<PAGE>
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Vanguard
PENNSYLVANIA
TAX-FREE FUND A Member of The Vanguard Group
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PROSPECTUS--MARCH 28, 1995
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NEW ACCOUNT INFORMATION: INVESTOR INFORMATION DEPARTMENT--1-800-662-7447 (SHIP)
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SHAREHOLDER ACCOUNT SERVICES: CLIENT SERVICES DEPARTMENT--1-800-662-2739 (CREW)
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INVESTMENT Vanguard Pennsylvania Tax-Free Fund (the "Fund") is
OBJECTIVE AND an open-end non-diversified investment company that
POLICIES seeks to provide income that is exempt from federal
and Pennsylvania personal income taxes. The Fund
will invest primarily in securities issued by
Pennsylvania state and local governments and public
financing authorities, but may also invest in secu-
rities of issuers other than Pennsylvania and its
political subdivisions. The Fund consists of a Money
Market Portfolio and an Insured Long-Term Portfolio,
each with distinct investment objectives and poli-
cies. The Portfolios are available only to Pennsyl-
vania residents. THE MONEY MARKET PORTFOLIO SEEKS TO
MAINTAIN, BUT DOES NOT GUARANTEE, A CONSTANT NET AS-
SET VALUE OF $1.00 PER SHARE. ALTHOUGH THE MONEY
MARKET PORTFOLIO INVESTS IN HIGH-QUALITY INSTRU-
MENTS, AN INVESTMENT IN THE PORTFOLIO IS NEITHER IN-
SURED NOR GUARANTEED BY THE U.S. GOVERNMENT.
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OPENING AN Please complete and return the Account Registration
ACCOUNT Form. If you need assistance in completing this
Form, please call the Investor Information Depart-
ment, Monday through Friday, from 8:00 a.m. to 9:00
p.m. and Saturday, from 9:00 a.m. to 4:00 p.m.
(Eastern time). The minimum initial investment is
$3,000 for each Portfolio or $500 for Uniform
Gifts/Transfers to Minors Act accounts. The Fund is
offered on a no-load basis (i.e., there are no sales
commissions or 12b-1 fees). However, the Fund incurs
expenses for investment advisory, management, admin-
istrative, and distribution services.
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ABOUT THIS This Prospectus is designed to set forth concisely
PROSPECTUS the information you should know about the Fund be-
fore you invest. It should be retained for future
reference. A "Statement of Additional Information"
containing additional information about the Fund has
been filed with the Securities and Exchange Commis-
sion. This Statement is dated March 28, 1995 and has
been incorporated by reference into this Prospectus.
It may be obtained, without charge, by writing to
the Fund or by calling the Investor Information De-
partment.
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<TABLE>
<CAPTION>
TABLE OF CONTENTS Page
<S> <C>
Fund Expenses......... 2
Financial Highlights.. 3
Yield and Total
Return............... 4
FUND INFORMATION
Investment Objective.. 5
Investment Policies... 5
Investment Risks...... 8
Who Should Invest..... 10
How to Compare Tax-
Free and Taxable
Yields............... 11
</TABLE>
<TABLE>
<CAPTION>
Page
<S> <C>
Implementation of
Policies............. 12
Investment
Limitations.......... 17
Management of the
Fund................. 17
Investment Adviser.... 18
Dividends, Capital
Gains and Taxes...... 19
The Share Price of
Each Portfolio....... 21
General Information... 22
</TABLE>
<TABLE>
<CAPTION>
Page
<S> <C>
SHAREHOLDER GUIDE
Opening an Account
and Purchasing
Shares............... 24
When Your Account
Will Be Credited..... 27
Selling Your Shares... 28
Exchanging Your
Shares............... 30
Important Information
About Telephone
Transactions......... 32
Transferring
Registration......... 32
Other Vanguard
Services............. 33
</TABLE>
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THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION, NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE COMMISSION PASSED UPON THE ACCURACY OR AD-
EQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OF-
FENSE.
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<PAGE>
FUND EXPENSES The following table illustrates ALL expenses and fees that
you would incur as a shareholder of the Fund. The expenses
and fees set forth in the table are for the 1994 fiscal year.
<TABLE>
<CAPTION>
MONEY INSURED
MARKET LONG-TERM
SHAREHOLDER TRANSACTION EXPENSES PORTFOLIO PORTFOLIO
--- --------------------------------------------------------------
<S> <C> <C>
Sales Load Imposed on Purchases..... None None
Sales Load Imposed on Reinvested
Dividends........................... None None
Redemption Fees*.................... None None
Exchange Fees....................... None None
</TABLE>
<TABLE>
<CAPTION>
MONEY INSURED
MARKET LONG-TERM
ANNUAL FUND OPERATING EXPENSES PORTFOLIO PORTFOLIO
-------------------------------------------------------------------
<S> <C> <C> <C> <C>
Management & Administrative
Expenses........................... 0.16% 0.16%
Investment Advisory Expenses....... 0.01 0.01
12b-1 Fees......................... None None
Other Expenses
Distribution Costs................ 0.03% 0.02%
Miscellaneous Expenses............ 0.00 0.01
Fund Insurance.................... None 0.00
---- ----
Total Other Expenses............... 0.03% 0.03%
---- -----
TOTAL OPERATING EXPENSES........ 0.20% 0.20%
==== =====
</TABLE>
*Wire redemptions under $5,000 are subject to a $5
charge.
The purpose of this table is to assist you in understanding
the various costs and expenses that you would bear directly
or indirectly as an investor in the Fund.
The following example illustrates the expenses that you would
incur on a $1,000 investment over various periods, assuming
(1) a 5% annual rate of return and (2) redemption at the end
of each period. As noted in the table above, the Fund charges
no redemption fees of any kind.
<TABLE>
<CAPTION>
1 YEAR 3 YEARS 5 YEARS 10 YEARS
------ ------- ------- --------
<S> <C> <C> <C> <C>
Money Market Portfolio............. $2 $6 $11 $26
Insured Long-Term Portfolio........ $2 $6 $11 $26
</TABLE>
THIS EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF
PAST OR FUTURE EXPENSES OR PERFORMANCE. ACTUAL EXPENSES MAY
BE HIGHER OR LOWER THAN THOSE SHOWN.
--------------------------------------------------------------------------------
2
<PAGE>
FINANCIAL The following financial highlights for a share outstanding
HIGHLIGHTS throughout each period insofar as they relate to each of the
five years in the period ended November 30, 1994, have been
audited by Price Waterhouse LLP, independent accountants,
whose report thereon was unqualified. This information should
be read in conjunction with the Fund's financial statements
and notes thereto, which are incorporated by reference in the
Statement of Additional Information and in this Prospectus,
and which appear, along with the report of Price Waterhouse
LLP, in the Fund's 1994 Annual Report to Shareholders. For a
more complete discussion of the Fund's performance, please
see the Fund's 1994 Annual Report to Shareholders, which may
be obtained without charge by writing to the Fund or by call-
ing our Investor Information Department at 1-800-662-7447.
<TABLE>
<CAPTION>
---------------------------------------------------------
MONEY MARKET PORTFOLIO
---------------------------------------------------------
YEAR ENDED
NOVEMBER 30, JUNE 13** TO
------------------------------------------- NOV. 30,
1994 1993 1992 1991 1990 1989 1988
-----------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
NET ASSET VALUE,
BEGINNING OF PERIOD.... $ 1.00 $ 1.00 $ 1.00 $1.00 $1.00 $1.00 $1.00
------ ------ ------ ----- ----- ----- -----
INVESTMENT OPERATIONS
Net Investment Income.. .025 .024 .029 .045 .057 .062 .025
Net Realized and
Unrealized Gain (Loss)
on Investments........ -- -- -- -- -- -- --
------ ------ ------ ----- ----- ----- -----
TOTAL FROM INVESTMENT
OPERATIONS........... .025 .024 .029 .045 .057 .062 .025
-----------------------------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net
Investment Income..... (.025) (.024) (.029) (.045) (.057) (.062) (.025)
Distributions from
Realized Capital
Gains................. -- -- -- -- -- -- --
------ ------ ------ ----- ----- ----- -----
TOTAL DISTRIBUTIONS... (.025) (.024) (.029) (.045) (.057) (.062) (.025)
-----------------------------------------------------------------------------------
NET ASSET VALUE, END OF
PERIOD................. $11.00 $ 1.00 $ 1.00 $1.00 $1.00 $1.00 $1.00
-----------------------------------------------------------------------------------
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TOTAL RETURN............ 2.57% 2.38% 2.96% 4.59% 5.85% 6.38% 2.54%
-----------------------------------------------------------------------------------
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RATIOS/SUPPLEMENTAL DATA
Net Assets, End of
Period (Millions)...... $1,105 $935 $782 $818 $730 $448 $173
Ratio of Expenses to
Average Net Assets..... .20% .20% .24% .24% .23% .23% .33%*
Ratio of Net Investment
Income to Average Net
Assets................. 2.55% 2.35% 2.93% 4.48% 5.68% 6.19% 5.59%*
Portfolio Turnover Rate. N/A N/A N/A N/A N/A N/A N/A
</TABLE>
*Annualized.
**Commencement of operations.
3
<PAGE>
<TABLE>
<CAPTION>
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INSURED LONG-TERM PORTFOLIO
-----------------------------------------------------------------------------------
YEAR ENDED
NOVEMBER 30, APRIL 7** TO
-------------------------------------------------------------------- NOV. 30,
1994 1993 1992 1991 1990 1989 1988 1987 1986
-------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
NET ASSET VALUE,
BEGINNING OF PERIOD.... $11.36 $10.96 $10.47 $10.19 $10.16 $ 9.70 $ 9.28 $10.30 $10.00
------ ------ ------ ------ ------ ------ ------ ------ ------
INVESTMENT OPERATIONS
Net Investment Income.. .625 .631 .664 .667 .679 .687 .670 .678 .410
Net Realized and
Unrealized Gain (Loss)
on Investments........ (1.211) .624 .520 .286 .030 .460 .420 (1.020) .300
------ ------ ------ ------ ------ ------ ------ ------ ------
TOTAL FROM INVESTMENT
OPERATIONS........... (.586) 1.255 1.184 .953 .709 1.147 1.090 (.342) .710
-------------------------------------------------------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net
Investment Income..... (.625) (.631) (.664) (.667) (.679) (.687) (.670) (.678) (.410)
Distributions from
Realized Capital
Gains................. (.079) (.224) (.030) (.006) -- -- -- -- --
------ ------ ------ ------ ------ ------ ------ ------ ------
TOTAL DISTRIBUTIONS... (.704) (.855) (.694) (.673) (.679) (.687) (.670) (.678) (.410)
-------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF
PERIOD................. $10.07 $11.36 $10.96 $10.47 $10.19 $10.16 $ 9.70 $ 9.28 $10.30
-------------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------------
TOTAL RETURN............ (5.44)% 11.90% 11.65% 9.65% 7.27% 12.16% 12.01% (3.33)% 7.65%
-------------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------------
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of
Period (Millions)...... $1,299 $1,496 $1,130 $828 $556 $416 $270 $194 $122
Ratio of Expenses to
Average Net Assets..... .20% .20% .24%+ .25%+ .25%+ .26%+ .33%+ .31%+ .33%+*
Ratio of Net Investment
Income to Average Net
Assets................. 5.76% 5.61% 6.17% 6.46% 6.77% 6.87% 6.95% 7.06% 6.65%*
Portfolio Turnover Rate. 16% 14% 17% 2% 9% 8% 3% 15% 0%
</TABLE>
*Annualized.
+Insurance expense represents .01%, .01%, .02%, .03%, .04%, .05%, and .05%.
**Commencement of operations.
--------------------------------------------------------------------------------
YIELD AND From time to time a Portfolio of the Fund may advertise its
TOTAL RETURN yield and total return. Both yield and total return figures
are based on historical earnings and are not intended to in-
dicate future performance. The "total return" of a Portfolio
refers to the average annual compounded rates of return over
one-, five- and ten-year periods or over the life of a Port-
folio (as stated in the advertisement) that would equal an
initial amount invested at the beginning of a stated period
to the ending redeemable value of the investment, assuming
the reinvestment of all dividend and capital gains distribu-
tions.
In accordance with industry guidelines set forth by the U.S.
Securities and Exchange Commission, the "30-day yield" of the
Insured Long-Term Portfolio is calculated by dividing the net
investment income per share earned during a 30-day period by
the net asset value per share on the last day of the period.
Net investment income includes interest and dividend income
earned on the Portfolio's securities; it is net of all ex-
penses and all recurring and nonrecurring charges that have
been applied to all shareholder accounts. The yield calcula-
tion assumes that the net investment income earned over 30
days is compounded monthly for six months and then
annualized.
The "seven-day" or "current" yield of the Money Market Port-
folio reflects the income earned by a hypothetical account in
the Portfolio during a seven-day period, expressed as an an-
nual percentage rate. The "effective yield" of the
4
<PAGE>
Money Market Portfolio assumes the income over the seven-day
period is reinvested weekly, resulting in a slightly higher
stated yield through compounding.
Methods used to calculate advertised yields are standardized
for money market and bond funds. However, these methods dif-
fer from the accounting methods used by the Portfolios to
maintain their books and records, and so advertised yields
may not fully reflect the income paid to your own account or
the yield reported in the Fund's Annual Report to Sharehold-
ers.
--------------------------------------------------------------------------------
INVESTMENT The Fund consists of the Pennsylvania Money Market Portfolio
OBJECTIVE and the Pennsylvania Insured Long-Term Portfolio, each of
which pursues a distinct investment objective:
THE FUND SEEKS . The objective of the PENNSYLVANIA MONEY MARKET PORTFOLIO is
TO PROVIDE to provide investors with income that is exempt from both
INCOME THAT IS federal and Pennsylvania personal income taxes. The Portfo-
EXEMPT FROM lio also seeks to maintain, but does not guarantee, a con-
FEDERAL AND stant net asset value of $1.00 per share. Although the
PENNSYLVANIA Portfolio invests in high-quality instruments, an invest-
INCOME TAXES ment in the Portfolio is neither insured nor guaranteed by
the U.S. Government.
. The objective of the PENNSYLVANIA INSURED LONG-TERM PORTFO-
LIO is to provide investors with a high level of income
that is exempt from federal and Pennsylvania personal in-
come taxes.
The two Portfolios of the Fund are available only to invest-
ors who reside in Pennsylvania. There is no assurance that
either Portfolio of the Fund will achieve its stated objec-
tive.
The investment objective of each Portfolio is fundamental and
so may not be changed without the approval of a majority of
the Fund's shareholders.
--------------------------------------------------------------------------------
INVESTMENT Each Portfolio of the Fund will invest at least 80% of its
POLICIES net assets in Pennsylvania municipal securities, exclusive of
Pennsylvania AMT bonds (see Page 6). Pennsylvania municipal
securities are debt obligations issued by Pennsylvania state
and local governments and public financing authorities (and
debt obligations issued by certain U.S. territories) that
provide interest income that is exempt from both federal and
Pennsylvania personal income taxes. The Pennsylvania munici-
pal securities described above, may include securities in
which the tax-exempt interest rate is determined by an index,
swap or some other formula. Although both invest primarily in
Pennsylvania municipal obligations, the two Portfolios differ
in terms of credit quality and maturity standards.
THE MONEY Under normal circumstances, the Pennsylvania Money Market
MARKET Portfolio will invest at least 80% of its net assets in the
PORTFOLIO WILL following high quality, short-term Pennsylvania municipal se-
INVEST IN SHORT- curities:
TERM
PENNSYLVANIA . Municipal notes and variable rate demand instruments, in-
MUNICIPAL cluding derivative securities, rated MIG-1 or VMIG-1, or P-
SECURITIES 1 by Moody's Investors Service, Inc.
5
<PAGE>
("Moody's") or SP-1+, SP-1, A-1+, or A-1 by Standard &
Poor's Corporation ("Standard & Poor's");
. Tax-exempt commercial paper rated P-1 by Moody's or A-1+ or
A-1 by Standard & Poor's;
. Municipal bonds, including derivative securities, with an
effective maturity of 13 months or less rated a minimum of
A by Moody's or Standard & Poor's; and
. Unrated municipal notes considered by the Board of Trustees
to be comparable in credit quality to securities rated MIG-
1 by Moody's or SP-1+ or SP-1 by Standard & Poor's.
In seeking to provide a stable share price of $1.00, the
Pennsylvania Money Market Portfolio is expected to maintain
an average weighted maturity of 90 days or less, and will
purchase securities with an effective maturity of 13 months
or less and that are eligible for purchase under Rule 2a-7 of
the Investment Company Act of 1940 (the "1940 Act").
Normally, the Pennsylvania Money Market Portfolio will seek
to invest substantially all of its assets in the short-term
Pennsylvania municipal obligations listed above. However, un-
der certain circumstances, such as a temporary decline in the
issuance of Pennsylvania obligations, the Portfolio may in-
vest up to 20% of its assets in the following: short-term mu-
nicipal securities issued outside of Pennsylvania (the income
from which may be subject to Pennsylvania income taxes) or
certain taxable fixed-income securities (the income from
which may be subject to federal and Pennsylvania income tax-
es).
Subject to the same 20% limit, the Portfolio is also autho-
rized to invest in short-term Pennsylvania AMT bonds. The in-
come from Pennsylvania AMT bonds is exempt from regular fed-
eral and Pennsylvania income taxes, but may be a tax prefer-
ence item for purposes of the federal alternative minimum
tax. See "Implementation of Policies" for more information.
Under unusual circumstances, such as a national financial
emergency, the Portfolio reserves the right to invest more
than 20% of its assets in securities other than Pennsylvania
municipal obligations. In most instances, however, the Penn-
sylvania Money Market Portfolio will seek to avoid such hold-
ings in an effort to provide income that is fully exempt from
federal and Pennsylvania personal income taxes.
THE INSURED Under normal circumstances, the Pennsylvania Insured Long-
LONG-TERM Term Portfolio will invest at least 80% of its net assets in
PORTFOLIO insured Pennsylvania municipal securities.
INVESTS IN
INSURED Insured municipal bonds are those in which scheduled payments
PENNSYLVANIA of interest and principal are guaranteed by a private (non-
MUNICIPAL governmental) insurance company. THE INSURANCE FEATURE DOES
SECURITIES NOT GUARANTEE THE MARKET VALUE OF THE MUNICIPAL BONDS OR THE
VALUE OF THE SHARES OF THE PENNSYLVANIA INSURED LONG-TERM
PORTFOLIO. The insurance refers to the face or par value of
the securities in the Portfolio, not the market values of
those securities or the share price of the
6
<PAGE>
Portfolio. See "Implementation of Policies" for a description
of the insurance feature of the Pennsylvania Insured Long-
Term Portfolio.
The Pennsylvania Insured Long-Term Portfolio is expected to
maintain a dollar- weighted average maturity between 15 and
25 years. BONDS WITH LONGER MATURITIES USUALLY OFFER HIGHER
YIELDS, BUT ARE ALSO SUBJECT TO GREATER MARKET FLUCTUATIONS
AS INTEREST RATES CHANGE. See "Investment Risks."
Normally, the Pennsylvania Insured Long-Term Portfolio seeks
to invest substantially all of its assets in insured Pennsyl-
vania municipal obligations. However, under certain
circumstances, the Portfolio may invest up to 20% of its as-
sets in any combination of the following securities:
. Uninsured, long-term Pennsylvania municipal securities
rated a minimum of Aa by Moody's or AA by Standard &
Poor's;
. Uninsured, short-term municipal securities, issued in Penn-
sylvania or in other states, with the same quality stan-
dards that apply for the Pennsylvania Money Market Portfo-
lio;
. Certain taxable fixed-income securities, including U.S.
Government securities; and
. Certain tax-exempt municipal securities issued by other
states that have similar characteristics to the securities
typically purchased by the Portfolio.
In such cases, a portion of the Portfolio's income may be
subject to Pennsylvania income taxes, federal income taxes,
or both. (See page 20).
Subject to the same 20% limit, the Portfolio is also autho-
rized to invest in Pennsylvania AMT bonds. The income from
Pennsylvania AMT bonds is exempt from federal and Pennsylva-
nia income taxes, but may be a tax preference item for pur-
poses of the federal alternative minimum tax. See "Implemen-
tation of Policies" for more information.
Under unusual circumstances, such as a national financial
emergency, the Portfolio reserves the right to invest more
than 20% of its assets in securities other than insured Penn-
sylvania municipal obligations. In most instances, however,
the Pennsylvania Insured Long-Term Portfolio will seek to
avoid such holdings in an effort to provide income that is
fully exempt from federal and Pennsylvania personal income
taxes.
EACH PORTFOLIO Although the Fund is organized as a non-diversified invest-
WILL DIVERSIFY ment company, each Portfolio of the Fund intends to diversify
ITS HOLDINGS its holdings of Pennsylvania municipal securities by comply-
ing with Subchapter M of the Internal Revenue Code. In part,
Subchapter M requires that, at the close of each quarter of
the taxable year, those issues which represent more than 5%
of each Portfolio's assets be limited in aggregate to 50% of
each Portfolio, and that no one issue exceed 25% of a Portfo-
lio's total assets. As of November 30, 1994, the Pennsylvania
Money Market Portfolio held securities of 40 issuers, with
the largest holding representing
7
<PAGE>
7.77% of the Portfolio's assets; the Pennsylvania Insured
Long-Term Portfolio held securities of 122 issuers, with the
largest holding representing 5.6% of the Portfolio's assets.
The Fund's policy of investing at least 80% of its assets in
Pennsylvania municipal securities under normal circumstances
is fundamental and may not be changed without shareholder ap-
proval. The other investment policies described above are not
fundamental and so may be changed by the Board of Trustees
without shareholder approval.
--------------------------------------------------------------------------------
INVESTMENT As mutual funds investing in municipal securities, both Port-
RISKS folios of the Fund are subject to interest rate, credit,
call, income and manager risk. However, the risk characteris-
THE FUND IS tics of the two Portfolios vary because of differing maturity
SUBJECT TO and credit quality standards.
INTEREST RATE,
CREDIT, CALL, INTEREST RATE RISK is the potential for fluctuations in the
INCOME AND price of a Portfolio's investments due to changes in interest
MANAGER RISK rates. In general, bond prices vary inversely with interest
rates. If interest rates rise, bond prices generally decline;
if interest rates fall, bond prices generally rise. In addi-
tion, for a given change in interest rates, longer-maturity
bonds exhibit greater price fluctuations than shorter-matu-
rity bonds. To compensate investors for this risk, longer-ma-
turity bonds generally offer higher yields than shorter-matu-
rity bonds, other factors, including credit quality, being
equal. Interest rate risk may be increased or decreased when
a portfolio initiates or purchases derivative Pennsylvania
municipal securities. Such derivative securities rely on so-
phisticated interest rate calculation mechanisms. For certain
types of derivative bonds, the magnitude of increases and de-
creases in their price may be proportionately larger or
smaller than, or inverse to, the price changes that broad
market interest rate fluctuations would produce in long-term
bonds.
CREDIT RISK is the possibility that a bond issuer will fail
to make timely payments of interest or principal to a Portfo-
lio. The credit risk of a Portfolio depends on the credit
quality of its underlying securities. In general, the lower
the credit quality of a Portfolio's municipal securities, the
higher a Portfolio's yield, all other factors, such as matu-
rity, being equal.
CALL RISK is the possibility that, during periods of falling
interest rates, a municipal security with a high stated in-
terest rate will be prepaid (or "called") prior to its ex-
pected maturity date. As a result, a Portfolio will be re-
quired to invest the unanticipated proceeds at lower interest
rates, and the Portfolio's income may decline. Call provi-
sions are most common for intermediate- and long-term munici-
pal bonds.
INCOME RISK is the potential for a decline in a Portfolio's
income due to falling market interest rates. Because a Port-
folio's income is based on interest rates, which can fluctu-
ate substantially over short periods, income risk is expected
to vary from Portfolio to Portfolio.
8
<PAGE>
THE FUND IS Finally, the investment adviser manages the Fund's Portfolios
SUBJECT TO according to the traditional methods of "active" investment
MANAGER RISK management, which involve the buying and selling of securi-
ties based upon economic, financial and market analysis and
investment judgment. MANAGER RISK refers to the possibility
that the Fund's investment adviser may fail to execute a
Portfolio's investment strategy effectively. As a result, a
Portfolio may fail to achieve its stated objective.
Given the Portfolio's stated objectives and policies, inter-
est rate risk for the Pennsylvania Money Market Portfolio is
expected to be negligible. The Money Market Portfolio is ex-
pected to maintain a stable share price of $1.00. In con-
trast, interest rate risk for the Pennsylvania Insured Long-
Term Portfolio may be high. The average weighted maturity of
the Insured Long-Term Portfolio is expected to exceed 15
years, meaning that the Portfolio's share price will fluctu-
ate, sometimes substantially, when interest rates change.
The following chart illustrates the potential interest rate
risk of the Pennsylvania Insured Long-Term Portfolio. The
chart shows the market value of a $1,000 investment in a sin-
gle bond with the same yield and maturity characteristics as
the Insured Long-Term Portfolio on December 29, 1994, assum-
ing a 1% and 2% point increase or decrease in interest rates:
<TABLE>
<CAPTION>
HYPOTHETICAL VALUE OF $1,000 INVESTMENT
---------------------------------------
AFTER CHANGE IN INTEREST RATES OF:
-----------------------------------
30-DAY AVERAGE 1% POINT 1% POINT 2% POINT 2% POINT
PORTFOLIO YIELD MATURITY INCREASE DECREASE INCREASE DECREASE
--------- ------ ---------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Insured Long-Term 6.14% 15.3 years $908 $1,105 $827 $1,225
</TABLE>
This chart is intended to provide you with general guidelines
for evaluating the effect of interest rate changes on the
Pennsylvania Insured Long-Term Portfolio and determining the
degree of interest rate risk you may be willing to assume.
The yields and price changes shown are purely for illustra-
tive purposes, and should not be taken as representative of
current or future yields or expected changes in the share
price of the Pennsylvania Insured Long-Term Portfolio.
CREDIT RISK IS Credit risk depends on the average quality of a Portfolio's
EXPECTED TO BE underlying securities and its degree of diversification. The
LOW Pennsylvania Money Market Portfolio invests primarily in
high-quality, short-term Pennsylvania municipal securities,
and the Pennsylvania Insured Long-Term Portfolio invests pri-
marily in bonds insured by top-rated insurance companies
against the possible default of an issuer as to the timely
payment of interest and principal. As a result, the average
credit quality of each Portfolio is expected to be very high,
and credit risk is expected to be minimal.
Ordinarily, an investment company concentrating its invest-
ments in one state, such as the Fund, would be exposed to
greater credit risks than an investment company investing in
a nationally diversified portfolio of municipal securities.
These risks include possible tax law changes, a deterioration
9
<PAGE>
in economic conditions, and differing levels of supply and
demand for Pennsylvania municipal obligations.
To minimize the effects of concentrating its investments in
Pennsylvania obligations, each Portfolio of the Fund intends
to diversify its holdings by complying with Subchapter M of
the Internal Revenue Code. (See "Investment Policies" for a
description of the requirements of Subchapter M.) In addi-
tion, the high-quality instruments held by the Pennsylvania
Money Market Portfolio and the use of municipal bond insur-
ance in the Pennsylvania Insured Long-Term Portfolio should
minimize the credit risk associated with the Fund.
As of November 30, 1994, the top ten portfolio holdings,
based on market value, represented 55.1% of the Money Market
Portfolio's net assets and 35.2% of the Insured Long-Term
Portfolio's net assets.
The following chart summarizes credit, interest rate, income
and call risks for the Fund's Portfolios:
<TABLE>
<CAPTION>
CREDIT INTEREST INCOME PREPAYMENT/
PORTFOLIO RISK RATE RISK RISK CALL RISK
---------------------------------------------------------------
<S> <C> <C> <C> <C>
Money Market Low Low High Very Low
Insured Long-Term Very Low High Low Medium
</TABLE>
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WHO SHOULD The Fund is intended for Pennsylvania residents seeking in-
INVEST come that is exempt from federal and Pennsylvania personal
income taxes. As a rule, tax-free income is attractive to in-
PENNSYLVANIA vestors in high federal tax brackets. You can determine
RESIDENTS whether tax-exempt or taxable income is more attractive in
SEEKING TAX- your own case by comparing a Portfolio's tax-free yield with
EXEMPT INCOME the yield from a comparable taxable mutual fund investment.
See "How to Compare Tax-Free and Taxable Yields".
Assuming that tax-free income is attractive in your own tax
bracket, you should base your selection of a Portfolio (or
Portfolios) on its expected price volatility and yield, and
your own investment objectives, risk preferences and time
horizon.
The PENNSYLVANIA MONEY MARKET PORTFOLIO is intended for in-
vestors who are seeking a stable share price and minimal
credit risk. The yield on the Portfolio is expected to fluc-
tuate from day to day and to be lower on average than the
yield from the Pennsylvania Insured Long-Term Portfolio. The
Pennsylvania Money Market Portfolio is suitable as a short-
term investment vehicle, emphasizing maximum protection of
principal.
In contrast, the PENNSYLVANIA INSURED LONG-TERM PORTFOLIO is
intended for investors who are seeking the highest, most du-
rable streams of income and who can tolerate sometimes sharp
fluctuations in share price in pursuit of their income objec-
tives. The yield of the Portfolio is expected to be higher,
and the level of income provided more stable, than that of
the Pennsylvania Money Market Portfolio. However, because of
the potential volatility of the Portfolio's share price, the
Pennsylvania Insured Long-Term Portfolio is appropriate only
for those investors who can hold their investment over the
long term.
10
<PAGE>
The Fund is intended to be a long-term investment vehicle and
is not designed to provide investors with a means of specu-
lating on short-term market movement. Investors who engage in
excessive account activity generate additional costs which
are borne by all of the Fund's shareholders. In order to min-
imize such costs, the Fund has adopted the following poli-
cies. The Fund reserves the right to reject any purchase re-
quest (including exchange purchases from other Vanguard port-
folios) that is reasonably deemed to be disruptive to effi-
cient portfolio management either because of the timing of
the investment or previous excessive trading by the investor.
Additionally, the Fund has adopted exchange privilege limita-
tions as described in the section "Exchange Privilege Limita-
tions." Finally, the Fund reserves the right to suspend the
offering of its shares.
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HOW TO COMPARE Before choosing a specific tax-exempt investment, such as a
TAX-FREE AND Portfolio of the Fund, you should determine if you would be
TAXABLE YIELDS better off with taxable or tax-exempt income in your tax
bracket. To compare taxable and tax-free income, you should
first determine your combined federal, state and local tax
bracket. Then you should calculate the "taxable equivalent
yield" for the Portfolio you are considering, and compare it
with the yield of a taxable investment with similar credit
and maturity characteristics.
1. DETERMINE YOUR COMBINED TAX BRACKET. Your combined tax
bracket depends on whether you itemize state and local taxes
as a deduction on your federal return. If you do not itemize,
then your combined tax bracket is the sum of your federal,
state and local tax brackets.
If you do itemize, then your combined tax bracket is calcu-
lated as follows. First, calculate your effective state and
local tax bracket using the following formula:
Federal Effective
( 100% - Tax ) X State & = State &
Bracket Local Bracket Local Bracket
For example, if you are in a 2.8% state and local tax bracket
and a 28% federal tax bracket, your effective state and local
tax bracket would be 2.0%:
(100% - 28%) X 2.8% = 2.0%
Second, add your effective state and local tax bracket to
your federal tax bracket to determine your combined tax
bracket:
Federal Effective Combined
Tax + State & = Tax
Bracket Local Bracket Bracket
28% + 2.0% = 30%
11
<PAGE>
2. CALCULATE YOUR TAXABLE EQUIVALENT YIELD. The taxable
equivalent yield for a Portfolio is based upon the Portfo-
lio's current tax-exempt yield and your combined tax bracket.
The formula is:
Portfolio's Tax-Free Yield
-------------------------------- = Your Taxable
100% - Your Combined Tax Bracket Equivalent Yield
For example, if you are in a combined tax bracket of 30%, and
a Portfolio's tax-free yield is 6%, the Portfolio's taxable
equivalent yield would be 8.6%:
6%
---------- = 8.6%
100% - 30%
In this example, you would choose the tax-free investment if
the 8.6% taxable equivalent yield were greater than the tax-
able yield from a comparable investment (e.g., a taxable bond
fund of comparable maturity and credit quality).
--------------------------------------------------------------------------------
IMPLEMENTATION The Fund's adviser uses a variety of investment vehicles to
OF POLICIES achieve the objective of the Fund.
THE FUND Each Portfolio of the Fund invests principally in tax-exempt
INVESTS IN Pennsylvania municipal securities, which are debt obligations
MUNICIPAL issued by state and local governments and public financing
BONDS, NOTES authorities (and by certain U.S. territories) that provide
AND SECURITIES interest income that is exempt from federal and Pennsylvania
DERIVED FROM personal income taxes. Municipal securities include both mu-
MUNICIPAL nicipal bonds (those securities with maturities of five years
BONDS AND or more) municipal notes (those securities with maturities of
NOTES less than five years) and derivative securities (those secu-
rities in which a maturity may have been shortened by a de-
mand feature).
Municipal bonds are issued for a wide variety of reasons: to
construct public facilities, such as airports, highways,
bridges, schools, hospitals, housing, mass transportation,
streets, water and sewer works; to obtain funds for operating
expenses; to refund outstanding municipal obligations; and to
loan funds to various public institutions and facilities.
Certain industrial development bonds are also considered mu-
nicipal bonds if their interest is exempt from federal income
tax. Industrial development bonds are issued by or on behalf
of public authorities to obtain funds for privately-operated
manufacturing facilities, housing, sports arenas, convention
centers, airports, mass transportation systems, and water,
gas or sewage works.
General obligation municipal bonds are secured by the is-
suer's pledge of full faith, credit and taxing power. Revenue
or special tax bonds are payable from the revenues derived
from a particular facility or, in some cases, from a special
excise or other tax, but not from general tax revenue. Indus-
trial development bonds are ordinarily dependent on the
credit quality of a private authority.
Municipal notes are issued to meet the short-term funding re-
quirements of local, regional and state governments. Munici-
pal notes include tax anticipation notes, bond anticipation
notes, revenue anticipation notes, tax and revenue anticipa-
12
<PAGE>
tion notes, construction loan notes, short-term discount
notes, tax-exempt commercial paper, demand notes, and similar
instruments. Demand notes permit an investor (such as the
Fund) to demand from the issuer payment of principal plus ac-
crued interest upon a specified number of days' notice.
THE FUND MAY Each Portfolio of the Fund is authorized to invest up to 20%
INVEST IN AMT of its assets in so-called "AMT" bonds. AMT bonds are tax-ex-
BONDS empt "private activity" bonds issued after August 7, 1986,
whose proceeds are directed at least in part to a private,
for-profit organization. While the income from AMT bonds is
exempt from regular federal income tax, it is a tax prefer-
ence item for purposes of the alternative minimum tax. The
alternative minimum tax is a special separate tax that ap-
plies to a limited number of taxpayers who have certain ad-
justments to income or tax preference items.
THE FUND MAY The Fund may invest in "Market Discount" bonds when, in the
INVEST IN opinion of the Fund's adviser, the investment will be advan-
MARKET tageous to the Fund's shareholders. A Market Discount bond is
DISCOUNT BONDS a bond purchased at a discount from its original issue price
after April 30, 1993 and with a maturity in excess of one
year from its issue date. In certain circumstances, disposi-
tion of a Market Discount bond will result in taxable ordi-
nary income to the extent of any gain realized.
Although the objective of the Fund is to provide income free
of federal income tax, certain market conditions may make
Market Discount bonds desirable investments. The Fund will
purchase Market Discount bonds only if the Fund's adviser ex-
pects that the purchase of these investments on an after-tax
basis will enhance the Fund's total return.
THE INSURED The Pennsylvania Insured Long-Term Portfolio may utilize bond
LONG- TERM futures contracts and options to a limited extent. Specifi-
PORTFOLIO MAY cally, the Portfolio may enter into futures contracts pro-
USE FUTURES vided that not more than 5% of its assets are required as a
CONTRACTS AND futures contract deposit; in addition, the Portfolio may en-
OPTIONS ter into futures contracts and options transactions only to
the extent that obligations under such contracts or transac-
tions represent not more than 20% of the Portfolio's assets.
Futures contracts and options may be used for several rea-
sons: to maintain cash reserves while simulating full invest-
ment, to facilitate trading, to reduce transaction costs, or
to seek higher investment returns when a futures contract is
priced more attractively than the underlying municipal secu-
rity or index. The Fund may not use futures contracts or op-
tions transactions to leverage its assets.
For example, in order to simulate full investment in bonds,
while maintaining liquidity to meet potential shareholder re-
demptions, the Pennsylvania Insured Long-term Portfolio may
invest a portion of its assets in a bond futures contract.
Because futures contracts only require a small initial margin
deposit, the Portfolio would then be able to maintain a cash
reserve to meet potential redemptions, while at the same time
remaining fully invested. Also, because the transaction costs
of futures and options may be lower than the costs of invest-
ing in bonds directly, it is expected that the use of futures
contracts and options may reduce the Portfolio's total trans-
action costs.
13
<PAGE>
The primary risks associated with the use of futures and op-
FUTURES tions are: (i) imperfect correlation between the change in
CONTRACTS AND market value of the bonds held by the Portfolio and the
OPTIONS POSE prices of futures and options; and (ii) possible lack of a
CERTAIN RISKS liquid secondary market for a futures contract and the re-
sulting inability to close a futures position prior to its
maturity date. The risk of imperfect correlation will be min-
imized by investing in those contracts whose price fluctua-
tions are expected to resemble those of the Portfolio's un-
derlying securities. The risk that the Portfolio will be un-
able to close out a futures position will be minimized by en-
tering into such transactions on a national exchange with an
active and liquid secondary market. In general, the futures
market is more liquid than the municipal bond market; there-
fore, the Portfolio's liquidity may be improved by investing
in futures.
The risk of loss in trading futures contracts in some strate-
gies can be substantial, due both to the low margin deposits
required and the extremely high degree of leverage involved
in futures pricing. As a result, a relatively small price
movement in a futures contract may result in immediate and
substantial loss (or gain) to the investor. When investing in
futures contracts, a Portfolio will segregate cash or cash
equivalents in the amount of the underlying obligation.
DERIVATIVE Derivative securities represent the purchaser's right to re-
SECURITIES ceive principal and interest payments from underlying bonds.
A Fund may purchase a derivative security from another port-
folio within the Vanguard Group, as permitted by the Invest-
ment Company Act of 1940 and applicable rules thereunder, or
from an outside financial institution. There are different
derivative structures. An example of the steps involved in
creating and using a derivative structure follows: 1) a de-
positor places the underlying bond into a trust supervised by
an independent party; 2) a financial institution provides the
purchasers the right, at periodic intervals, to tender the
derivative security; 3) the financial institution receives
the difference between the prevailing short-term interest
rate (which is paid to the Portfolio holding the derivative
security) and the coupon on the underlying bond in considera-
tion for providing the tender option; and 4) the tender op-
tion may be discontinued upon the occurrence of certain
events, in which case, the Fund which owns the derivative se-
curity should receive its proportional share of the under-
lying bond. The primary risks associated with the use of de-
rivative securities are the interest rate risks discussed un-
der "Investment Risks," the possible lack of a liquid second-
ary market, the risk that the other party in a contractual
derivative agreement cannot meet its obligations and the po-
tential for greater price volatility relative to the under-
lying security on which the derivative is based.
The Portfolios intend to limit the risk of derivative securi-
ties by purchasing only those derivative securities that are
consistent with a Portfolio's investment objectives and poli-
cies. The Portfolios will not use such instruments to lever-
age securities. Hence, derivative securities' contributions
to the overall market risk characteristics of a Portfolio
will not materially alter its risk profile and will be fully
representative of the Portfolio's maturity guidelines.
14
<PAGE>
To provide an added level of credit protection, the Pennsyl-
vania Insured Long-Term Portfolio uses three types of insur-
THREE TYPES OF ance: new issue, mutual fund and secondary market insurance.
INSURANCE MAY A new issue insurance policy is purchased by a bond issuer
BE USED IN THE who wishes to increase the credit rating of a security. By
INSURED LONG- paying a premium and meeting the insurer's underwriting stan-
TERM PORTFOLIO dards, the bond issuer is able to obtain a high credit rating
for the security (usually Aaa from Moody's or AAA from Stan-
dard & Poor's). New issue insurance policies are non-
cancellable and continue in force as long as the bonds are
outstanding.
A mutual fund insurance policy may be used to guarantee spe-
cific bonds only while owned by a mutual fund. The Insured
Long-Term Portfolio of the Fund has obtained a mutual fund
insurance policy from Financial Guaranty Insurance Company
("Financial Guaranty"), a AAA-rated insurance company. Based
upon the expected composition of the Portfolio, the annual
premiums for the policy are likely to range from 0.20% to
0.40% of the principal value of the bonds insured under the
policy, thereby reducing the Portfolio's current yield.
A secondary market insurance policy is purchased by an in-
vestor (such as the Insured Long-Term Portfolio) subsequent
to the bond's original issuance and generally insures a par-
ticular bond for the remainder of its term. The Portfolio may
purchase bonds which have already been insured under a sec-
ondary market insurance policy by a prior investor, or the
Portfolio may itself purchase such a policy from Financial
Guaranty for bonds that are currently uninsured.
An insured municipal bond in the Portfolio will typically be
covered by only one of the three policies. For instance, if a
bond is already covered by a new issue insurance policy or a
secondary market insurance policy, then that security will
not be insured under the Portfolio's mutual fund insurance
policy. All of the insurance policies used by the Portfolio
will be obtained only from insurance companies rated Aaa by
Moody's or AAA by Standard & Poor's.
THE INSURED Each Portfolio of the Fund observes strict maturity guide-
LONG- TERM lines as set forth in detail under "Investment Policies."
PORTFOLIO MAY These maturity standards are specified in terms of a Portfo-
REPORT AN lio's average weighted maturity. From time to time, however,
EFFECTIVE the Fund may also report an effective average weighted matu-
AVERAGE rity for the Insured Long-Term Portfolio, which reflects,
WEIGHTED among other items, the likelihood that a municipal bond or
MATURITY note held by the Portfolio may be redeemed or "called" prior
to its stated maturity date. For example, if the Portfolio
consists entirely of 20-year bonds, some of which may be
"called" prior to their stated maturity in 20 years, the
Portfolio's average weighted maturity will be 20 years, while
its effective average maturity will be shorter.
A Portfolio's effective average weighted maturity will be in-
fluenced by bond market conditions, and so may vary from day-
to-day, even if no change has been made to the Portfolio's
underlying investment securities. For example, if interest
rates decline, a greater proportion of a Portfolio's securi-
ties may be subject to call (redemption) prior to their
stated maturity. As a result, reflecting this in-
15
<PAGE>
creased call risk, the effective average maturity of the
Portfolio will shorten, independent of actual purchases or
sales of portfolio securities.
TEMPORARY
INVESTMENTS Except as described on page 7, each Portfolio will not invest
in securities other than municipal bonds except that each
Portfolio may make temporary investments for defensive pur-
poses in (a) notes issued by or on behalf of municipal or
corporate issuers, obligation of the U.S. Government and its
agencies, commercial paper and bank certificates of deposits;
(b) investment companies investing in such securities which
have investment objectives consistent with those of the Port-
folio to the extent permitted by the Investment Company Act
of 1940; and (c) any such securities or municipal bonds sub-
ject to repurchase agreements.
THE FUND MAY Each Portfolio may purchase tax-exempt securities on a "when-
PURCHASE WHEN- issued" basis. In buying "when-issued" securities, a Portfo-
ISSUED lio commits to buy securities at a certain price even though
SECURITIES the securities may not be delivered for up to 45 days. The
Portfolio pays for the securities and begins earning interest
when the securities are actually delivered. As a consequence,
it is possible that the market price of the securities at the
time of delivery may be higher or lower than the purchase
price.
THE FUND MAY Each Portfolio may lend its investment securities on either a
LEND ITS short-term or long-term basis to qualified institutional in-
SECURITIES vestors for the purpose of realizing additional net invest-
ment income. Loans of securities by a Portfolio will be col-
lateralized by cash, letters of credit, or securities issued
or guaranteed by the U.S. Government or its agencies. The
collateral will equal at least 100% of the current market
value of the loaned securities. Income derived from the lend-
ing of securities is not tax-exempt, and a portion of the
tax-exempt interest earned when a municipal security is on
loan must be characterized as taxable income. Therefore, each
Portfolio will limit such activity in accordance with its in-
vestment objective.
THE FUND MAY Each Portfolio may purchase municipal lease obligations,
INVEST IN which are securities issued by state and local governments to
MUNICIPAL acquire land, equipment and facilities. These obligations
LEASE typically are not backed by the issuing municipality's full
OBLIGATIONS authority to assess taxes to meet its debt obligations. If
the issuing authority fails to make the appropriations neces-
sary to cover lease payments, then the lease may terminate,
with the possibility of default on the lease obligation and
loss to investors.
EACH PORTFOLIO Each Portfolio will invest in securities to benefit from the
WILL AVOID income they generate and not to generate trading profits. Un-
TRADING der the Fund's Declaration of Trust, the Portfolios have no
PROFITS power to vary the portfolio investments except to: (1) elimi-
nate unsafe investments and investments not consistent with
the preservation of the capital or the tax status of the
Portfolios; (2) honor redemption orders and meet anticipated
redemption requirements; (3) reinvest the earnings from secu-
rities in like securities; (4) defray normal administrative
expenses; or (5) in the case of the Pennsylvania Money Market
Portfolio, maintain a constant net asset value per share pur-
suant to, and in compliance with, an order or rule of the
United States Securities and Exchange Commission.
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16
<PAGE>
INVESTMENT The Fund has adopted certain limitations designed to reduce
LIMITATIONS its exposure to specific situations. These limitations in-
clude the following:
THE FUND HAS a) The Pennsylvania Insured Long-Term Portfolio will invest a
ADOPTED minimum of 80% of its net assets in insured municipal
CERTAIN bonds, the interest on which is exempt from federal and
FUNDAMENTAL Pennsylvania personal income taxes, except that it may
LIMITATIONS make temporary investments as described in "Implementation
of Policies."
b) The Pennsylvania Money Market Portfolio will invest a min-
imum of 80% of its net assets in short-term municipal se-
curities, the interest on which is exempt from federal and
Pennsylvania personal income taxes, except that it may
make temporary investments as described in "Implementation
of Policies."
c) At the close of each quarter of the taxable year, those
issues which represent more than 5% of a Portfolio's as-
sets will be limited in aggregate to 50% of the assets of
that Portfolio (except U.S. Government securities and cash
items, as defined in the Internal Revenue Code (the
"Code")).
d) Each Portfolio will limit the aggregate value of holdings
of a single issuer (except U.S. Government and cash items
as defined in the Code) to a maximum of 25% of the Portfo-
lio's total assets. For the purposes of this limitation,
identification of the issuer will be based on a determina-
tion of the source of assets and revenues committed to
meeting interest and principal payments on each security.
e) A Portfolio will not borrow money except for temporary or
emergency purposes, and then not in excess of 10% of the
Portfolio's total assets. The Portfolio will repay all
borrowings before making additional investments, and the
interest paid on such borrowings will reduce income.
f ) A Portfolio will not pledge, mortgage, or hypothecate
more than 10% of its total assets.
The above-mentioned investment limitations are considered at
the time investment securities are purchased. The investment
limitations described here and in the Statement of Additional
Information may be changed only with the approval of a major-
ity of the Fund's shareholders.
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MANAGEMENT OF The Fund is a member of The Vanguard Group of Investment Com-
THE FUND panies, a family of more than 30 investment companies with
more than 80 distinct investment portfolios and total assets
VANGUARD in excess of $130 billion. Through their jointly-owned sub-
ADMINISTERS sidiary, The Vanguard Group, Inc. ("Vanguard"), the Fund and
AND the other funds in the Group obtain at cost virtually all of
DISTRIBUTES their corporate management, administrative, shareholder ac-
THE FUND counting and distribution services. Vanguard also provides
investment advisory services on an at-cost basis to certain
Vanguard funds. As a result of Vanguard's unique corporate
structure, the Vanguard funds have costs substantially lower
than those of most competing mutual funds. In 1994, the aver-
age expense ratio (annual costs including advisory
17
<PAGE>
fees divided by total net assets) for the Vanguard funds
amounted to approximately .30% compared to an average of
1.05% for the mutual fund industry (data provided by Lipper
Analytical Services).
The Officers of the Fund manage its day-to-day operations and
are responsible to the Fund's Trustees. The Trustees set
broad policies for the Fund and choose its Officers. A list
of Trustees and Officers of the Fund and a statement of their
present positions and principal occupations during the past
five years can be found in the Statement of Additional Infor-
mation.
Vanguard employs a supporting staff of management and admin-
istrative personnel needed to provide the requisite services
to the funds and also furnishes the funds with necessary of-
fice space, furnishings and equipment. Each fund pays its
share of Vanguard's total expenses, which are allocated among
the funds under methods approved by the Board of Trustees
(Directors) of each fund. In addition, each fund bears its
own direct expenses, such as legal, auditing and custodian
fees.
Vanguard also provides distribution and marketing services to
the Vanguard funds. The funds are available on a non-load ba-
sis (i.e., there are no sales commissions or 12b-1 fees).
However, each fund bears its share of the Group's distribu-
tion costs.
--------------------------------------------------------------------------------
INVESTMENT The two Portfolios of the Fund receive all investment advi-
ADVISER sory services on an at-cost basis from Vanguard's Fixed In-
come Group. The Group provides investment advisory services
VANGUARD to more than 40 Vanguard money market and bond portfolios,
MANAGES THE both taxable and tax-exempt. Total assets under management by
FUND'S Vanguard's Fixed Income Group were $55 billion as of December
INVESTMENTS 31, 1994. The Fixed Income Group is supervised by the Offi-
cers of the Fund. Ian A. MacKinnon, Senior Vice President of
Vanguard, has been in charge of the Group since its inception
in 1981.
. Reid Smith, Assistant Vice President of Vanguard, serves as
portfolio manager of the Pennsylvania Insured Long-Term
Portfolio. Mr. Smith has managed the Insured Long-Term
Portfolio since 1992. (Previously, the Insured Long-Term
Portfolio was managed by David Hamlin of the Fixed Income
Group.) For 3 years prior to joining Vanguard, Mr. Smith
was associated with another mutual fund advisory firm as a
fixed-income portfolio manager.
The Fixed Income Group manages the investment and reinvest-
ment of the assets of the Fund's Portfolios and continuously
reviews, supervises and administers each Portfolio's invest-
ment program, subject to the maturity and quality standards
specified in this Prospectus, and supplemental guidelines ap-
proved by the Fund's Board of Trustees. The Fixed Income
Group's selection of investments for the Portfolios is based
on: (a) continuing credit analysis of those instruments held
in the Portfolios and those being considered for inclusion
therein; (b) possible disparities in yield relationships be-
tween different fixed-income securities and money market in-
struments; and (c) actual or anticipated movements in the
general level of interest rates.
18
<PAGE>
Vanguard's Fixed Income Group places all orders for purchases
and sales of portfolio securities. Purchases of portfolio se-
curities are made either directly from the issuer or from mu-
nicipal securities dealers. The investment management staff
may sell portfolio securities prior to their maturity if cir-
cumstances and considerations warrant and if it believes such
dispositions advisable. The Fund's policy of investing in
short-term instruments in the Pennsylvania Money Market Port-
folio will likely result in significant portfolio turnover.
The staff seeks to obtain the best available net price and
most favorable execution for all portfolio transactions.
--------------------------------------------------------------------------------
DIVIDENDS, Dividends consisting of virtually all of the ordinary income
CAPITAL GAINS of each Portfolio are declared daily and are payable to
AND TAXES shareholders of record at the close of the previous business
day. Such dividends are paid on the first business day of
THE FUND PAYS each month. Capital gains distributions if any will be made
MONTH-END annually.
DIVIDENDS
Dividend and capital gains distributions may be automatically
reinvested or received in cash. See "Choosing a Distribution
Option" for a description of these distribution methods.
In addition, in order to satisfy certain distribution re-
quirements of the Tax Reform Act of 1986, each Portfolio may
declare special year-end dividend and capital gains distribu-
tions during December. Such distributions, if received by
shareholders by January 31, are deemed to have been paid by
the Portfolio and received by shareholders by December 31 of
the prior year.
DIVIDENDS WILL Each Portfolio of the Fund intends to continue to qualify for
BE EXEMPT FROM taxation as a "regulated investment company" under the Inter-
FEDERAL AND nal Revenue Code so that each Portfolio will not be subject
PENNSYLVANIA to federal income tax to the extent its income is distributed
INCOME TAXES to shareholders. In addition, each Portfolio intends to in-
vest a sufficient portion of its assets in municipal bonds
and notes so that it will qualify to pay "exempt-interest
dividends" to shareholders. Such exempt-interest dividends
are excluded from a shareholder's gross income for federal
tax purposes. The Revenue Reconciliation Act enacted during
1993 provides that market discount on tax-exempt bonds pur-
chased after April 30, 1993 must be taxed as ordinary income.
Accordingly, to the extent that the Fund purchases such dis-
counted securities, taxable income may result. Furthermore,
each Portfolio expects to invest substantially all of its as-
sets in Pennsylvania municipal securities. As a result, each
Portfolio will be eligible to pay dividends to Pennsylvania
residents that will be exempt from Pennsylvania personal in-
come taxes.
Net long-term capital gains realized by a Portfolio from the
sale of securities will be distributed as taxable capital
gains distributions. Any short-term capital gains or any tax-
able interest income will be distributed as taxable ordinary
dividend distribution. In general, such taxable income dis-
tributions from a Portfolio are expected to be negligible in
comparison with tax-exempt dividends. However, under certain
circumstances, a Portfolio may invest in securities other
than Penn-
19
<PAGE>
sylvania municipal obligations. In such cases, a portion of
the Portfolio's income may be subject to Pennsylvania income
taxes, federal income taxes, or both.
At present, neither Portfolio invests in AMT bonds. (See "In-
vestment Policies.") However, were a Portfolio to invest in
such bonds, a portion of the Portfolio's dividends, while ex-
empt from the regular federal income tax, would be a tax
preference item for purposes of the federal alternative mini-
mum tax.
A CAPITAL GAIN A sale of shares in the Insured Long-Term Portfolio is a tax-
OR LOSS MAY BE able event and may result in a capital gain or loss. A capi-
REALIZED UPON tal gain or loss may be realized from an ordinary redemption
EXCHANGE OR of shares, a checkwriting redemption, or an exchange of
REDEMPTION shares between two mutual funds (or two portfolios of a mu-
tual fund). In addition, if you held shares in the Insured
Long-Term Portfolio for six months or less, any capital loss
realized upon redemption is disallowed to the extent of the
tax-exempt dividend income you received.
Capital gains distributions from a Portfolio and any capital
gains or losses realized from the sale or exchange of shares
may also be subject to state and local taxes.
The Fund is required to withhold 31% of any taxable divi-
dends, capital gains distributions, and redemptions paid to
shareholders who have not complied with IRS taxpayer identi-
fication regulations. You may avoid this withholding require-
ment by indicating your proper Social Security or Employer
Identification number on your Account Registration Form and
by certifying that you are not subject to backup withholding.
Up to 85% of an individual's Social Security benefits may be
subject to federal income tax. Along with other factors, to-
tal tax-exempt income, including any tax-exempt dividend in-
come from Portfolios of the Fund, is used to calculate the
taxable portion of Social Security benefits.
Shares of the Portfolio are not subject to Pennsylvania
county personal property taxes, the personal property tax of
the City of Pittsburgh or the personal property tax of the
School District of Pittsburgh. Further, shareholders are not
subject to the investment income tax of the School District
of Philadelphia, to the extent that the income of the Portfo-
lios is derived from Pennsylvania obligations.
The Fund is organized as a Pennsylvania business trust and,
in the opinion of counsel, is not liable for any income or
franchise tax in the Commonwealth of Pennsylvania. The Fund
will be subject to Pennsylvania county personal property tax
in the county which is the site of its principal office.
The tax discussion set forth above is included for general
information only. Prospective investors should consult their
own tax advisers concerning the tax consequences of an in-
vestment in the Fund.
--------------------------------------------------------------------------------
20
<PAGE>
The share price or "net asset value" per share of each Port-
THE SHARE folio is computed daily by dividing the total value of the
PRICE OF EACH investments and other assets of each Portfolio, less any lia-
PORTFOLIO bilities, by the total outstanding shares of such Portfolio.
PENNSYLVANIA MONEY MARKET PORTFOLIO. For the purpose of cal-
culating the Pennsylvania Money Market Portfolio's net asset
value per share, securities are valued by the "amortized
cost" method of valuation, which does not take into account
unrealized gains or losses. This involves valuing an instru-
ment at its cost and thereafter assuming a constant amortiza-
tion to maturity of any discount or premium, regardless of
the impact of fluctuating interest rates on the market value
of the instrument. While this method provides certainty in
valuation, it may result in periods during which value, as
determined by amortized cost, is higher or lower than the
price the Portfolio would receive if it sold the instrument.
The use of amortized cost and the maintenance of the Pennsyl-
vania Money Market Portfolio's per share net asset value at
$1.00 is based on its election to operate under the provi-
sions of Rule 2a-7 under the Investment Company Act of 1940.
As a condition of operating under that rule, the Pennsylvania
Money Market Portfolio must maintain a dollar-weighted aver-
age portfolio maturity of 90 days or less, purchase only in-
struments having remaining maturities of 13 months or less,
and invest only in securities that are determined by the
Trustees to present minimal credit risks and that are of high
quality as determined by any major rating service, or in the
case of any instrument not so rated, considered by the Trust-
ees to be of comparable quality.
The Trustees have established procedures designed to stabi-
lize the net asset value per share, as computed for the pur-
poses of sales and redemptions, at $1.00. These procedures
include periodic review, as the Trustees deem appropriate and
at such intervals as are reasonable in light of current mar-
ket conditions, of the relationship between the amortized
cost value per share and a net asset value per share based
upon available indications of market value. In such a review,
investments for which market quotations are readily available
are valued at the most recent bid price or quoted yield
equivalent for such securities or for securities of compara-
ble maturity, quality and type as obtained from one or more
of the major market makers for the securities to be valued.
Other investments and assets are valued at fair value, as de-
termined in good faith by the Trustees.
In the event of a deviation of over 1/2 of 1% between a Port-
folio's net asset value based upon available market quota-
tions or market equivalents and $1.00 per share based on am-
ortized cost, the Trustees will promptly consider what ac-
tion, if any, should be taken. The Trustees will also take
such action as they deem appropriate to eliminate or to re-
duce, to the extent reasonably practicable, any material di-
lution or other unfair results to investors or existing
shareholders which might arise from differences between the
two. Such action may include redeeming shares in kind, sell-
ing instruments prior to maturity to realize capital gains or
losses or to shorten average maturity, withholding dividends,
paying
21
<PAGE>
distributions from capital or capital gains, or utilizing a
new asset value per share based upon available market quota-
tions.
PENNSYLVANIA INSURED LONG-TERM PORTFOLIO. The net asset value
per share of the Pennsylvania Insured Long-Term Portfolio is
determined as of the close of regular trading on the New York
Stock Exchange (generally 4:00 p.m. Eastern time) on each day
the Exchange is open for business. When approved by the Board
of Trustees, bonds and other fixed-income securities of each
of the Portfolios may be valued on the basis of the prices
provided by a pricing service when such prices are believed
to reflect the fair market value of such securities. (The
prices provided by pricing services are generally determined
without regard to bid or last sale prices. Because of the
large number of outstanding municipal bonds, the majority of
issues do not trade each day; therefore, last sale prices are
not normally available. In valuing such securities, the pric-
ing services generally take into account institutional size
trading in similar groups of securities and any developments
related to specific securities.) The methods used by the
pricing service and the valuations so established are re-
viewed by the Officers of the Fund under the general supervi-
sion of Trustees. There are a number of pricing services
available and the Trustees, on the basis of on-going evalua-
tion of these services, may use other pricing services or
discontinue the use of any pricing service.
Securities not priced in this manner are priced at the most
recent quoted bid price provided by investment dealers.
Short-term instruments maturing within 60 days of the valua-
tion date may be valued at cost, plus or minus any amortized
discount or premium. Other assets and securities for which no
quotations are readily available will be valued in good faith
at their fair value using methods determined by the Trustees.
The price per share of the Insured Long-Term Portfolio can be
found daily in the mutual fund section of most major newspa-
pers under the heading of The Vanguard Group.
--------------------------------------------------------------------------------
Vanguard Pennsylvania Tax-Free Fund is a Pennsylvania busi-
GENERAL ness trust. The Declaration of Trust permits the Trustees to
INFORMATION issue an unlimited number of shares of beneficial interest,
without par value, from an unlimited number of classes
of shares. Currently the Fund is offering two classes of
shares (known as "Portfolios").
Shares of each Portfolio, when issued, are fully paid and
non-assessable; participate equally in dividends, distribu-
tions and net assets; are entitled to one vote per share;
have pro rata liquidation rights; and do not have pre-emptive
rights. Also, shares of the Fund have non-cumulative voting
rights, meaning that the holders of more than 50% of the
shares voting for the election of the Trustees can elect all
of the Trustees if they so choose.
Annual meetings of shareholders will not be held except as
required by the Investment Company Act of 1940 and other ap-
plicable law. An annual meeting
22
<PAGE>
will be held to vote on the removal of a Trustee or Trustees
of the Fund if requested in writing by the holders of not
less than 10% of the outstanding shares of the Fund.
All securities and cash are held by CoreStates Bank, N.A.,
Philadelphia, PA. The Vanguard Group, Inc., Valley Forge, PA,
serves as the Fund's Transfer and Dividend Disbursing Agent.
Price Waterhouse LLP, serves as independent accountants for
the Fund and audits its financial statements annually. The
Fund is not involved in any litigation.
--------------------------------------------------------------------------------
23
<PAGE>
SHAREHOLDER GUIDE
OPENING AN To open a new account, either by mail or by wire, simply com-
ACCOUNT AND plete and return an Account Registration Form and any re-
PURCHASING quired legal documentation. Please indicate the Portfolio you
SHARES have chosen and the amount you wish to invest. Your purchase
must be equal to or greater than the $3,000 minimum initial
investment requirement ($500 for Uniform Gift/Transfer to Mi-
nors Act Accounts). In addition, you must be a Pennsylvania
resident to invest in the Fund. If you need assistance with
the Account Registration Form or have any questions, please
call our Investor Information Department at 1-800-662-7447.
NOTE: For other types of account registrations (e.g., corpo-
rations, associations, other organizations, trusts or powers
of attorney), please call us to determine which additional
forms you may need.
Because of the risks associated with bond investments, the
Fund is intended to be a long-term investment vehicle and is
not designed to provide investors with a means of speculating
on short-term market movements. Consequently, the Fund re-
serves the right to reject any specific purchase (and ex-
change purchase) request. The Fund also reserves the right to
suspend the offering of shares for a period of time.
Each Portfolio's shares are purchased at the next-determined
net asset value after your investment has been received in
the form of Federal Funds. See "When Your Account Will Be
Credited". The Fund is offered on a no-load basis (i.e.,
there are no sales commissions or 12b-1 fees).
ADDITIONAL Subsequent investments may be made by mail ($100 minimum per
INVESTMENTS Portfolio), wire ($1,000 minimum per Portfolio), exchange
from another Vanguard Fund account, or Vanguard Fund Express.
--------------------------------------------------------------
ADDITIONAL INVESTMENTS
TO EXISTING ACCOUNTS
NEW ACCOUNT
PURCHASING BY Please include the Additional investments
MAIL amount of your initial should include the In-
Complete and investment and the vest-by-Mail re-
sign the name of the Portfolios mittance form attached
enclosed you have selected on to your Fund confirma-
Account the registration form, tion statements.
Registration make your check pay- Please make your check
Form able to The Vanguard payable to The Van-
Group--(Portfolio Num- guard Group--(Portfo-
ber). See page 25 for lio Number). See page
appropriate Portfolio 25 for appropriate
number, and mail to: Portfolio number,
write your account
number on your check
and, using the return
envelope provided,
mail to the address
indicated on the In-
vest-by-Mail Form.
VANGUARD FINANCIAL All written requests
CENTER should be mailed to
P.O. BOX 2600 VALLEY one of the addresses
FORGE, PA 19482 indicated for new ac-
counts. Do not send
For express or VANGUARD FINANCIAL registered or express
registered CENTER 455 DEVON PARK mail to the post of-
mail, send to: DRIVE WAYNE, PA 19087 fice box address.
24
<PAGE>
VANGUARD PENNSYLVANIA TAX-FREE PORTFOLIOS:
Pennsylvania Money Market Portfolio--63 Pennsylvania Insured
Long-Term Portfolio--77
--------------------------------------------------------------
PURCHASING BY CORESTATES BANK, N.A.
WIRE ABA 031000011
Money should CORESTATES NO 0141 1274
be wired to: ATTN VANGUARD
BEFORE WIRING VANGUARD PENNSYLVANIA TAX-FREE FUND
Please contact NAME OF PORTFOLIO
Client ACCOUNT NUMBER
Services ACCOUNT REGISTRATION
(1-800-662-2739)
To assure proper receipt, please be sure your bank includes
the Portfolio name, the account number Vanguard has assigned
to you and the eight-digit CoreStates number. If you are
opening a new account, please complete the Account Registra-
tion Form and mail it to the "New Account" address above af-
ter completing your wire arrangement. NOTE: Federal Funds
wire purchase orders will be accepted only when the Fund and
Custodian Bank are open for business.
--------------------------------------------------------------
PURCHASING BY You may open an account or purchase additional shares of the
EXCHANGE (from Fund by making an exchange from an existing Vanguard Fund ac-
a Vanguard count. Accounts opened by exchange will have the same regis-
account) tration as the existing account. Please note: the Fund re-
serves the right to reject any exchange purchase request. For
more information, please call our Client Services Department
at 1-800-662-2739.
--------------------------------------------------------------
PURCHASING BY The Fund Express Special Purchase option lets you move money
FUND EXPRESS from your bank account to your Vanguard account on an "as
needed" basis. Or if you choose the Automatic Investment op-
Special tion, money will be moved automatically from your bank ac-
Purchase and count to your Vanguard account on the schedule (monthly, bi-
Automatic monthly [every other month], quarterly or yearly) you select.
Investment To establish these Fund Express options, please provide the
appropriate information on the Account Registration Form. We
will send you a confirmation of your Fund Express service;
please wait three weeks before using the service.
--------------------------------------------------------------------------------
CHOOSING A You must select one of three distribution options:
DISTRIBUTION
OPTION 1. AUTOMATIC REINVESTMENT OPTION--Both dividends and capital
gains distributions will be reinvested in additional Fund
shares. This option will be selected for you automatically
unless you specify one of the other options.
2. CASH DIVIDEND OPTION--Your dividends will be paid in cash
and your capital gains will be reinvested in additional
Fund shares.
3. ALL CASH OPTION--Both dividend and capital gains distribu-
tions will be paid in cash.
25
<PAGE>
You may change your option by calling our Client Services De-
partment (1-800-662-2739).
In addition, an option to invest your cash dividends and/or
capital gains distributions in another Vanguard Fund account
is available. Please call our Client Services Department (1-
800-662-2739) for information. You may also elect Vanguard
Dividend Express which allows you to transfer your cash divi-
dends and/or capital gains distributions automatically to
your bank account. Please see "Other Vanguard Services" for
more information.
--------------------------------------------------------------------------------
TAX CAUTION Under Federal tax laws, the Fund is required to distribute
net capital gains and investment income to Fund shareholders.
INVESTORS These distributions are made to all shareholders who own Fund
SHOULD ASK shares as of the distribution's record date, regardless of
ABOUT THE how long the shares have been owned. Purchasing shares just
TIMING OF prior to the record date could have a significant impact on
CAPITAL GAINS your tax liability for the year. For example, if you purchase
AND DIVIDEND shares immediately prior to the record date of a sizable cap-
DISTRIBUTIONS ital gain, you will be assessed taxes on the amount of the
BEFORE capital gain distribution later paid even though you owned
INVESTING the Fund shares for just a short period of time. (Taxes are
due on the distributions even if the dividend or gain is re-
invested in additional Fund shares.) While the total value of
your investment will be the same after the capital gain dis-
tribution--the amount of the capital gain distribution will
offset the drop in the net asset value of the shares--you
should be aware of the tax implications the timing of your
purchase may have.
Prospective investors should, therefore, inquire about poten-
tial distributions before investing. The Fund's annual capi-
tal gains distribution normally occurs in December, while in-
come dividends are generally paid on the first business day
of each month. For additional information on distributions
and taxes, see the section titled "Dividends, Capital Gains,
and Taxes."
--------------------------------------------------------------------------------
IMPORTANT The easiest way to establish optional Vanguard services on
INFORMATION your account is to select the options you desire when you
complete your Account Registration Form. IF YOU WISH TO ADD
ESTABLISHING SHAREHOLDER OPTIONS LATER, YOU MAY NEED TO PROVIDE VANGUARD
OPTIONAL WITH ADDITIONAL INFORMATION AND A SIGNATURE GUARANTEE. PLEASE
SERVICES CALL OUR CLIENT SERVICES DEPARTMENT (1-800-662-2739) FOR FUR-
THER ASSISTANCE.
SIGNATURE For our mutual protection, we may require a signature guaran-
GUARANTEES tee on certain written transaction requests. A signature
guarantee verifies the authenticity of your signature, and
may be obtained from banks, brokers and any other guarantor
institution that Vanguard deems acceptable. A SIGNATURE GUAR-
ANTEE CANNOT BE PROVIDED BY A NOTARY PUBLIC.
CERTIFICATES With the exception of the Money Market Portfolio, share cer-
tificates will be issued upon request. If a certificate is
lost, you may incur an expense to replace it.
BROKER-DEALER If you purchase shares in Vanguard funds through a registered
PURCHASES broker-dealer or investment adviser, the broker-dealer or ad-
viser may charge a service fee.
26
<PAGE>
The Fund will not cancel any trade (e.g., a purchase, ex-
CANCELLING change or redemption) believed to be authentic, received in
TRADES writing or by telephone, once the trade request has been re-
ceived.
ELECTRONIC If you would prefer to receive a prospectus for the Fund or
PROSPECTUS any of the Vanguard Funds in an electronic format, please
DELIVERY call 1-800-231-7870 for additional information. If you elect
to do so, you may also receive a paper copy of the prospec-
tus, by calling 1-800-662-7447.
--------------------------------------------------------------------------------
WHEN YOUR The trade date is the date on which your account is credited.
ACCOUNT WILL It is generally the day on which the Fund receives your in-
BE CREDITED vestment in the form of Federal Funds (monies credited to the
Fund's Custodian Bank by a Federal Reserve Bank). Your trade
date varies according to your method of payment for your
shares.
Purchases of Fund shares by check (except the Money Market
Portfolio) will receive a trade date the day the funds are
received in good order by Vanguard. Thus, if your purchase by
check is received by the close of regular trading on the New
York Stock Exchange (generally 4:00 p.m. Eastern time), your
trade date is the business day your check is received in good
order. If your purchase is received after the close of the
Exchange your trade date is the business day following re-
ceipt of your check. Vanguard will not accept third-party
checks to open an account. Please be sure your purchase check
is made payable to the Vanguard Group.
For purchases by check for the Money Market Portfolio, the
Fund is ordinarily credited with Federal Funds within one
business day. Thus, if your purchase by check is received by
the close of regular trading on the New York Stock Exchange
(generally 4:00 p.m. Eastern time), your trade date is the
business day following receipt of your check. If your pur-
chase is received after the close of the Exchange, your trade
date is the second business day following receipt of your
check.
For purchases by Federal Funds wire or exchange, the Fund is
credited immediately with Federal Funds. Thus, if your pur-
chase by Federal Funds wire or exchange is received by the
close of the Exchange, your trade date is the day of receipt.
If your purchase is received after the close of the Exchange,
your trade date is the business day following receipt of your
wire or exchange.
Your shares are purchased at the net asset value determined
on your trade date. You will begin to earn dividends on the
calendar day following the trade date. (For a Friday trade
date, you will begin earning dividends on Saturday.) For a
purchase of the Money Market Portfolio by Federal Funds wire,
you may qualify for a dividend on the date of purchase if you
have notified the Fund of your intention to make the purchase
by 10:45 a.m. (Eastern time) on the business day of the wire.
In order to prevent lengthy processing delays caused by the
clearing of foreign checks, Vanguard will only accept a for-
eign check which has been drawn in U.S. dollars AND has been
issued by a foreign bank with a U.S. correspondent bank.
27
<PAGE>
The name of the U.S. correspondent bank must be printed on
the face of the foreign check.
--------------------------------------------------------------------------------
You may withdraw any portion of the funds in your account by
SELLING YOUR redeeming shares at any time. You may initiate a request by
SHARES writing or by telephoning. Your redemption proceeds are nor-
mally mailed, credited or wired--depending upon the method of
withdrawal you have previously chosen within two business
days after the receipt of the request in Good Order.
SELLING BY You may withdraw funds from your account by writing a check
WRITING A payable in the amount of $250 or more. When a check is pre-
CHECK sented for payment to the Fund's agent, CoreStates Bank, the
Fund will redeem sufficient shares in your account at the
next determined net asset value to cover the amount of the
check.
In order to establish the checkwriting option on your ac-
count, all registered shareholders must sign a signature
card. After your completed signature card is received by the
Fund, an initial supply of checks will be mailed within 10
business days. There is no charge for checks or for their
clearance. CORPORATIONS, TRUSTS AND OTHER ORGANIZATIONS
SHOULD CALL OUR CLIENT SERVICES DEPARTMENT (1-800-662-2739)
BEFORE SUBMITTING SIGNATURE CARDS, AS ADDITIONAL DOCUMENTS
MAY BE REQUIRED TO ESTABLISH THE CHECKWRITING SERVICE.
Before establishing the checkwriting option, you should be
aware that:
1. Writing a check (a redemption of shares) is a taxable
event.
2. The Fund does not allow an account to be closed through
the checkwriting option.
3. Vanguard cannot guarantee a stop payment on any check. If
you wish to reverse a stop payment order, you must do so
in writing.
4. Shares held in certificate form cannot be redeemed using
the Checkwriting option.
5. The Fund reserves the right to terminate or alter this
service at any time.
--------------------------------------------------------------
Requests should be mailed to VANGUARD FINANCIAL CENTER, VAN-
SELLING BY GUARD PENNSYLVANIA TAX-FREE FUND, P.O. BOX 1120, VALLEY
MAIL FORGE, PA 19482 (For express or registered mail, send your
request to Vanguard Financial Center, Vanguard Pennsylvania
Tax-Free Fund, 455 Devon Park Drive, Wayne, PA 19087.)
The redemption price of shares will be the Portfolio's net
asset value next determined after Vanguard has received all
required documents in Good Order.
--------------------------------------------------------------
DEFINITION OF GOOD ORDER means that the request includes the following:
GOOD ORDER
1. The account number and Portfolio name.
2. The amount of the transaction (specified in dollars or
shares).
3. Signatures of all owners EXACTLY as they are registered on
the account.
4. Any required signature guarantees.
5. Other supporting legal documentation that might be re-
quired in the case of estates, corporations, trusts, and
certain other accounts.
6. Any certificates you are holding for the account.
28
<PAGE>
IF YOU HAVE QUESTIONS ABOUT THIS DEFINITION AS IT PERTAINS TO
YOUR REQUEST, PLEASE CALL OUR CLIENT SERVICES DEPARTMENT AT
1-800-662-2739.
--------------------------------------------------------------
SELLING BY To sell shares by telephone, you or your pre-authorized rep-
TELEPHONE resentative may call our Client Services Department at 1-800-
662-2739. For telephone redemptions, you may have the pro-
ceeds sent to you by mail or by wire. In addition to the de-
tails, please see "Important Information About Telephone
Transactions."
BY MAIL: Telephone mail redemption is automatically estab-
lished on your account unless you indicate otherwise on your
Account Registration Form. You may redeem any amount by call-
ing Vanguard. The proceeds will be paid to the registered
shareholders and mailed to the address of record.
BY WIRE: Telephone wire redemption must be specifically
elected for your account. The best time to elect telephone
wire redemption is at the time you complete your Account Reg-
istration Form. If you do not presently have telephone wire
redemption and wish to establish it, please contact our Cli-
ent Services Department.
With the wire redemption option, you may withdraw a minimum
of $1,000 and have the amount wired directly to your bank ac-
count. Wire redemptions less than $5,000 are subject to a $5
charge deducted by Vanguard. There is no Vanguard charge for
wire redemptions of $5,000 or more. However, your bank may
assess a separate fee to accept incoming wires.
A request to change the bank associated with your wire re-
demption option must be received in writing, signed by each
registered shareholder, and accompanied by a voided check or
preprinted deposit slip. A signature guarantee is required if
your bank registration is not identical to your Vanguard Fund
account registration.
--------------------------------------------------------------
SELLING BY If you select the Fund Express Automatic Withdrawal option,
FUND EXPRESS money will be automatically moved from your Vanguard Fund ac-
count to your bank account according to the schedule you have
Automatic selected. The Special Redemption option lets you move money
Withdrawal & from your Vanguard account to your bank account on an "as
Special needed" basis. To establish these Fund Express options,
Redemption please provide the appropriate information on the Account
Registration Form. We will send you a confirmation of your
Fund Express service; please wait three weeks before using
the service.
--------------------------------------------------------------
SELLING BY You may sell shares of a Portfolio by making an exchange to
EXCHANGE another Vanguard Fund account. Please see "Exchanging Your
Shares" for details.
--------------------------------------------------------------
IMPORTANT Shares purchased by check or Fund Express may be redeemed at
REDEMPTION any time. However, your redemption proceeds will not be paid
INFORMATION until payment for the purchase is collected, which may take
up to ten calendar days.
--------------------------------------------------------------
29
<PAGE>
Redemption requests received by telephone prior to the close
DELIVERY OF of regular trading on the New York Stock Exchange (generally
REDEMPTION 4:00 p.m. Eastern time) are processed on the day of receipt
PROCEEDS and the redemption proceeds are normally sent on the follow-
ing business day.
Redemption requests received by telephone after the close of
the Exchange are processed on the business day following re-
ceipt and the proceeds are normally sent on the second busi-
ness day following receipt.
Redemption proceeds must be sent to you within seven days of
receipt of your request in Good Order.
If you experience difficulty in making a telephone redemption
during periods of drastic economic or market changes, your
redemption request may be made by regular or express mail. It
will be implemented at the net asset value next determined
after your request has been received by Vanguard in Good Or-
der. The Fund reserves the right to revise or terminate the
telephone redemption privilege at any time.
The Fund may suspend the redemption right or postpone payment
at times when the New York Stock Exchange is closed or under
any emergency circumstances as determined by the United
States Securities and Exchange Commission.
--------------------------------------------------------------
If you make a redemption from a qualifying account, Vanguard
VANGUARD'S will send you an Average Cost Statement which provides you
AVERAGE COST with the tax basis of the shares you redeemed. Please see
STATEMENT "Other Vanguard Services" for additional information.
--------------------------------------------------------------
Due to the relatively high cost of maintaining smaller ac-
MINIMUM counts, the Fund reserves the right to redeem shares in any
ACCOUNT account that is below the minimum initial investment amount
BALANCE of $3,000. If at any time your total investment does not have
REQUIREMENT a value of at least $3,000, you may be notified that your ac-
count is below the Fund's minimum account balance require-
ments. You would then be allowed 60 days to make an addi-
tional investment before the account is liquidated. Proceeds
would be promptly paid to the registered shareholder. This
minimum does not apply to Uniform Gifts/Transfers to Minors
Act account.
The Fund's minimum account balance requirement will not apply
if your account falls below $3,000 solely as a result of de-
clining markets (i.e., a decline in a Portfolio's asset val-
ue).
--------------------------------------------------------------------------------
EXCHANGING Should your investment goals change, you may exchange your
YOUR SHARES shares of Vanguard Pennsylvania Tax-Free Fund for those of
other available Vanguard Funds.
EXCHANGING BY When exchanging shares by telephone, please have ready the
TELEPHONE Portfolio name, account number, Social Security Number or Em-
ployer Identification number listed on the account, and exact
name and address in which the account is registered. Only the
registered shareholder may complete such an exchange. Re-
quests for telephone exchanges received prior to the close of
trading on the
Call Client
Services (1-
800-662-2739)
30
<PAGE>
New York Stock Exchange (generally 4:00 p.m. Eastern time)
are processed at the close of business that same day. Re-
quests received after the close of the Exchange are processed
the next business day. TELEPHONE EXCHANGES ARE NOT ACCEPTED
INTO OR FROM VANGUARD BALANCED INDEX, VANGUARD INDEX TRUST,
VANGUARD INTERNATIONAL EQUITY INDEX FUND, AND VANGUARD QUAN-
TITATIVE PORTFOLIOS. If you experience difficulty in making a
telephone exchange, your exchange request may be made by reg-
ular or express mail, and it will be implemented at the clos-
ing net asset value on the date received by Vanguard provided
the request is received in Good Order.
--------------------------------------------------------------
Please be sure to include the name and account number of your
EXCHANGING BY current fund, and the name of the fund you wish to exchange
MAIL into, the amount you wish to exchange, and the signatures of
all registered account holders. Send your request to VANGUARD
FINANCIAL CENTER, VANGUARD PENNSYLVANIA TAX-FREE FUND, P.O.
BOX 1120, VALLEY FORGE, PA 19482. (For express or registered
mail, send your request to Vanguard Financial Center, Van-
guard Pennsylvania Tax-Free Fund, 455 Devon Park Drive,
Wayne, PA 19087.)
--------------------------------------------------------------
IMPORTANT Before you make an exchange, you should consider the follow-
EXCHANGE ing:
INFORMATION
. Please read the fund's prospectus before making an ex-
change. For a copy and for answers to any questions you may
have, call our Investor Information Department (1-800-662-
7447).
. An exchange is treated as a redemption and a purchase.
Therefore, you could realize a taxable gain or loss on the
transaction.
. Exchanges are accepted only if the registrations and Tax-
payer Identification numbers of the two accounts are iden-
tical.
. The shares to be exchanged must be on deposit and not held
in certificate form.
. New accounts are not currently accepted in Vanguard/Windsor
Fund or Vanguard/PRIMECAP Fund.
. The redemption price of shares redeemed by exchange is the
net asset value next determined after Vanguard has received
the required documentation in Good Order.
. When opening a new account by exchange, you must meet the
minimum investment requirement of the new fund.
Every effort will be made to maintain the exchange privilege.
However, the Fund reserves the right to revise or terminate
its provisions, limit the amount of or reject any exchange,
as deemed necessary, at any time.
The Fund's exchange privilege is only available in Pennsylva-
nia, the only state in which the Fund's shares are registered
for sale.
--------------------------------------------------------------------------------
31
<PAGE>
The Fund's exchange privilege is not intended to afford
EXCHANGE shareholders a way to speculate on short-term movements in
PRIVILEGE the market. Accordingly, in order to prevent excessive use of
LIMITATIONS the exchange privilege that may potentially disrupt the man-
agement of the Fund and increase transaction costs, the Fund
has established a policy of limiting excessive exchange ac-
tivity.
Exchange activity generally will not be deemed excessive if
limited to TWO SUBSTANTIVE EXCHANGE REDEMPTIONS (AT LEAST 30
DAYS APART) from a Portfolio during any twelve month period.
These limitations do not apply to exchanges from Vanguard's
money market portfolios. Notwithstanding these limitations,
the Fund reserves the right to reject any purchase request
(including exchange purchases from other Vanguard portfolios)
that is reasonably deemed to be disruptive to efficient port-
folio management.
--------------------------------------------------------------------------------
The ability to initiate redemptions (except wire redemptions)
IMPORTANT and exchanges by telephone is automatically established on
INFORMATION your account unless you request in writing that telephone
ABOUT transactions on your account not be permitted. The ability to
TELEPHONE initiate wire redemptions by telephone will be established on
TRANSACTIONS your account only if you specifically elect this option in
writing.
To protect your account from losses resulting from unautho-
rized or fraudulent telephone instructions, Vanguard adheres
to the following security procedures:
1.SECURITY CHECK. To request a transaction by telephone, the
caller must know (i) the name of the Portfolio; (ii) the 10-
digit account number; (iii) the exact name and address used
in the registration; and (iv) the Social Security or Employer
Identification number listed on the account.
2.PAYMENT POLICY. The proceeds of any telephone redemption by
mail will be made payable to the registered shareowner and
mailed to the address of record, only. In the case of a tele-
phone redemption by wire, the wire transfer will be made only
in accordance with the shareowner's prior written instruc-
tions.
Neither the Fund nor Vanguard will be responsible for the au-
thenticity of transaction instructions received by telephone,
provided that reasonable security procedures have been fol-
lowed. Vanguard believes that the security procedures de-
scribed above are reasonable, and that if such procedures are
followed, you will bear the risk of any losses resulting from
unauthorized or fraudulent telephone transactions on your ac-
count.
--------------------------------------------------------------------------------
You may transfer the registration of any of your Fund shares
TRANSFERRING to another person by completing a transfer form and sending
REGISTRATION it to: VANGUARD FINANCIAL CENTER, P.O. BOX 1110, VALLEY
FORGE, PA 19482. ATTENTION: TRANSFER DEPARTMENT. The request
must be in Good Order. BEFORE MAILING YOUR REQUEST, PLEASE
CALL OUR CLIENT SERVICES DEPARTMENT (1-800-662-2739) FOR FULL
INSTRUCTIONS.
--------------------------------------------------------------------------------
32
<PAGE>
Vanguard will send you a confirmation statement each time you
STATEMENTS AND initiate a transaction in your account except for
REPORTS checkwriting redemptions from Vanguard money market accounts.
You will also receive a comprehensive account statement at
the end of each calendar quarter. The fourth-quarter state-
ment will be a year-end statement, listing all transaction
activity for the entire calendar year.
Vanguard's Average Cost Statement provides you with the aver-
age cost of shares redeemed from your account, using the av-
erage cost single category method. This service is available
for most taxable accounts opened since January 1, 1986. In
general, investors who redeemed shares from a qualifying
Vanguard account may expect to receive their Average Cost
Statement in February of the following year. Please call our
Client Services Department (1-800-662-2739) for information.
Financial reports on the Fund will be mailed to you semi-an-
nually, according to the Fund's fiscal year-end.
--------------------------------------------------------------------------------
For more information about any of these services, please call
OTHER VANGUARD our Investor Information Department at 1-800-662-7447.
SERVICES
VANGUARD With Vanguard's Direct Deposit Service, most U.S. Government
DIRECT DEPOSIT checks (including Social Security and military pension
SERVICE checks) and private payroll checks may be automatically de-
posited into your Vanguard Fund account. Separate brochures
and forms are available for direct deposit of U.S. Government
and private payroll checks.
VANGUARD Vanguard's Automatic Exchange Service allows you to move
AUTOMATIC money automatically among your Vanguard Fund accounts. For
EXCHANGE instance, the service can be used to "dollar cost average"
SERVICE from a money market portfolio into a stock or bond fund, or
to contribute to an IRA or other retirement plan. Please con-
tact our Client Services Department at 1-800-662-2739 for ad-
ditional information.
VANGUARD FUND Vanguard's Fund Express allows you to transfer money between
EXPRESS your Fund account and your account at a bank, savings and
loan association, or a credit union that is a member of the
Automated Clearing House (ACH) system. You may elect this
service on the Account Registration Form or call our Investor
Information Department (1-800-662-7447) for a Fund Express
application.
The minimum amount that can be transferred by telephone is
$100. However, if you have established one of the automatic
options, the minimum amount is $50. The maximum amount that
can be transferred using any of the options is $100,000.
Special rules govern how your Fund Express purchases or re-
demptions are credited to your account. In addition, some
services of Fund Express cannot be used with specific Van-
guard Funds. For more information, please refer to the Van-
guard Fund Express brochure.
33
<PAGE>
Vanguard's Dividend Express allows you to transfer your divi-
VANGUARD dends and/or capital gains distributions automatically from
DIVIDEND your Fund account, one business day after the Fund's payable
EXPRESS date, to your account at a bank, savings and loan associa-
tion, or a credit union that is a member of the Automated
Clearing House (ACH) system. You may elect this service on
the Account Registration Form or call our Investor Informa-
tion Department (1-800-662-7447) for a Vanguard Dividend Ex-
press application.
VANGUARD TELE- Vanguard's Tele-Account is a convenient, automated service
ACCOUNT that provides share price, price change and yield quotations
on Vanguard funds through any TouchTone(TM) telephone. This
service also lets you obtain information about your account
balance, your last transaction, and your most recent dividend
or capital gains payment. To contact Vanguard's Tele-Account
service, dial 1-800-ON-BOARD (1-800-662-6273). A brochure of-
fering detailed operating instructions is available from our
Investor Information Department (1-800-662-7447).
--------------------------------------------------------------------------------
34
<PAGE>
Vanguard
PENNSYLVANIA
TAX-FREE FUND
---------------
THE VANGUARD GROUP
OF INVESTMENT
COMPANIES
Vanguard Financial Center
P.O. Box 2600
Valley Forge, PA 19482
INVESTOR INFORMATION
DEPARTMENT:
1-800-662-7447 (SHIP)
CLIENT SERVICES
DEPARTMENT:
1-800-662-2739 (CREW)
TELE-ACCOUNT FOR
24-HOUR ACCESS:
1-800-662-6273 (ON-BOARD)
TELECOMMUNICATION SERVICE FOR THE
HEARING-IMPAIRED:
1-800-662-2738
TRANSFER AGENT:
The Vanguard Group, Inc.
Vanguard Financial Center
Valley Forge, PA 19482
Vanguard
PENNSYLVANIA
TAX-FREE FUND
P R O S P E C T U S
MARCH 28, 1995
A member of
THE Vanguard GROUP
OF INVESTMENT COMPANIES(R)
P077
<PAGE>
PART B
VANGUARD PENNSYLVANIA TAX-FREE FUND
STATEMENT OF ADDITIONAL INFORMATION
MARCH 28, 1995
This Statement is not a prospectus but should be read in conjunction with
the Fund's current Prospectus dated March 28, 1995. To obtain this Prospectus,
please call:
VANGUARD'S INVESTOR INFORMATION DEPARTMENT
1-800-662-7447
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Investment Limitations..................................................... B-1
Risks Factors.............................................................. B-6
Yield and Total Return..................................................... B-7
Calculation of Yield....................................................... B-7
Comparative Indexes........................................................ B-8
Investment Management...................................................... B-10
Purchase of Shares......................................................... B-10
Redemption of Shares....................................................... B-11
Valuation of Shares........................................................ B-11
Management of the Fund..................................................... B-13
Description of Shares and Voting Rights.................................... B-16
Financial Statements....................................................... B-17
Appendix A--Description of Municipal Bonds and their Ratings............... B-17
Appendix B--Municipal Lease Obligations.................................... B-19
</TABLE>
INVESTMENT LIMITATIONS
The following limitations cannot be changed without the consent of the hold-
ers of a majority of the Fund's outstanding shares (as defined in the Invest-
ment Company Act of 1940 (the "1940 Act")), including a majority of the shares
of each Portfolio.
1. Each Portfolio will limit the aggregate value of all holdings (except
U.S. Government and cash items, as defined under Subchapter M of the Internal
Revenue Code (the "Code")), each of which exceeds 5% of the Portfolio's total
assets, to an aggregate amount of 50% of such assets;
2. Each Portfolio will limit the aggregate value of holdings of a single is-
suer (except U.S. government and cash items, as defined in the Code) to a max-
imum of 25% of the Portfolio's total assets. For the purposes of this limita-
tion, identification of the issuer will be based on a determination of the
source of assets and revenues committed to meeting interest and principal pay-
ments of each security;
3. Each Portfolio will not borrow money except for temporary or emergency
purposes, and then only in an amount not exceeding 10% of the value of the to-
tal assets of that Portfolio. The Portfolio will repay all borrowings before
making additional investments. Interest paid on such borrowings will reduce
income;
4. Each Portfolio will not pledge, mortgage or hypothecate its assets to any
extent greater than 10% of the value of the total assets of the Portfolio;
B-1
<PAGE>
5. Each Portfolio will not issue senior securities as defined in the 1940
Act;
6. Each Portfolio will not engage in the business of underwriting securities
issued by other persons, except to the extent that the Portfolio may techni-
cally be deemed an underwriter under the Securities Act of 1933, as amended,
in disposing of portfolio securities;
7. Each Portfolio will not purchase or otherwise acquire any security, if as
a result, more than 15% (10% with respect to the Money Market Portfolio) of
its net assets would be invested in securities that are illiquid (included in
this limitation is the Fund's investment in the Vanguard Group, Inc.);
8. Each Portfolio will not purchase or sell real estate, but this shall not
prevent investments in municipal bonds secured by real estate or interests
therein;
9. Each Portfolio will not make loans to other persons, except by the pur-
chase of bonds, debentures or similar obligations which are publicly distrib-
uted and as provided under "Lending of Securities";
10. Each Portfolio will not purchase on margin or sell short, except as
specified below in Investment Limitation No. 12;
11. Each Portfolio will not purchase or retain securities of an issuer if
those Trustees of the Fund, each of whom owns more than 1/2 of 1% of such se-
curities, together own more than 5% of the securities of such issuer:
12. Each Portfolio will not purchase or sell commodities or commodities con-
tracts, except that the Pennsylvania Insured Long-Term Portfolio may invest in
bond futures contracts, bond options and options on bond futures contracts to
the extent that not more than 5% of the Portfolio's assets are required as de-
posit on futures contracts and not more than 20% of the Portfolio's assets are
invested in futures contracts and/or options transactions at any time;
13. Each Portfolio will not invest its assets in securities of other invest-
ment companies except as they may be part of a merger, consolidation, reorga-
nization or acquisition of assets or otherwise to the extent permitted by Sec-
tion 12 of the 1940 Act;
14. Each Portfolio will not invest in securities other than municipal bonds,
except that each Portfolio may make temporary investments in (a) notes issued
by or on behalf of municipal or corporate issuers, obligations of the U.S.
Government and its agencies, commercial paper and bank certificates of depos-
it; (b) investment companies investing in such securities which have invest-
ment objectives consistent with those of the Portfolio to the extent permitted
by the 1940 Act; and (c) any such securities or municipal bonds subject to re-
purchase agreements;
15. Each Portfolio will not invest in put, call, straddle or spread options
(except as described above in investment limitation No. 12) or interests in
oil, gas or other mineral exploration or development programs;
16. Each Portfolio will not purchase an industrial revenue bond if as a re-
sult of such purchase (i) more than 5% of the Portfolio's total assets, deter-
mined at market value at the time of the proposed investment, would be in-
vested in industrial revenue bonds where the payment of principal and interest
is the responsibility of a company with less than three (3) years' operating
history; or (ii) more than 20% of the Portfolio's total assets, determined at
market value at the time of the proposed investment, would be invested in in-
dustrial development bonds. These restrictions do not apply to municipal obli-
gations where the payment of principal and interest is the responsibility of a
government or the political subdivision of a government.
B-2
<PAGE>
The above-mentioned investment limitations are considered at the time in-
vestment securities are purchased. Notwithstanding these limitations, each
Portfolio may own all or any portion of the securities of, or make loans to,
or contribute to the costs or other financial requirements of, any company
which will be (1) wholly-owned by the Fund and one or more other investment
companies and (2) primarily engaged in the business of providing, at cost,
management, administrative, distribution and/or related services to the Fund
and such other investment companies. Additionally, the Fund may invest in
when-issued securities without limitation. Please see the prospectus for a de-
scription of such securities.
LENDING OF SECURITIES Each Portfolio may lend its investment securities to
qualified institutions who need to borrow securities in order to complete cer-
tain transactions, such as covering short sales, avoiding failures to deliver
securities or completing arbitrage operations. By lending its investment secu-
rities, the Portfolio attempts to increase its income through the receipt of
interest on the loan. Any gain or loss in the market price of the securities
loaned that might occur during the term of the loan would be for the account
of the Portfolio. The Portfolio may lend its investment securities to quali-
fied brokers, dealers, banks or other financial institutions, so long as the
terms and the structure of such loans are not inconsistent with the 1940 Act,
or the Rules and Regulations or interpretations of the Securities and Exchange
Commission (the "Commission") thereunder, which currently require that (a) the
borrower pledge and maintain with the Portfolio collateral having a value at
all times not less than 100% of the value of the securities loaned, (b) the
borrower add to such collateral whenever the price of the securities loaned
rises (i.e., the borrower "marks to the market" on a daily basis), (c) the
loan be made subject to termination by the Portfolio at any time and (d) the
Portfolio receive reasonable interest on the loan (which may include the Port-
folio investing any cash collateral in interest bearing short-term invest-
ments), any distribution on the loaned securities and any increase in their
market value. A Portfolio will not lend its investment securities, if as a re-
sult, the aggregate of such loans exceeds 10% of the value of its total as-
sets. Loan arrangements made by the Portfolio will comply with all other ap-
plicable regulatory requirements, including the rules of the New York Stock
Exchange, which rules presently require the borrower, after notice, to rede-
liver the securities within the normal settlement time of five business days.
All relevant facts and circumstances, including the creditworthiness of the
broker, dealer or institution, will be considered in making decisions with re-
spect to the lending of securities, subject to review by the Fund's Board of
Trustees. Income derived from lending of securities is not tax-exempt, and,
thus, a portfolio will limit such activity in accordance with its investment
objective.
FUTURES CONTRACTS AND OPTIONS The Insured Long-Term Portfolio may enter into
futures contracts, options, and options on futures contracts for the purpose
of simulating full investment and reducing transactions costs. Futures con-
tracts provide for the future sale by one party and purchase by another party
of a specified amount of a specific security at a specified future time and at
a specified price. Futures contracts which are standardized as to maturity
date and underlying financial instrument are traded on national futures ex-
changes. Futures exchanges and trading are regulated under the Commodity Ex-
change Act by the Commodity Futures Trading Commission ("CFTC"), a U.S. Gov-
ernment Agency.
Although futures contracts by their terms call for actual delivery or ac-
ceptance of the underlying securities, in most cases the contracts are closed
out before the settlement date without the making or taking of delivery. Clos-
ing out an open futures position is done by taking an opposite position ("buy-
ing" a contract which has previously been "sold," or "selling" a contract pre-
viously purchased) in an identical contract to terminate the position. Broker-
age commissions are incurred when a futures contract is bought or sold.
Futures traders are required to make a good faith margin deposit in cash or
government securities with a broker or custodian to initiate and maintain open
positions in futures contracts. A margin
B-3
<PAGE>
deposit is intended to assure completion of the contract (delivery or accept-
ance of the underlying security) if it is not terminated prior to the speci-
fied delivery date. Minimal initial margin requirements are established by the
futures exchange and may be changed. Brokers may establish deposit require-
ments which are higher than the exchange minimums. Futures contracts are cus-
tomarily purchased and sold at prices which may range upward from less than 5%
of the value of the contract being traded.
After a futures contract position is opened, the value of the contract is
marked to market daily. If the futures contract price changes, to the extent
that the margin on deposit does not satisfy margin requirements, payment of
additional "variation" margin will be required. Conversely, changes in the
contract value may reduce the required margin, resulting in a repayment of ex-
cess margin to the contract holder. Variation margin payments are made to and
from the futures broker for as long as the contract remains open. The Fund ex-
pects to earn interest income on its margin deposits.
Traders in futures contracts may be broadly classified as either "hedgers"
or "speculators." Hedgers use the futures markets primarily to offset unfavor-
able changes in the value of securities otherwise held for investment purposes
or expected to be acquired by them. Speculators are less inclined to own the
securities underlying the futures contracts which they trade, and use futures
contracts with the expectation of realizing profits from fluctuations in the
interest rate of underlying securities. The Fund intends to use futures con-
tracts only for bona fide hedging purposes.
Regulations of the CFTC applicable to the Fund require that all of its
futures transactions constitute bona fide hedging transactions. The Insured
Long-Term Portfolio will only sell futures contracts to protect securities it
owns against price declines or purchase contracts to protect against an in-
crease in the price of securities it intends to purchase. As evidence of this
hedging interest, the Portfolio expects that approximately 75% of its futures
contract purchases will be "completed," that is, equivalent amounts of related
securities will have been purchased or are being purchased by the Portfolio
upon sale of open futures contracts.
Although techniques other than the sale and purchase of futures contracts
could be used to control the Portfolio's exposure to market fluctuations, the
use of futures contracts may be a more effective means of hedging this expo-
sure. While the Portfolio will incur commission expenses in both opening and
closing out futures positions, these costs are lower than transaction costs
incurred in the purchase and sale of the underlying securities.
RESTRICTIONS ON THE USE OF FUTURES CONTRACTS The Insured Long-Term Portfolio
will not enter into futures contract transactions to the extent that, immedi-
ately thereafter, the sum of its initial margin deposits on open contracts ex-
ceeds 5% of the market value of the Fund's total assets. In addition, the
Portfolio will not enter into futures contracts to the extent that its out-
standing obligations to purchase securities under these contracts would exceed
20% of the Portfolio's total assets. Assets committed to futures contracts or
options will be held in a segregated account at the Fund's custodian bank.
RISK FACTORS IN FUTURES TRANSACTIONS Positions in futures contracts may be
closed out only on an Exchange which provides a secondary market for such
futures. However, there can be no assurance that a liquid secondary market
will exist for any particular futures contract at any specific time. Thus, it
may not be possible to close a futures position. In the event of adverse price
movements, the Insured Long-Term Portfolio would continue to be required to
make daily cash payments to maintain its required margin. In such situations,
if the Portfolio has insufficient cash, it may have to sell portfolio securi-
ties to meet daily margin requirements at a time when it may be disadvanta-
geous to do so. In addition, the Portfolio may be required to make delivery of
the instruments underlying futures contracts it holds. The inability to close
options and futures positions also could have an adverse impact on the ability
to effectively hedge it.
B-4
<PAGE>
The Insured Long-Term Portfolio will minimize the risk that it will be un-
able to close out a futures contract by only entering into futures which are
traded on national futures exchanges and for which there appears to be a liq-
uid secondary market.
The risk of loss in trading futures contracts in some strategies can be sub-
stantial, due both to the low margin deposits required, and the extremely high
degree of leverage involved in futures pricing. As a result, a relatively
small price movement in a futures contract may result in immediate and sub-
stantial loss (as well as gain) to the investor. For example, if at the time
of purchase, 10% of the value of the futures contract is deposited as margin,
a subsequent 10% decrease in the value of the futures contract would result in
a total loss of the margin deposit, before any deduction for the transaction
costs, if the account were then closed out. A 15% decrease would result in a
loss equal to 150% of the original margin deposit if the contract were closed
out. Thus, a purchase or sale of a futures contract may result in losses in
excess of the amount invested in the contract. However, because the futures
strategies of the Portfolio are engaged in only for hedging purposes, the Ad-
viser does not believe that the Portfolio is subject to the risks of loss fre-
quently associated with futures transactions. The Portfolio would presumably
have sustained comparable losses if, instead of the futures contract, it had
invested in the underlying financial instrument and sold it after the decline.
Utilization of futures transactions by the Portfolio does not involve the
risk of imperfect or no correlation where the securities underlying futures
contracts have different maturities in other characteristics than the portfo-
lio securities being hedged. It is also possible that the Portfolio could both
lose money on futures contracts and also experience a decline in value of its
portfolio securities. There is also the risk of loss by the Portfolio of mar-
gin deposits in the event of bankruptcy of a broker with whom the Portfolio
has an open position in a futures contract or related option.
Most futures exchanges limit the amount of fluctuation permitted in futures
contract prices during a single trading day. The daily limit establishes the
maximum amount that the price of a futures contract may vary either up or down
from the previous day's settlement price at the end of a trading session. Once
the daily limit has been reached in a particular type of contract, no trades
may be made on that day at a price beyond that limit. The daily limit governs
only price movement during a particular trading day and therefore does not
limit potential losses, because the limit may prevent the liquidation of unfa-
vorable positions. Futures contract prices have occasionally moved to the
daily limit for several consecutive trading days with little or no trading,
thereby preventing prompt liquidation of future positions and subjecting some
futures traders to substantial losses.
FEDERAL TAX TREATMENT OF FUTURES CONTRACTS The Insured Long-Term Portfolio
is required for federal income tax purposes to recognize as income for each
taxable year their net unrealized gains and losses on certain futures con-
tracts held as of the end of the year as well as those actually realized dur-
ing the year. In most cases, any gain or loss recognized with respect to a
futures contract is considered to be 60% long-term capital gain or loss and
40% short-term capital gain or loss, without regard to the holding period of
the contract. Furthermore, sales of futures contracts which are intended to
hedge against a change in the value of securities held by the Portfolio may
affect the holding period of such securities and, consequently, the nature of
the gain or loss on such securities upon disposition. The Portfolio may be re-
quired to defer the recognition of losses on futures contracts to the extent
of any unrecognized gains on related positions held by the Portfolio.
In order for a Portfolio to continue to qualify for federal income tax
treatment as a regulated investment company, at least 90% of its gross income
for a taxable year must be derived from qualifying income; i.e., dividends,
interest, income derived from loans of securities, gains from the sale of se-
curities or of foreign currencies or other income derived with respect to the
Portfolio's business of investing in securities. In addition, gains realized
on the sale or other disposition of securities held for less than three months
must be limited to less than 30% of the Portfolio's annual gross income. It is
anticipated that any net gain realized from the closing out of futures con-
tracts will be considered
B-5
<PAGE>
gain from the sale of securities and therefore be qualifying income for pur-
poses of the 90% requirement. In order to avoid realizing excessive gains on
securities held less than three months, the Insured Long-Term Portfolio may be
required to defer the closing out of futures contracts beyond the time when it
would otherwise be advantageous to do so. It is anticipated that unrealized
gains on futures contracts, which have been open for less than three months as
of the end of the Portfolio's fiscal year and which are recognized for tax
purposes, will not be considered gains on sales of securities held less than
three months for the purpose of the 30% test.
Each Portfolio will distribute to shareholders annually any net capital
gains which have been recognized for federal income tax purposes (including
unrealized gains at the end of the Portfolio's fiscal year) on futures trans-
actions. Such distributions will be combined with distributions of capital
gains realized on the Portfolio's other investments and shareholders will be
advised on the nature of the transactions.
RISK FACTORS VANGUARD PENNSYLVANIA TAX-FREE FUND
Vanguard Pennsylvania Tax-Free Fund invests primarily in the obligations of
Pennsylvania state government, state agencies and various local governments,
including counties, cities, townships, special districts, and authorities. In
general, the credit quality and credit risk of any issuer's debt depend on the
state and local economy, the health of the issuer's finances, the amount of
the issuer's debt, the quality of management, and the strength of legal provi-
sions in debt documents that protect debt holders. Credit risk is usually
lower wherever the economy is strong, growing and diversified; financial oper-
ations are sound; and the debt burden is reasonable.
The average rating among American states for full faith and credit state
debt is "Aa" and "AA" by Moody's Investors Service and Standard & Poor's Cor-
poration, respectively. Against this measure and the criteria listed above,
the credit risk associated with direct obligations of the Commonwealth of
Pennsylvania and State agencies, including general obligation and revenue
bonds, lease debt, and notes, compares somewhat unfavorably. During most of
the last two decades, the Commonwealth's general obligation bonds have been
rated just below this average by both rating agencies. Nonetheless, during
this period the Commonwealth's obligations could still be characterized as
providing upper medium grade security, with a strong capacity for timely re-
payment of debt.
Factors contributing positively to credit quality in Pennsylvania include a
favorable debt structure, a diversifying economic base, and conservatively
managed financial operations on the part of state government. Tax-supported
debt is only slightly above average state levels on a per capita basis and as
a percent of state personal income. Over the past two decades, this debt bur-
den has improved considerably in Pennsylvania, and debt continues to be rap-
idly retired, while state borrowing plans are modest.
In the past twenty years, Pennsylvania's economy has undergone a healthy,
though traumatic, transformation. Manufacturing employment has declined from
35% of total state employment in 1970 to 18.4% of total employment in 1993,
only slightly above the U.S. average. Growth in service sector jobs offset the
loss of manufacturing jobs, and Pennsylvania's economy is now much more
closely aligned with the national economy. In the future, economic booms and
busts should be milder than in the past and more closely follow national aver-
ages. The positive change in the economy has not been without costs. Growth
levels in employment, population and personal income lagged behind U.S. aver-
ages in the 1980s. During this period, per capita personal income slipped to
about the U.S. average. Many communities dominated by a single industry were
particularly hurt, and recent growth in the state economy has bypassed much of
the state outside of the immediate Philadelphia and Pittsburgh metropolitan
areas. As a result, the credit quality of these areas is often marginal.
B-6
<PAGE>
During the 1991-1992 national economic recession, Pennsylvania fared a bit
worse than the U.S. average but better than many neighboring Northeastern and
Mid-Atlantic states. Led by continuing declines in manufacturing, employment
decreased about 4%, or double the U.S. loss rate. The Commonwealth is expected
to experience economic recovery in line with the U.S.
Fiscally, Pennsylvania has historically maintained balanced budgets, a re-
sult of sound and conservative budgeting policies. During the period of eco-
nomic growth in the late 1980s, operating surpluses were recorded, and a
"rainy day" fund was established. The recent recession tested these policies,
but the Commonwealth emerged from the recession with its finances and credit
quality intact. In 1990 and 1991, as the recession worsened, budget balances
were eliminated, and the state ended 1991 in a deficit position. However, a
combination of expenditure restraint and broad-based tax increases enabled the
state to end 1992 with a surplus. Finances are now stable.
The risk factors in Pennsylvania's credit quality may be summarized as slow
growth, an aging population, average income, and a continuing challenge to
maintain balanced budgets. In addition, a number of local governments in the
Commonwealth, most notably Philadelphia, are in serious fiscal difficulty, and
are unable to address serious economic, social and healthcare problems within
revenue constraints. Philadelphia's credit prospects have recently improved
but remain a challenge to the credit quality of Pennsylvania.
YIELD AND TOTAL RETURN
The yield of the Pennsylvania Insured Long-Term Portfolio for the 30-day pe-
riod ended November 30, 1994 was +6.41%. Yield is calculated daily and premium
and discounts on asset-backed securities are not amortized.
The average annual total return of the Pennsylvania Insured Long-Term Port-
folio for the one-year and five-year period ending November 30, 1994 and since
its inception on April 7, 1986 was -5.44%, +6.81% and +7.16%, respectively.
The average total return of the Pennsylvania Money Market Portfolio for the
one-year and five-year period ending November 30, 1994 and since its inception
on June 13, 1988 was +2.57%, +3.67% and +4.22%, respectively. Total return is
computed by determining the average compounded rates of return over the period
set forth above that would equate an initial amount invested at the beginning
of the period to the ending redeemable value of the investment.
CALCULATION OF YIELD
The current yield of the Pennsylvania Money Market Portfolio is calculated
daily on a base period return of a hypothetical account having a beginning
balance of one share for a particular period of time (generally 7 days). The
return is determined by dividing the net change (exclusive of any capital
changes) in such account by its average net assets value for the period, and
then multiplying it by 365/7 to get the annualized current yield. The calcula-
tion of net change reflects the value of additional shares purchased with the
dividends by the Portfolio, including dividends on both the original share and
on such additional shares. An effective yield, which reflects the effects of
compounding and represents an annualization of the current yield with all div-
idends reinvested, may also be calculated for the Portfolio by adding 1 to the
net change, raising the sum to the 365/7 power, and subtracting 1 from the re-
sult.
B-7
<PAGE>
Set forth below is an example, for purposes of illustration only, of the
current and effective yield calculations for the Pennsylvania Money Market
Portfolio for the 7-day base period ended November 30, 1994.
<TABLE>
<CAPTION>
MONEY MARKET PORTFOLIO
----------------------
11/30/94
--------
<S> <C>
Value of account at beginning of period.............. $1.00000
Value of same account at end of period*.............. 1.00067
--------
Net Change in account value.......................... $ .00067
Annualized Current Net Yield (Net Change X 365/7)/
average net asset value............................. 3.51%
Effective Yield [(Net Change) +1] 365/7 - 1.......... 3.55%
Average Weighted Maturity of Investments............. 45 Days
</TABLE>
--------
* Exclusive of any capital changes.
The net asset value of the Pennsylvania Money Market Portfolio is $1.00 and
it is not expected to fluctuate. The yield of the Portfolio will fluctuate.
The Money Market Portfolio seeks to maintain, but does not guarantee, a con-
stant net asset value of $1.00 per share. Although the Money Market Portfolio
invests in high-quality instruments, the shares of the Portfolio are not in-
sured or guaranteed by the U.S. Government. The annualization of a week's div-
idend is not a representation by the Portfolio as to what an investment in the
Portfolio will actually yield in the future. Actual yields will depend on such
variables as investment quality, average maturity, the type of instruments the
Portfolio invests in, changes in interest rates on instruments, changes in the
expenses of the Fund and other factors. Yields are one basis investors may use
to analyze the Portfolios of the Fund, and other investment vehicles, however,
yields of other investment vehicles may not be comparable because of the fac-
tors set forth in the preceding sentence, differences in the time periods com-
pared, and differences in the methods used in valuing portfolio instruments,
computing net asset value and calculating yield.
COMPARATIVE INDEXES
Each of the investment company members of the Vanguard Group, including Van-
guard Pennsylvania Tax-Free Fund, may from time to time, use one or more of
the following unmanaged indexes for comparative performance purposes.
STANDARD AND POOR'S 500 COMPOSITE STOCK PRICE INDEX -- is a well diversified
list of 500 companies representing the U.S. Stock Market.
WILSHIRE 5000 EQUITY INDEXES -- consists of more than 6,000 common equity se-
curities, covering all stocks in the U.S. for which daily pricing is avail-
able.
WILSHIRE 4500 EQUITY INDEX -- consists of all stocks in the Wilshire 5000 ex-
cept for the 500 stocks in the Standard and Poor's 500 Index.
RUSSELL 3000 STOCK INDEX -- a diversified portfolio of approximately 3,000
common stocks accounting for over 90% of the market value of publicly traded
stocks in the U.S.
RUSSELL 2000 STOCK INDEX -- a subset of approximately 2,000 of the smallest
stocks contained in the Russell 3000; a widely-used benchmark for small capi-
talization common stocks.
MORGAN STANLEY CAPITAL INTERNATIONAL EAFE INDEX -- is an arithmetic, market
value-weighted average of the performance of over 900 securities listed on the
stock exchanges of countries in Europe, Australia and the Far East.
B-8
<PAGE>
GOLDMAN SACHS 100 CONVERTIBLE BOND INDEX -- currently includes 67 bonds and 33
preferreds. The original list of names was generated by screening for convert-
ible issues of 100 million or greater in market capitalization. The index is
priced monthly.
SALOMON BROTHERS GNMA INDEX -- includes pools of mortgages originated by pri-
vate lenders and guaranteed by the mortgage pools of the Government National
Mortgage Association.
SALOMON BROTHERS HIGH-GRADE CORPORATE BOND INDEX -- consists of publicly is-
sued, non-convertible corporate bonds rated AA or AAA. It is a value-weighted,
total return index, including approximately 800 issues with maturities of 12
years or greater.
LEHMAN LONG-TERM TREASURY BOND -- is composed of all bonds covered by the
Shearson Lehman Hutton Treasury Bond Index with maturities of 10 years or
greater.
MERRILL LYNCH CORPORATE & GOVERNMENT BOND -- consists of over 4,500 U.S. Trea-
sury, Agency and investment grade corporate bonds.
LEHMAN CORPORATE (BAA) BOND INDEX -- all publicly offered fixed-rate, noncon-
vertible domestic corporate bonds rated Baa by Moody's, with a maturity longer
than 1 year and with more than $25 million outstanding. This index includes
over 1,000 issues.
BOND BUYER MUNICIPAL INDEX (20 YEAR) BOND -- is a yield index on current cou-
pon high-grade general obligation municipal bonds.
STANDARD & POOR'S PREFERRED INDEX -- is a yield index based upon the average
yield of four high-grade, non-callable preferred stock issues.
NASDAQ INDUSTRIAL INDEX -- is composed of more than 3,000 industrial issues.
It is a value-weighted index calculated on price change only and does not in-
clude income.
COMPOSITE INDEX -- 70% Standard & Poor's 500 Index and 30% NASDAQ Industrial
Index.
COMPOSITE INDEX -- 35% Standard & Poor's 500 Index and 65% Salomon Brothers
High-Grade Bond Index.
COMPOSITE INDEX -- 65% Standard & Poor's 500 Index and 35% Salomon Brothers
High-Grade Bond Index.
LEHMAN BROTHERS AGGREGATE BOND INDEX -- is a market weighted index that con-
tains individually priced U.S. Treasury, agency, corporate, and mortgage pass-
through securities corporate rated BBB -- or better. The Index has a market
value of over $4 trillion.
LEHMAN BROTHERS MUTUAL FUND SHORT (1-5) GOVERNMENT/CORPORATE INDEX -- is a
market weighted index that contains individually priced U.S. Treasury, agency,
and corporate investment grade bonds rated BBB -- or better with maturities
between 1 and 5 years. The index has a market value of over $1.3 trillion.
LEHMAN BROTHERS MUTUAL FUND INTERMEDIATE (5-10) GOVERNMENT/CORPORATE INDEX --
is a market weighted index that contains individually priced U.S. Treasury,
agency, and corporate securities rated BBB -- or better with maturities be-
tween 5 and 10 years. The index has a market value of over $600 billion.
LEHMAN BROTHERS MUTUAL FUND LONG (10+) GOVERNMENT/CORPORATE INDEX -- is a mar-
ket weighted index that contains individually priced U.S. Treasury, agency,
and corporate securities rated BBB -- or better with maturities greater than
10 years. The index has a market value of over $900 billion.
B-9
<PAGE>
LIPPER SMALL COMPANY GROWTH FUND AVERAGE -- the average performance of small
company growth funds as defined by Lipper Analytical Services, Inc. Lipper de-
fines a small company growth fund as a fund that by prospectus of portfolio
practice, limits its investments to companies on the basis of the size of the
company. From time to time, Vanguard may advertise using the average perfor-
mance and/or the average expense ratio of the small company growth funds. (The
fund category was first established in 1982. For years prior to 1982, the re-
sults of the Lipper Small Company Growth category were estimated using the re-
turns of the Funds that constituted the Group at its inception.)
LIPPER BALANCED FUND AVERAGE -- An industry benchmark of average balanced
funds with similar investment objectives and policies, as measured by Lipper
Analytical Services, Inc.
LIPPER NON-GOVERNMENT MONEY MARKET FUND AVERAGE -- An industry benchmark of
average non-government money market funds with similar investment objectives
and policies, as measured by Lipper Analytical Services, Inc.
LIPPER GOVERNMENT MONEY MARKET FUND AVERAGE -- An industry benchmark of aver-
age government money market funds with similar investment objectives and poli-
cies, as measured by Lipper Analytical Services, Inc.
INVESTMENT MANAGEMENT
The Fund receives all investment advisory services on an "internalized," at-
cost basis from an experienced investment management staff employed directly
by The Vanguard Group, Inc. ("Vanguard"), a subsidiary jointly-owned by the
Fund and the other funds in The Vanguard Group of Investment Companies. The
investment management staff is supervised by the senior officers of the Fund.
The investment management staff is responsible for: maintaining the speci-
fied standards; making changes in specific issues in light of changes in the
fundamental basis for purchasing such securities; and adjusting the Fund to
meet cash inflow (or outflow), which reflects net purchases and exchanges of
shares by investors (or net redemptions of shares) and reinvestment of the
Fund's income.
A change in securities held by the Fund is known as "portfolio turnover" and
may involve the payment by the Fund of dealer mark-ups, underwriting commis-
sions and other transaction costs on the sales of securities as well as on the
reinvestment of the proceeds in other securities. The annual portfolio turn-
over rate for each of the Fund's Portfolios is set forth under the heading
"Financial Highlights" in the prospectus. The portfolio turnover rate is not a
limiting factor when management deems it desirable to sell or purchase securi-
ties. It is impossible to predict whether or not the portfolio turnover rate
in future years will vary significantly from the rates in recent years.
PURCHASE OF SHARES
The Fund reserves the right in its sole discretion (i) to suspend the offer-
ing of its shares, (ii) to reject purchase orders when in the judgment of man-
agement such rejection is in the best interest of the Fund, and (iii) to re-
duce or waive the minimum for initial and subsequent investments under circum-
stances where certain economies, can be achieved in sales of the Fund's
shares.
STOCK CERTIFICATES. Your purchase will be made in full and fractional shares
of the Fund calculated to three decimal places. Shares are normally held on
deposit for shareholders by the Fund, which will send to shareholders a state-
ment of shares owned at the time of each transaction. This saves the share-
holders the trouble of safekeeping the certificates and saves the Fund the
cost of issuing certificates. Share certificates for the Pennsylvania Insured
Long-Term Portfolio are, of course,
B-10
<PAGE>
available at any time upon written request at no additional cost to sharehold-
ers. No certificates will be issued for fractional shares or shares of the
Pennsylvania Money Market Portfolio.
REDEMPTION OF SHARES
The Fund may suspend redemption privileges or postpone the date of payment
(i) during any period that the New York Stock Exchange is closed, or trading
on the Exchange is restricted as determined by the Securities and Exchange
Commission (the "Commission"), (ii) during any period when an emergency exists
as defined by the rules of the Commission as a result of which it is not rea-
sonably practicable for the Fund to dispose of securities owned by it, or
fairly to determine the value of its assets, and (iii) for such other periods
as the Commission may permit.
If the Board of Trustees determines that it would be detrimental to the best
interests of the remaining shareholders of the Fund to make payment wholly or
partly in cash, the Fund may pay the redemption price in whole or in part by a
distribution in kind of securities held by the Fund in lieu of cash in confor-
mity with applicable rules of the Commission. Investors may incur brokerage
charges on the sale of such securities so received in payment of redemptions.
No charge is made by the Fund for redemptions except for wire redemptions of
under $5,000 which may be charged a maximum fee of $5.00. Any redemption may
be more or less than the shareholder's cost depending on the market value of
the securities held by the Fund.
SIGNATURE GUARANTEES. To protect your account, the Fund and Vanguard from
fraud, signature guarantees are required for certain redemptions. Signature
guarantees enable the Fund to verify the identity of the person who has autho-
rized a redemption from your account. Signature guarantees are required in
connection with: (1) redemptions involving more than $25,000 on the date of
receipt by Vanguard of all necessary documents; (2) all redemptions, regard-
less of the amount involved, when the proceeds are to be paid to someone other
than the registered owners); and (3) share transfer requests.
A signature guarantee may be obtained from banks, brokers and any other
guarantor institution that Vanguard deems acceptable. Notaries public are not
acceptable guarantors.
The signature guarantees must appear either: (1) on the written request for
redemption, (2) on a separate instrument for assignment ("stock power") which
should specify the total number of shares to be redeemed, or (3) on all stock
certificates tendered for redemption and, if shares held by the Fund are also
being redeemed, on the letter or stock power.
VALUATION OF SHARES
The valuation of shares of the Pennsylvania Insured Long-Term Portfolio is
described in detail in the Prospectus.
PENNSYLVANIA MONEY MARKET PORTFOLIO. The net asset value per share of the
Pennsylvania Money Market Portfolio is determined on each day that the New
York Stock Exchange is open and on any other day on which there is sufficient
trading in the Fund's securities to materially affect the Fund's net asset
value per share.
It is the policy of the Pennsylvania Money Market Portfolio to attempt to
maintain a net asset value of $1.00 per share for purposes of sales and re-
demptions. The Portfolio seeks to maintain, but does not guarantee, a constant
net asset value of $1.00 per share. Although the Pennsylvania Money Market
Portfolio invests in high-quality instruments, the shares of the Portfolio are
not insured or
B-11
<PAGE>
guaranteed by the U.S. Government. The instruments held by the Pennsylvania
Money Market Portfolio are valued on the basis of amortized cost which does
not take into account unrealized capital gains or losses. This involves valu-
ing an instrument at-cost and thereafter assuming a constant amortization to
maturity of any discount or premium, regardless of the impact of fluctuating
interest rates on the market value of the instrument. While this method pro-
vides certainty in valuation, it may result in periods during which value, as
determined by amortized cost, is higher or lower than the price the Portfolio
would receive if it sold the instrument. During periods of declining interest
rates, the daily yield on shares of the Portfolio computed as described above
may tend to be higher than a like computation made by a fund with identical
investments utilizing a method of valuation based upon market prices and esti-
mates of market prices for all of its portfolio instruments. Thus, if the use
of amortized cost of the Portfolio resulted in a lower aggregate portfolio
value on a particular day, a prospective investor in the Portfolio would be
able to obtain a somewhat higher yield than would result from investment in a
fund utilizing solely market values, and existing investors in the Portfolio
would receive less investment income. The converse would apply in a period of
rising interest rates.
The valuation of the Pennsylvania Money Market Portfolio's instruments based
upon their amortized cost and the commitment to maintain the Portfolio's per
share net asset value of $1.00 is permitted by Rule 2a-7 under the Investment
Company Act of 1940 pursuant to which the Fund must adhere to certain condi-
tions. Accordingly, the Fund has agreed to maintain a dollar-weighted average
portfolio maturity for the Pennsylvania Money Market Portfolio of 90 days or
less, to purchase instruments having remaining maturities of thirteen months
or less only, and to invest only in securities determined by the Board of
Trustees to be of good quality with minimal credit risks.
It is a fundamental objective of management to maintain the Portfolio's
price per share as computed for the purpose of sales and redemptions at $1.00.
The Trustees have established procedures designed to achieve this objective.
Such procedures will include a review of the Portfolio's holdings by the
Trustees, at such intervals as they may deem appropriate, to determine whether
the Portfolio's net asset value calculated by using available market quota-
tions deviates from $1.00 per share based on amortized cost. The extent of any
deviation will be examined by the Trustees. If such deviation exceeds 1/2 of
1%, the Trustees will promptly consider what action, if any, will be initiat-
ed. In the event the Trustees determine that a deviation exists which may re-
sult in material dilution or other unfair results to investors or existing
shareholders, they have agreed to take such corrective action as they regard
as necessary and appropriate, including the sale of portfolio instruments
prior to maturity to realize capital gains or losses or to shorten average
portfolio maturity; withholding dividends; making a special capital distribu-
tion; redemptions of shares in kind; or establishing a net asset value per
share by using available market quotations.
B-12
<PAGE>
MANAGEMENT OF THE FUND
OFFICERS AND TRUSTEES
The Officers of the Fund manage its day-to-day operations and are responsible
to the Fund's Trustees. The Trustees set broad policies for the Fund and choose
its Officers. The following is a list of Trustees and Officers of the Fund and
a statement of their present positions and principal occupations during the
past five years is set forth below. As of November 30, 1994, the Trustees owned
less than 1% of the Fund's outstanding shares. The mailing address of the
Fund's Trustees and Officers is Post Office Box 876, Valley Forge, PA 19482.
JOHN C. BOGLE, Chairman, Chief JOHN C. SAWHILL, Trustee
Executive Officer and Trustee* President and Chief Executive Of-
Chairman, Chief Executive Offi- ficer, The Nature Conservancy;
cer, and Director of The Vanguard formerly, Director and Senior
Group, Inc., and of each of the Partner, McKinsey & Co., Presi-
investment companies in The Van- dent, New York University; Direc-
guard Group. Director of The Mead tor of Pacific Gas and Electric
Corporation and General Accident Company and NACCO Industries.
Insurance.
JOHN J. BRENNAN, President & JAMES O. WELCH, JR., Trustee
Trustee* Retired Chairman of Nabisco
President and Director of the Brands Inc. retired Vice Chairman
Fund, The Vanguard Group, Inc. and Director of RJR Nabisco; Di-
and each of the investment compa- rector of TECO Energy, Inc.
nies in The Vanguard Group.
ROBERT E. CAWTHORN, Trustee J. LAWRENCE WILSON, Trustee
Chairman of Rhone-Poulenc Rorer, Chairman and Chief Executive Of-
Inc.; Director of Sun Company, ficer of Rohm & Haas Company; Di-
Inc. rector of Cummins Engine Company;
Trustee of Vanderbilt University
and the Culver Educational Foun-
dation.
BARBARA BARNES HAUPTFUHRER, Trustee RAYMOND J. KLAPINSKY, Secretary*
Director of The Great Atlantic Senior Vice President and Secre-
and Pacific Tea Company, Alco tary of The Vanguard Group, Inc.;
Standard Corp., Raytheon Company, Secretary of each of the invest-
Knight-Ridder, Inc., and Massa- ment companies in The Vanguard
chusetts Mutual Life Insurance Group.
Co. and Trustee Emerita of
Wellesley College.
BURTON G. MALKIEL, Trustee RICHARD F. HYLAND, Treasurer*
Chemical Bank Chairman's Profes- Treasurer of The Vanguard Group,
sor of Economics, Princeton Uni- Inc. and of each of the invest-
versity; Director of Prudential ment companies in The Vanguard
Insurance Co. of America, Amdahl Group.
Corporation, Baker Fentress &
Co., The Jeffrey Co., and South-
ern New England Communications
Company.
ALFRED M. RANKIN, Trustee KAREN E. WEST, Controller*
Chairman, President and Chief Ex- Vice President of The Vanguard
ecutive Officer of NACCO Indus- Group, Inc.; Controller of each
tries, Inc.; Director of the of the investment companies in
BFGoodrich Company, The Standard The Vanguard Group.
Products Company and The Reliance
Electric Company.
--------
* Officers of the Fund are "inter-
ested persons" as defined in the
Investment Company Act of 1940.
B-13
<PAGE>
THE VANGUARD GROUP
Vanguard Pennsylvania Tax-Free Fund is a member of The Vanguard Group of In-
vestment Companies. Through their jointly-owned subsidiary, The Vanguard
Group, Inc. ("Vanguard"), the Fund and the other Funds in the Group obtain at-
cost virtually all of their corporate management, administrative and distribu-
tion services. Vanguard also provides investment advisory services on an at-
cost basis to several of the Vanguard Funds, including the Vanguard Pennsylva-
nia Tax-Free Fund.
Vanguard employs a supporting staff of management and administrative person-
nel needed to provide the requisite services to the Funds and also furnishes
the Funds with necessary office space, furnishings and equipment. Each Fund
pays its share of Vanguard's net expenses which are allocated among the Funds
under methods approved by the Board of Trustees (Directors) of each Fund. In
addition, each Fund bears its own direct expenses such as legal, auditing and
custodian fees. In order to generate additional revenues for Vanguard and
thereby reduce the Funds' expenses, Vanguard also provides certain administra-
tive services to other organizations.
The Fund's Officers are also officers and employees of Vanguard. No officer
or employee owns, or is permitted to own, any securities of any external ad-
viser for the Funds.
The Vanguard Group adheres to a Code of Ethics established pursuant to Rule
17j-1 under the Investment Company Act of 1940. The Code is designed to pre-
vent unlawful practices in connection with the purchase or sale of securities
by persons associated with Vanguard. Under Vanguard's Code of Ethics, certain
officers and employees of Vanguard who are considered access persons are per-
mitted to engage in personal securities transactions. However, such transac-
tions are subject to procedures and guidelines substantially similar to those
recommended by the mutual fund industry and approved by the U.S. Securities
and Exchange Commission.
The Vanguard Group, Inc. ("Vanguard") was established and operates under a
Funds' Service Agreement which was approved by the shareholders of each of the
Funds in 1992. The amounts which each of the Funds have invested are adjusted
from time to time in order to maintain the proportionate relationship between
each Fund's relative net assets and its contribution to Vanguard's capital. At
November 30, 1994 Vanguard Pennsylvania Tax-Free Fund had contributed capital
of $372,000 to Vanguard representing 1.9% of Vanguard's capitalization. The
Funds' Service Agreement provides as follows: (a) each Vanguard Fund may in-
vest up to 0.40% of its current net assets in Vanguard, and (b) there is no
other limitation on the amount that each Vanguard Fund may contribute to Van-
guard's capitalization.
MANAGEMENT. Corporate management and administrative services include: (1)
executive staff; (2) accounting and financial; (3) legal and regulatory; (4)
shareholder account maintenance; (5) monitoring and control of custodian rela-
tionships; (6) shareholder reporting; and (7) review and evaluation of advi-
sory and other services provided to the Funds by third parties. During the
fiscal year ended November 30, 1994, the Funds share of Vanguard's actual net
costs of operations relating to management and administrative services (in-
cluding transfer agency) totaled approximately $3,978,000.
DISTRIBUTION. Vanguard provides all distribution and marketing activities
for the Funds in the Group. Vanguard Marketing Corporation, a wholly-owned
subsidiary of The Vanguard Group, Inc. acts as Sales Agent for shares of the
Funds, in connection with any sales made directly to investors in the states
of Florida, Missouri, New York, Ohio, Texas and such other states as it may be
required.
The principal distribution expenses are for advertising, promotional materi-
als and marketing personnel. Distribution services may also include organizing
and offering to the public, from time to time, one or more new investment com-
panies which will become members of the Group. The Trustees (Directors) and
officers of Vanguard determine the amount to be spent annually on distribution
activ-
B-14
<PAGE>
ities, the manner and amount to be spent on each Fund, and whether to organize
new investment companies.
One half of the distribution expenses of a marketing and promotional nature
is allocated among the Funds based upon their relative net assets. The remain-
ing one half of these expenses is allocated among the Funds based upon each
Fund's sales for the preceding 24 months relative to the total sales of the
Funds as a Group, provided, however, that no Fund's aggregate quarterly rate
of contribution for distribution expenses of a marketing and promotional na-
ture shall exceed 125% of the average distribution expense rate for the Group,
and that no Fund shall incur annual distribution expenses in excess of 20/100
of 1% of its average month-end net assets. During the year ended November 30,
1994 the Fund paid approximately $576,000 of the Group's distribution and mar-
keting expenses.
INVESTMENT ADVISORY SERVICES. Vanguard also provides investment advisory
services to the Fund; Vanguard Municipal Bond Fund; Vanguard Money Market Re-
serves; Vanguard Institutional Money Market Portfolio; Vanguard Admiral Funds;
the several Portfolios of Vanguard Fixed Income Securities Fund; Vanguard In-
stitutional Index Fund; Vanguard Bond Index Fund; the Vanguard California Tax-
Free Fund; Vanguard Florida Insured Tax-Free Fund; Vanguard New Jersey Tax-
Free Fund; Vanguard New York Insured Tax-Free Fund; Vanguard Ohio Tax-Free
Fund; Vanguard Balanced Index Fund; Vanguard Index Trust; Vanguard Interna-
tional Equity Index Fund; Vanguard Tax-Managed Fund; several Portfolios of
Vanguard Variable Insurance Fund; a portion of Vanguard/Windsor II; a portion
of Vanguard/Morgan Growth Fund as well as several indexed separate accounts.
These services are provided on an at-cost basis from a money management staff
employed directly by Vanguard. The compensation and other expenses of this
staff are paid by the Funds utilizing these services. During the years ended
November 30, 1992, 1993 and 1994 the Fund paid approximately $164,000,
$204,000 and $281,000 of Vanguard's investment advisory expenses.
REMUNERATION OF TRUSTEES AND OFFICERS. The Fund pays each Trustee, who is
not also an Officer, an annual fee plus travel and other expenses incurred in
attending Board meetings. During the year ended November 30, 1994 the Fund
paid $12,000 in Trustees' expenses. The Fund's officers and employees are paid
by Vanguard which, in turn, is reimbursed by the Fund, and each other Fund in
the Group, for its proportionate share of Officers' and employees' salaries
and retirement benefits. During the year ended November 30, 1994, the Fund's
proportionate share of remuneration paid to all officers of the Fund, as a
group, was approximately $99,952.
Trustees who are not Officers are paid an annual fee based on the number of
years of service on the Board upon retirement. The fee is equal to $1,000 for
each year of service (up to fifteen years) and each investment Company member
of the Vanguard Group contributes a proportionate amount to this fee based on
its relative net assets. Under its Retirement Plan, Vanguard contributes annu-
ally an amount equal to 10% of each eligible officer's annual compensation
plus 5.7% of that part of an eligible officer's compensation during the year,
if any, that exceeds the Social Security Taxable Wage Base then in effect. Un-
der its Thrift Plan, all eligible officers are permitted to make pre-tax con-
tributions in an amount up to 4% of total compensation, subject to federal tax
limitations, which are matched by Vanguard on a 100% basis. The Fund's propor-
tionate share of retirement contributions made by Vanguard under its Retire-
ment and Thrift Plans on behalf of all Officers of the Fund, as a group, dur-
ing the 1994 fiscal year was approximately $11,400.
B-15
<PAGE>
The following table provides detailed information with respect to the
amounts paid or accrued for the Trustees for the fiscal year ended November
30, 1994.
VANGUARD PENNSYLVANIA TAX-FREE FUND
COMPENSATION TABLE
<TABLE>
<CAPTION>
TOTAL
PENSION OR COMPENSATION
RETIREMENT ESTIMATED FROM ALL
AGGREGATE BENEFITS ACCRUED ANNUAL VANGUARD
COMPENSATION AS PART OF BENEFITS UPON FUNDS PAID
NAMES OF TRUSTEES FROM FUND FUND EXPENSES RETIREMENT TO TRUSTEES(2)
----------------- ------------ ---------------- ------------- --------------
<S> <C> <C> <C> <C>
John C. Bogle(1)........ -- -- -- --
John J. Brennan(1)...... -- -- -- --
Barbara Barnes
Hauptfuhrer............ $1,510 $306 $15,000 $50,000
Robert E. Cawthorn...... $1,510 $255 $13,000 $50,000
Burton G. Malkiel....... $1,510 $204 $15,000 $50,000
Alfred M. Rankin, Jr.... $1,510 $161 $15,000 $50,000
John C. Sawhill......... $1,510 $191 $15,000 $50,000
James O. Welch, Jr...... $1,449 $235 $15,000 $48,000
J. Lawrence Wilson...... $1,479 $170 $15,000 $49,000
</TABLE>
--------
(1) As "Interested Trustees," Messrs. Bogle and Brennan receive no compensa-
tion for their service as Trustees.
(2) The amounts reported in this column reflect the total compensation paid to
each Trustee for their service as Director or Trustee of 33 Vanguard
Funds.
DESCRIPTION OF SHARES AND VOTING RIGHTS
The Fund was organized as a Pennsylvania Trust on January 15, 1986.
The Declaration of Trust permits the Trustees to issue an unlimited number
of shares of beneficial interest, without par value, from an unlimited number
of separate classes ("Portfolios") of shares. Currently, the Fund is offering
shares of two Portfolios.
The shares of the Fund are fully paid and nonassessable, except as set forth
under "Shareholder and Trustee Liability," and have no preference as to con-
version, exchange, dividends, retirement or other features. The shares of the
Fund have no pre-emptive rights. The shares of the Fund have non-cumulative
voting rights, which means that the holders of more than 50% of the shares
voting for the election of Trustees can elect 100% of the Trustees if they
choose to do so. A shareholder is entitled to one vote for each full share
held (and a fractional vote for each fractional share held), then standing in
his name on the books of the Fund. On any matter submitted to a vote of share-
holders, all shares of the Fund then issued and outstanding and entitled to
vote, irrespective of the class, shall be voted in the aggregate and not by
class: except (i) when required by the Investment Company Act of 1940, shares
shall be voted by individual class; and (ii) when the matter does not affect
any interest of a particular class, then only shareholders of the affected
class or classes shall be entitled to vote thereon.
The Fund will continue without limitation of time, provided, however that:
1) Subject to the majority vote of the holders of shares of the Fund out-
standing, the Trustees may sell or convert the assets of the Fund to
another investment company in exchange for shares of such investment
company, and distribute such shares, ratably among the shareholders of
the Fund.
2) Subject to the majority vote of shares of the Fund outstanding, the
Trustees may sell and convert into money to the assets of the Fund and
distribute such assets ratably among the shareholders of the Fund; and
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Upon completion of the distribution of the remaining assets of any Portfolio
as provided in paragraphs 1) and 2) above the Fund shall terminate and the
Trustees shall be discharged of any and all further liabilities and duties
hereunder and the right, title and interest of all parties shall be cancelled
and discharged.
SHAREHOLDER AND TRUSTEE LIABILITY. Under Pennsylvania law, shareholders of
such a Trust may under certain circumstances, be held personally liable as
partners for the obligations of the Fund. Therefore, the Declaration of Trust
contains an express disclaimer of shareholder liability for acts or obliga-
tions of the Fund and requires that notice of such disclaimer be given in each
agreement, obligation, or instrument entered into or executed by the Fund or
the Trustees. The Declaration of Trust provides for indemnification out of the
Fund property of any shareholder held personally liable for the obligations of
the Fund. The Declaration of Trust also provides that the Fund shall, upon re-
quest, assume the defense of any claim made against any shareholder for any
act or obligation of the Fund and satisfy any judgment thereon. Thus, the risk
of a shareholder incurring financial loss on account of shareholder liability
is limited to circustances in which the Fund itself would be unable to meet
its obligations.
The Declaration of Trust further provides that the Trustees will not be lia-
ble for errors of judgment or mistakes of fact or law but nothing in the Dec-
laration of Trust protects a Trustee against any liability to which he would
otherwise be subject by reason of willful misfeasance, bad faith, gross negli-
gence, or reckless disregard of the duties involved in the conduct of his of-
fice.
FINANCIAL STATEMENTS
The Fund's financial statements for the year ended November 30, 1994, in-
cluding the financial highlights for each of the five years in the period
ended November 30, 1994, appearing in the Vanguard Pennsylvania Tax-Free Fund
1994 Annual Report to Shareholders, and the report thereon of Price Waterhouse
LLP, independent accountants, also appearing therein, are incorporated by ref-
erence in this Statement of Additional Information. The Fund's 1994 Annual Re-
port to Shareholders is enclosed with this Statement of Additional Informa-
tion.
APPENDIX A--DESCRIPTION OF MUNICIPAL BONDS AND THEIR RATINGS
MUNICIPAL BONDS--GENERAL. Municipal Bonds generally include debt obligations
issued by states and their political subdivisions, and duly constituted au-
thorities and corporation, to obtain funds to construct, repair or improve
various public facilities such as airports, bridges, highways, hospitals,
housing, schools, streets and water and sewer works. Municipal Bonds may also
be issued to refinance outstanding obligations as well as to obtain funds for
general operating expenses and for loan to other public institutions and fa-
cilities.
The two principal classifications of Municipal Bonds are "general obliga-
tion" and "revenue" or "special tax" bonds. General obligation bonds are se-
cured by the issuer's pledge of its full faith, credit and taxing power for
the payment of principal and interest. Revenue or special tax bonds are pay-
able only from the revenues derived from a particular facility or class of fa-
cilities or, in some cases, from the proceeds of a special excise or other
tax, but not from general tax revenues. The Fund may also invest in tax-exempt
industrial development bonds, short-term municipal obligations (rated SP-1+ of
SP-1 by Standard & Poor's Corp. or MIG by Moody's Investors Service), project
notes, demand notes and tax-exempt commercial papers (rated A-1 by Standard &
Poor's Corp. or P-1 by Moody's Investors Service).
Industrial revenue bonds in most cases are revenue bonds and generally do
not have the pledge of the credit of the issuer. The payment of the principal
and interest on such industrial revenue bonds
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is dependent solely on the ability of the user of the facilities financed by
the bonds to meet its financial obligations and the pledge, if any, of real
and personal property so financed as security for such payment. Short-term mu-
nicipal obligations issued by states, cities, municipalities or municipal
agencies, include Tax Anticipation Notes, Revenue Anticipation Notes, Bond An-
ticipation Notes, Construction Loan Notes and Short-Term Discount Notes. Proj-
ect Notes are instruments issued by the Department of Housing and Urban Devel-
opment but issued by a state or local housing agency. While the issuing agency
has the primary obligation on such Project notes, they are are also secured by
the full faith and credit of the United States.
Note obligations with demand or put options may have a stated maturity in
excess of one year, but permit any holder to demand payment of principal plus
accrued interest upon a specified number of days' notice. Frequently, such ob-
ligations are secured by letters of credit or other credit support arrange-
ments provided by banks. The issuer of such notes normally has a corresponding
right, after a given period, to repay in its discretion the outstanding prin-
cipal of the note plus accrued interest upon a specific number of days' notice
to the bondholders. The interest rate on a demand note may be based upon a
known lending rate, such as a bank's prime rate, and be adjusted when such
rate changes, or the interest rate on a demand note may be a market rate that
is adjusted at specified intervals. The demand notes in which the Fund will
invest are payable on not more than one year's notice. Each note purchased by
the Fund will meet the quality criteria set out above for the Fund.
The yields of Municipal Bonds depend on, among other things, general money
market conditions conditions in the Municipal Bond market, the size of a par-
ticular offering, the maturity of the obligation, and the rating of the issue.
The ratings of Moody's Investors Service, Inc. and Standard & Poor's Corpora-
tion represent their opinions of the quality of the Municipal Bonds rated by
them. It should be emphasized that such ratings are general and are not abso-
lute standards of quality. Consequently, Municipal Bonds with the same maturi-
ty, coupon and rating may have different yields, while Municipal Bonds of the
same maturity and coupon, but with different ratings may have the same yield.
It will be the responsibility of the investment management staff to appraise
independently the fundamental quality of the bonds held by the Fund.
Municipal Bonds are sometimes purchased on a "when issued" basis meaning the
Fund has committed to purchasing certain specified securities at an agreed
upon price when they are issued. The period between commitment date and issu-
ance date can be a month or more. It is possible that the securities will
never be issued and the commitment canceled.
From time to time proposals have been introduced before Congress to restrict
or eliminate the Federal income tax exemption for interest on Municipal Bonds.
Similar proposals may be introduced in the future. If any such proposal were
enacted, it might restrict or eliminate the ability of the Fund to achieve its
investment objective. In that event, the Fund's Trustees and officers would
reevaluate its investment objective and policies and consider recommending to
its shareholders changes in such objective and policies.
Similarly, from time to time proposals have been introduced before State and
local legislatures to restrict or eliminate the State and local income tax ex-
emption for interest on Municipal Bonds. Similar proposals may be introduced
in the future. If any such proposal were enacted, it might restrict or elimi-
nate the ability of each Portfolio to achieve its respective investment objec-
tive. In that event, the fund's trustees and officers would reevaluate its in-
vestment objective and policies and consider recommending to its shareholders
changes in such objective and policies. (For more information please refer to
"Risk Factors" on page B-6.)
RATINGS. Excerpts from Moody's Investors Service, Inc.'s Municipal Bond rat-
ings; Aaa--judged to be of the "best quality" and are referred to as "gilt
edge"; interest payments are protected by a large or by an exceptionally sta-
ble margin and principal is secure; Aa--judged to be of "high quality by all
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standards" but as to which margins of protection or other elements make long-
term risks appear somewhat larger than Aaa-rated Municipal Bonds; together
with Aaa group they comprise what are generally known as "high grade bonds";
A--possess many favorable investment attributes and are considered "upper me-
dium grade obligations." Factors giving security to principal and interest of
A-rated Municipal Bonds are considered adequate, but elements may be present
which suggest a susceptibility to impairment sometime in the future; Baa--con-
sidered 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 char-
acteristically unreliable over any great length of time; Ba--protection of
principal and interest payments may be very moderate; judged to have specula-
tive elements; their future cannot be considered as well-assured; B--lack
characteristics of a desirable investment; assurance of interest and principal
payments over any long period of time may be small; Caa--poor standing; may be
in default or there may be present elements of danger with respect to princi-
pal and interest; Ca--speculative in a high degree; often in default; C--low-
est rated class of bonds; issues so rated can be regarded as having extremely
poor prospects for ever attaining any real investment standing.
Description of Moody's ratings of state and municipal notes: Moody's ratings
for state and municipal notes and other short-term obligations are designated
Moody's Investment Grade ("MIG"). Symbols used will be as follows: MIG-1--Best
quality, enjoying strong protection from established cash flows of funds for
their servicing or from established and broad-based access to the market for
refinancing, or both; MIG-2--High quality with margins of protection ample al-
though not so large as in the preceding group.
Description of Moody's highest commercial paper rating. PRIME-1 ("P-1)--
Judged to be of the best quality. Their short-term debt obligations carry the
smallest degree of investment risk.
Excerpts from Standard & Poor's Corporation's Municipal Bond ratings: AAA--
has the highest rating assigned by S&P; extremely strong capacity to pay prin-
cipal and interest; AA--has a very strong capacity to pay interest and repay
principal and differs from the higher rated issues only in a small degree; A--
has a strong capacity to pay principal and interest, although somewhat more
susceptible to the adverse changes in circumstances and economic conditions;
BBB--regarded as having an adequate capacity to pay principal and interest;
normally exhibit adequate protection parameters but adverse economic condi-
tions or changing circumstances are more likely to lead to a weakened capacity
to pay principal and interest than for bonds in A category; BB--B--CCC--CC--
predominantly speculative with respect to capacity to pay interest and repay
principal in accordance with terms of obligation; BB is being paid; D--in de-
fault, and payment of principal and/or interest is in arrears.
The ratings from "AA" to "B" may be modified by the addition of a plus or
minus sign to show relative standing within the major rating categories.
Excerpt from Standard & Poor's Corporation's rating of municipal note is-
sues: SP-1+--very strong capacity to pay principal and interest; SP-1--strong
capacity to pay principal and interest.
Description of S&P's highest commercial papers ratings: A-1+--This designa-
tion indicates the degree of safety regarding timely payment is overwhelming.
A-1--This designation indicates the degree of safety regarding timely payment
is very strong.
APPENDIX B--MUNICIPAL LEASE OBLIGATIONS
Each Portfolio may invest in municipal lease obligations. Such securities
will be treated as liquid under the following guidelines which have been es-
tablished by the Board of Trustees.
1. The obligation has been rated "investment grade" by at least on NRSRO
and is considered to be investment grade by the investment adviser.
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2. The obligation is secured by payments from a governmental lessee which
is generally recognized and has debt obligations which are actively traded
by a minimum of five broker/dealers.
3. At least $25 million of the lessee debt is outstanding either in a
single transaction or on parity, and owned by a minimum of five institu-
tional investors.
4. The investment adviser has determined that the obligation, or a compa-
rable lessee security, trades in the institutional marketplace at least pe-
riodically, with a bid/offer spread of 20 basis points or less.
5. The governmental lessee has a full faith and credit general obligation
rating of at least "A-" as published by at least one NRSRO or as determined
by the investment adviser. If the lessee is a state government, the general
obligation rating must be at least BAA1, BBB+, or equivalent, as determined
above.
6. The projects to be financed by the obligation are determined to be
critical to the lessee's ability to deliver essential services.
7. Specific legal features such as covenants to maintain the tax-exempt
status of the obligation, covenants to make lease payments without the
right of offset or counterclaim, covenants to return leased property to the
lessor in the event of non-appropriation, insurance policies, debt service
reserve fund, are present.
8. The lease must be "triple net" (i.e., lease payments are net of prop-
erty maintenance, taxes and insurance).
9. If the lessor is a private entity, there must be a sale and absolute
assignment of rental payments to the trustee, accompanied by a legal opin-
ion from recognized bond counsel that lease payments would not be consid-
ered property of the lessor's estate in the event of lessor's bankruptcy.
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