
- ------------------------------------------
+9.48% +7.01% +7.38%
79
.
