<PAGE> 1
VANGUARD
PENNSYLVANIA
TAX-FREE-FUND
ANNUAL REPORT 1994
THE VANGUARD VOYAGE . . . STAYING THE COURSE
<PAGE> 2
THE VANGUARD VOYAGE . . . STAYING THE COURSE
WE ARE PRESENTLY OBSERVING TWO MILESTONES IN OUR HISTORY: (1) THE 20TH
ANNIVERSARY OF THE VANGUARD GROUP; AND (2) THE 65TH ANNIVERSARY YEAR OF
WELLINGTON FUND, THE OLDEST MUTUAL FUND ASSOCIATED WITH VANGUARD. WE CELEBRATE
THESE TWO EVENTS SINCE THEY HAVE INDELIBLY ALTERED THE MUTUAL FUND INDUSTRY--IN
OUR VIEW, FOR THE BETTER.
Wellington Fund--a pioneer in the mutual fund industry--began operations
on June 30, 1929. Its first fifteen years were a struggle for survival in an
industry that was shaken to its roots by the Great Crash of 1929-1933. From an
initial base of $100,000, Wellington's assets had grown to but $27 million by
the end of World War II. The Vanguard Group was founded on September 24, 1974.
Soon thereafter, we assumed responsibility for the management of Wellington
Fund and ten associated funds, with assets aggregating $1.4 billion.
The years that followed the founding of The Vanguard Group were marked by
exceptional growth. Today, Wellington Fund, with assets of nearly $9 billion,
remains one of the largest mutual funds in the nation. And Vanguard, now
managing 85 mutual fund portfolios, is entrusted with assets of $134 billion,
and ranks as the second largest fund complex in the world.
Our durability in an era of change--and our longevity in an era of
challenge--didn't "just happen." What brought us to where we are today is what
we were when we began. Put another way, we set our original investment course
based on sound principles, and our corporate course based on a single focus:
serving solely the interests of our Fund shareholders.
FOUNDING INVESTMENT PRINCIPLES
The founding investment principles of Wellington Fund were, above all,
conservative. The Fund provided a broadly diversified portfolio at a time when
holding individual securities was the conventional strategy. It incurred no
debt in an era of high leverage that would soon come back to haunt less
cautious investors. And it was a "balanced" fund--in fact, Wellington is
America's oldest balanced fund--with holdings from each of the three basic
financial asset classes: cash reserves, bonds, and common stocks. In short,
Wellington Fund was a staid investment in an era of stock speculation that was
to become, almost within moments, an era of conservatism.
For Vanguard, these investment principles endure. "Balance" is still our
watchword, because the three basic financial asset classes have different--and
usually countervailing--investment characteristics. When it began, Wellington
Fund provided a balanced program in a single investment; in 1994, such a
balance is often achieved by a combination of Vanguard money market, bond, and
stock funds.
"Conservatism," too, remains our standard. Over the years, we have tried
to maintain the discipline to eschew offering funds that lack sound financial
principles, often based on marketplace fads that could not--and did
not--endure. Our conservatism applies not only to the funds we offer, but to
the instruments in which they invest. For example, we have steered clear of
exotic derivative securities with unpredictable investment characteristics. Too
many fund managers have been taken in by these highly risky instruments, and
their shareholders have paid a heavy price--except in cases where the manager
has "made the fund whole," when to do otherwise would have shocked investors
and impaired their confidence in the fund complex.
Speculation, it seems, comes and goes, albeit in different guises. But the
investment principles to which we have adhered since Wellington Fund began in
1929 remain firm:
* We offer Funds with sound and durable investment objectives, designed
for long-term investors.
(please turn to inside back cover)
- --------------------------------------------------------------------------------
VANGUARD PENNSYLVANIA TAX-FREE FUND OFFERS TWO PORTFOLIOS THAT SEEK TO PROVIDE
A HIGH LEVEL OF INCOME THAT IS EXEMPT FROM FEDERAL AS WELL AS PENNSYLVANIA
STATE PERSONAL INCOME TAXES. THE INSURED LONG-TERM PORTFOLIO INVESTS PRIMARILY
IN INSURED LONG-TERM MUNICIPAL BONDS. THE MONEY MARKET PORTFOLIO SEEKS TO
MAINTAIN A CONSTANT NET ASSET VALUE OF $1.00 PER SHARE ALONG WITH REASONABLE
CURRENT INCOME.
<PAGE> 3
CHAIRMAN'S LETTER
FELLOW SHAREHOLDER:
The 1994 fiscal year for Vanguard State Tax-Free Fund, which ended on November
30, 1994, was the most difficult year for bonds since the Fund's inception some
eight years ago, in April 1986. A persistent rise in long-term interest rates
during the twelve-month period sharply reduced the prices of long-term
tax-exempt bonds, and the net asset values of our Insured Long-Term Portfolios
declined accordingly. Rates also increased in the short-term arena, to the
substantial benefit of our Money Market Portfolios, which saw sharply higher
income yields during the year.
In each of our Money Market Portfolios and our Insured Long-Term
Portfolios, our returns exceeded the results of competitive funds with similar
objectives. The detailed fiscal year results for each of our State Tax-Free
Portfolios, including per share net asset values, dividends and capital gains
distributions for the year, as well as current yields, are presented in a table
at the conclusion of this letter.
Over the past twelve months, the STATE MONEY MARKET PORTFOLIOS provided
total returns in the area of +2.6%. As expected, net asset values remained at
$1.00 per share. Yields at the end of the fiscal year were generally about 50%
higher than they were at the beginning of the year, as shown in the following
table:
<TABLE>
<CAPTION>
- -------------------------------------------------------------------
Total Return Seven Day Annualized Yield
-------------- ----------------------------------
Money Market 12 Months Ended Nov. 30, Nov. 30,
Portfolio Nov. 30, 1994 1993 1994 Increase
- -------------------------------------------------------------------
<S> <C> <C> <C> <C>
California +2.6% 2.32% 3.44% +1.12%
Pennsylvania +2.6 2.25 3.51 +1.26
New Jersey +2.5 2.23 3.34 +1.11
Ohio +2.6 2.36 3.47 +1.11
- -------------------------------------------------------------------
</TABLE>
These yields, of course, reflect income that is entirely exempt both from
Federal income taxes and from state and local taxes in the respective states. I
would reemphasize that in each case our yields exceed those available on
comparable state money market portfolios as a group. Indeed, our yield
advantage has persisted with remarkable regularity, year in and year out, such
that the longer-term returns of our Money Market Portfolios have nicely
exceeded the returns of their peer groups. Specifically, the Pennsylvania Money
Market Portfolio has earned an average annual total return of +4.2% since its
inception in June 1988, compared to +4.1% for the average Pennsylvania money
market fund.
The STATE INSURED LONG-TERM PORTFOLIOS suffered through a challenging year
of rising rates, resulting in negative total returns (capital change plus
income) ranging from -5.4% to -6.4%. The good news is that current yields are
considerably more generous than they were one year ago, having risen by an
average of 1.5 percentage points (150 basis points).
In contrast to a year ago, when declining interest rates resulted in a
solid positive capital contribution (in the area of 6%) to our Insured
Long-Term Portfolios' total returns, this year the contribution from capital
return has been decidedly negative. The table on the following page summarizes
the components of return for each of our State Insured Long-Term Portfolios
over the past twelve months. If there is a better example of the "two way
street" of interest rate sensitivity, I am not sure that I have seen it.
(continued)
[FIGURE 1]
1
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[FIGURE 2]
<TABLE>
<CAPTION>
Average Annual Total Returns--Periods Ended November 30, 1994
- ---------------------------------------------------------------------
Since
1 Year 5 Years Inception*
- ---------------------------------------------------------------------
<S> <C> <C> <C>
VANGUARD PA LONG-TERM PORTFOLIO -5.44% +6.81% +7.27%
AVERAGE PA MUNICIPAL FUND -7.18 +6.00 +6.65
LEHMAN MUNICIPAL BOND INDEX -5.23 +6.58 +7.29
</TABLE>
*Inception on, April 7, 1986. Performance begins on April 30, 1986, to show
competitive data.
Note: Past performance is not predictive of future performance.
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------
Investment Returns
------------------------------------------
Twelve Months Ended
November 30, 1994
Insured Long-Term -----------------------------------------
Portfolio Income Capital Total
- ---------------------------------------------------------------------
<S> <C> <C> <C>
CALIFORNIA 5.1% -11.0% -5.9%
NEW YORK 5.1 -11.5 -6.4
PENNSYLVANIA 5.3 -10.7 -5.4
NEW JERSEY 5.1 -11.2 -6.1
OHIO 4.9 -11.2 -6.3
FLORIDA 4.9 -11.0 -6.1
- ---------------------------------------------------------------------
</TABLE>
Note: The California Insured Intermediate-Term Portfolio began
operations on March 4, 1994. The Portfolio's returns since inception
were: Income +3.4%; Capital -3.6%; Total -0.2%.
In last year's letter, speaking about the remarkable capital returns that had
redounded to long-term bond investors over the prior two years, I cautioned
that "capital returns of the magnitude shown simply cannot be taken for
granted," adding that "should rates reverse direction and move higher, 'capital
reward' will inevitably translate to 'capital penalty' for each of our six
Insured Long- Term Portfolios." That capital penalty has surely come to pass.
Despite a difficult 1994, the long-term returns of each of our Insured
Long-Term Portfolios remain exemplary, particularly when considered in the
context of what we would regard as our two most appropriate benchmarks: the
unmanaged Lehman Municipal Bond Index and the average competitive fund in each
respective state category. The chart above shows the cumulative returns earned
by the Pennsylvania Insured Long-Term Portfolio since its inception in April
1986, compared with each of these benchmarks.
You can see in the chart that the Portfolio achieved a solid margin over
the average Pennsylvania municipal fund, and virtually matched the return of
the unmanaged Lehman Municipal Bond Index. This Index, I would remind you,
represents a challenging hurdle for all state tax-free funds, existing, as it
does, outside of the "real world" of operating expenses and transaction costs.
Given that transaction costs in the bond market are normally quite substantial,
our ability to match the Index over the long term is exceptional.
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<PAGE> 5
[FIGURE 3]
THE FISCAL YEAR IN REVIEW
The declining interest rate environment that had persisted with striking
consistency since October 1987 came to an end in mid- October 1993. By November
30, 1993, the yield on the long-term U.S. Treasury bond had fallen to 6.3%; by
the end of the Fund's fiscal year on November 30, 1994, the long Treasury yield
had jumped back to the 8.0% level. In all, the prices of long-term U.S.
Treasury bonds fell nearly -20% over the fiscal period. In the short-term
arena, the yield on the U.S. Treasury bill rose from 3.2% to 5.8% over the same
period. Because of the bill's short maturity, its price remained virtually flat
during the entire period.
A primary cause of the interest rate rise was investor fears about a
resurgence of inflation. So far, at least, the U.S. Consumer Price Index gives
little evidence of it. The CPI has risen just 2.7% over the past twelve months,
although more sensitive indicators--such as commodity prices and producer
prices--have been rising at higher rates.
In an effort to quell inflationary fears, the Federal Reserve has acted to
"tighten" the money supply in order to slow economic growth and rein in
potential future inflation. Fully six rate increases--in February, March,
April, May, August, and again in November--combined to raise the federal funds
rate (at which banks borrow from one another) from 3.00% to 5.50%. Still, the
specter of inflation remains, and further rate increases may well lie in
prospect.
Yields on long-term municipal bonds followed the lead of U.S. Treasury
bonds, although the prices of long municipals provided slightly better
resistance than their taxable cousins to the overall decline in the bond
market. This resistance was based largely on the fact that tax-exempt bonds
began the fiscal year with yields that were extremely attractive relative to
taxable bonds. Indeed, as I mentioned a year ago in our Annual Report for
fiscal 1993, "relative values in tax-exempt bonds are as great on a sustained
basis as they have been for two decades." The result was that municipal bond
prices pretty much held their own through January, declined slightly less than
long Treasuries through the end of August, only to fall more sharply in the
final months of the Fund's fiscal year. On balance, for the full period, the
yield on high-grade, 30-year tax-exempt bonds rose from 5.5% to 6.9%, reflected
in a price decline of about -18%.
The chart to the left shows the changing pattern of long-term and
short-term tax-exempt yields during our past five fiscal years. It provides
some perspective on the recent increase in yields, which, on the long-term
side, have merely returned to their level in mid-1991, about the same as the
yield level at the beginning of 1990. The 3.8% yield on short-term tax-exempt
notes is now approximately at the level reached in late 1991, but is well below
the 5.8% yield that prevailed when 1990 began.
The interplay of short-term and long-term rates has resulted in dramatic
changes over time in the yield "spread" (the difference between the two yields,
as shown in the lower chart). At the start of the period, the spread amounted
to only 110 "basis points" (1.1%) with 30-year municipal bonds yielding 7.0%
and 90-day notes yielding 5.9%. By early 1992 the
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<PAGE> 6
spread had risen to nearly 400 basis points, and investors who decided to
choose short-term notes over long-term bonds had to relinquish nearly
two-thirds of their yield. Today, the spread has narrowed to about 300 basis
points, but fixed-income investors who are willing to extend the maturity of
their bond holdings still earn a solid premium in return for the additional
price volatility that they incur.
TAX-EXEMPT VERSUS TAXABLE YIELDS
One of the (too often) unsung advantages of tax-exempt income is the sharp
increase in spendable income compared to the income that would be garnered,
after taxes, on a taxable bond. In the lower rate environment of a year ago, as
I mentioned earlier in this letter, this advantage--for investors in the
highest marginal Federal tax bracket (now 39.6%)--was well above historical
norms, with tax-exempt securities providing net spendable income 45% higher
than that available on taxable U.S. Treasury bonds, and 26% higher than that
available on U.S. Treasury bills.
One year later, this "spread" remains virtually unchanged on the long-term
side (a +44% premium) but has been more than halved on the short-term side (a
+9% premium). This table presents a comparison of the income earned on
tax-exempt and taxable securities as of November 30, 1994, assuming a $100,000
investment.
<TABLE>
<CAPTION>
- --------------------------------------------------------------
Illustration of Income on
Hypothetical $100,000 Investment
---------------------------------
Long-Term Short-Term
- --------------------------------------------------------------
<S> <C> <C>
Taxable Gross Income $ 8,000 $ 5,800
Less Taxes (39.6%) (3,200) (2,300)
------- -------
Net After-Tax Income 4,800 3,500
- --------------------------------------------------------------
Tax-Exempt Income $ 6,900 $ 3,800
- --------------------------------------------------------------
Increase in After-Tax Income $ 2,100 $ 300
- --------------------------------------------------------------
</TABLE>
Table assumes current yields (as of November 30, 1994) of 8.0% for
U.S. Treasury bonds, 5.8% for U.S. Treasury bills, 6.9% for long-term
municipals, and 3.8% for short-term municipals. The illustration is not
intended to represent future results.
The table provides a clear illustration of the yield improvement available
today to an investor in the top tax bracket. Of course, the comparison is
hardly perfect, since the "full faith and credit" of the U.S. Treasury remains
peerless, while municipal bonds engender some degree of risk. Perhaps nothing
could have made this risk clearer than the recent debacle in Orange County,
California, in which an investment pool managed by the County suffered huge
losses resulting from its leveraged strategy and derivative securities
holdings. This event serves as an important reminder that "state-specific"
portfolios engender an additional level of risk due to their highly
concentrated investments in particular economic regions.
The Orange County bankruptcy reinforces the substantial value of private
portfolio insurance, which is provided--by high- quality insurance
companies--for virtually all of the bonds held in our Insured Portfolios. This
insurance, in effect, guarantees the full payment of annual income and, at
maturity, principal for the municipal bonds that we hold. (It does not, of
course, protect against price volatility.) The result is that each of our
Insured Long-Term Portfolios carries an implied average quality rating of
Aaa--the highest rating accorded by Moody's Investor Services. This insurance
provides credit quality enhancement that virtually eliminates the extra risk
that would otherwise be engendered by the concentration of investments that is
inevitably part and parcel of investing in single-state municipal bond funds.
We believe such protection is critical.
Portfolio insurance is generally not available for money market
portfolios, although the same state-specific risks exist. In the absence of
portfolio insurance, our professional money managers must be even more diligent
in their scrutiny of the credit quality of our portfolio holdings. Their
efforts here include purchasing as many high-quality and "credit-enhanced"
securities as they can. The enhancements for these securities consist of
irrevocable letters of credit from high-quality banks guaranteeing each
issuer's timely payments of principal and interest. This credit support, in
conjunction with our diligent credit analysis, has earned each of the holdings
in our Money Market Portfolios Moody's highest quality rating (or the
equivalent) for shorter-term instruments. As far as we know, our Portfolios are
unsurpassed with respect to credit quality by any competitor.
On this point, I would stress that no state money market portfolio is
exempt from credit and
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<PAGE> 7
maturity risk. That is to say, there is no principal guarantee such as that
provided through bank savings accounts and certificates of deposit insured by
the Federal Deposit Insurance Corporation. However, we believe that the $1.00
net asset value will be preserved by state money market funds that maintain
diligent credit analysis, secure letters of credit to the degree possible, and
maintain their average portfolio maturities within the statutory maximum of 90
days.
LOOKING AHEAD
A year ago in my 1993 letter to shareholders, I cautioned that "with rates
having come down so far and so fast, there is always the risk of a sharp
rebound." That risk "came home to roost" during fiscal 1994. However, I believe
that during fiscal 1995 the probabilities now favor greater stability in
long-term tax-exempt rates, and somewhat higher short-term rates. While there
are some recent signals of higher inflation in the economy, it would not be
unusual if the financial markets' expectations are already, at least in part,
manifested in higher yields.
Whatever the future course of interest rates, I urge you to consider the
risk-reward pattern of your investment in the Vanguard State Tax-Free Fund in
terms of your own needs and circumstances. In our Insured Long-Term Portfolios,
that means balancing the need for income stability with a commensurate level of
principal volatility. Our Money Market Portfolios seek to maintain a $1.00 per
share net asset value, but this capital stability comes at the expense of
substantial income volatility.
In the final analysis, the best course of action is almost always to "stay
the course" with the long-term objectives that you have established. We, too,
intend to stay the course with the consistent objectives and policies that we
have established for our Portfolios. In doing so, we are confident that the
Vanguard State Tax-Free Portfolios will continue to provide returns that
generally exceed those of their respective competitors.
In a very real sense, this is no idle boast, since our durable cost
advantage gives us a "leg up" in performance before the year has even begun.
Indeed, while the average competitive state tax-free fund charges annual fees
at the rate of 0.78% of average net assets, the expense ratio for the Vanguard
State Tax-Free Portfolios, at 0.20%, is only about one-quarter of this amount.
In the case of a municipal money market portfolio earning a current gross yield
of, say, 3.8%, the expenses for the average state tax-free fund would consume
about 20% of their income; Vanguard's expenses, on the other hand, would
consume but 5%. This remarkable income advantage--available with no sacrifice
whatsoever in credit quality-- is there for the taking.
I look forward to writing to you again six months hence.
Sincerely,
/s/ JOHN C. BOGLE
- -----------------
John C. Bogle
Chairman of the Board
December 20, 1994
Note: Mutual fund data from Lipper Analytical Services, Inc.
5
<PAGE> 8
<TABLE>
<CAPTION>
Net Asset Value
Total Per Share
Net Assets ---------------------- Twelve Months
(millions) Average Average Nov. 30, Nov. 30, ----------------------- Current
Portfolio Nov. 30, 1994 Maturity Quality* 1993 1994 Dividends Total Return Yield**
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
MONEY MARKET
CALIFORNIA . . . . . . . $1,159 51 DAYS MIG 1 $ 1.00 $ 1.00 $ .026 + 2.6% 3.44%
PENNSYLVANIA . . . . . . 1,105 45 DAYS MIG 1 1.00 1.00 .025 + 2.6 3.51
NEW JERSEY . . . . . . . 792 48 DAYS MIG 1 1.00 1.00 .025 + 2.5 3.34
OHIO . . . . . . . . . . 147 50 DAYS MIG 1 1.00 1.00 .026 + 2.6 3.47
- -------------------------------------------------------------------------------------------------------------------------
INSURED LONG-TERM
CALIFORNIA . . . . . . . $ 834 18.7 YEARS AAA $ 11.30 $ 9.92 $ .756+ - 5.9% 6.49%
CALIFORNIA INTERMEDIATE-
TERM . . . . . . . . . 100 8.2 YEARS AAA -- 9.64 .346++ - 0.2++ 5.80
NEW YORK . . . . . . . . 695 16.1 YEARS AAA 10.97 9.70 .600+ - 6.4 6.32
PENNSYLVANIA . . . . . . 1,299 18.4 YEARS AAA 11.36 10.07 .704+ - 5.4 6.41
NEW JERSEY . . . . . . . 645 17.2 YEARS AAA 11.77 10.40 .685+ - 6.1 6.28
OHIO . . . . . . . . . . 149 17.6 YEARS AAA 11.61 10.28 .631+ - 6.3 6.31
FLORIDA . . . . . . . . 284 18.5 YEARS AAA 10.86 9.61 .620+ - 6.1 6.31
- -------------------------------------------------------------------------------------------------------------------------
</TABLE>
* MIG 1 and Aaa are Moody's highest ratings for short-term and long-term
municipal bonds, respectively.
** Money Market Portfolios' yields are 7-day annualized yields; others are
30-day SEC yields.
+ Include capital gains distributions of $.152 for California, $.012 for New
York, $.079 for Pennsylvania, $.063 for New Jersey, and $.032 for Ohio, and
$.070 for Florida.
++ Since inception, March 4, 1994.
Note: The shares of each of the Vanguard "single state" Portfolios are
available for purchase solely by residents of the designated states.
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<PAGE> 9
AVERAGE ANNUAL TOTAL RETURNS
THE CURRENT YIELDS NOTED IN THE CHAIRMAN'S LETTER ARE CALCULATED IN ACCORDANCE
WITH SEC GUIDELINES. THE AVERAGE ANNUAL TOTAL RETURNS FOR THE PORTFOLIOS
(PERIODS ENDED SEPTEMBER 30, 1994) ARE AS FOLLOWS:
<TABLE>
<CAPTION>
SINCE INCEPTION
----------------------------
INCEPTION TOTAL INCOME CAPITAL
DATE 1 YEAR 5 YEARS RETURN RETURN RETURN
-------- ------- -------- ------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
CALIFORNIA INSURED LONG-TERM 4/7/86 -3.33% +7.74% +7.44% +6.55% +0.89%
CALIFORNIA INSURED INTERMEDIATE-TERM 3/4/94 -- -- +2.23 +2.63 -0.40
CALIFORNIA MONEY MARKET 6/1/87 +2.46 +3.69 +4.22 +4.22 0.00
NEW YORK INSURED TAX-FREE 4/7/86 -3.25 +8.04 +6.96 +6.54 +0.42
PENNSYLVANIA INSURED LONG-TERM 4/7/86 -2.23 +8.36 +7.81 +6.77 +1.04
PENNSYLVANIA MONEY MARKET 6/13/88 +2.44 +3.77 +4.25 +4.25 0.00
NEW JERSEY INSURED LONG-TERM 2/3/88 -3.30 +8.10 +8.22 +6.56 +1.66
NEW JERSEY MONEY MARKET 2/3/88 +2.36 +3.73 +4.23 +4.23 0.00
OHIO INSURED LONG-TERM 6/18/90 -3.32 -- +8.31 +6.05 +2.26
OHIO MONEY MARKET 6/18/90 +2.44 -- +3.43 +3.43 0.00
FLORIDA INSURED TAX-FREE 9/1/92 -2.98 -- +5.99 +5.25 +0.74
</TABLE>
THESE DATA REPRESENT PAST PERFORMANCE. THE INVESTMENT RETURN AND PRINCIPAL
VALUE OF AN INVESTMENT WILL FLUCTUATE SO THAT AN INVESTOR'S SHARES, WHEN
REDEEMED, MAY BE WORTH MORE OR LESS THAN THEIR ORIGINAL COST.
PLEASE NOTE THAT AN INVESTMENT IN A MONEY MARKET FUND, SUCH AS THE MONEY MARKET
PORTFOLIO OF VANGUARD PENNSYLVANIA TAX-FREE FUND, IS NEITHER INSURED NOR
GUARANTEED BY THE U.S. GOVERNMENT, AND THERE IS NO ASSURANCE THAT THE FUND WILL
BE ABLE TO MAINTAIN A STABLE NET ASSET VALUE OF $1.00 PER SHARE.
7
<PAGE> 10
REPORT FROM THE INVESTMENT ADVISER
STATE INSURED LONG-TERM PORTFOLIOS
LOOK TO THE LONG TERM
It has been a volatile fiscal year for fixed-income investors. The economy
continued down the path of robust expansion, raising fears of a pick-up in
inflation and resulting in a broadbased decline in bond prices. For example,
the Bond Buyer 40 Municipal Bond Index lost -18% of its principal value over
the period as its yield rose from 5.7% to 7.2%.
Considering this hostile economic environment, the State Insured Long-Term
Portfolios performed somewhat better than one might expect. On a total return
basis, each Portfolio performed competitively relative to similar long-term
bond funds. It is particularly important in difficult markets to remain focused
on long-term objectives. While share price volatility is far easier to endure
when prices rise than when they fall, the long-term reward of a period of
falling prices is ultimately a higher and more durable level of tax-exempt
income.
LIQUIDITY "CRISIS"
Municipal bonds fell sharply in price during the spring, leveled off briefly
during the early summer, and then resumed falling sharply after August.
Shareholder redemptions created periods of distressed municipal bond fund
selling; for many portfolios, maintaining liquidity was a key factor in
weathering the downturn. Our Portfolios carry a high percentage of cash
reserves (8%-10%) to meet shareholder transactions, a policy which proved
especially helpful during the recent price declines. At no time were the State
Insured Long-Term Portfolios forced to sell securities at "distressed" levels.
On the plus side, the higher yields in the marketplace have greatly
reduced the issuance of new municipal bonds. The total issuance of tax-exempt
securities has declined 37% during the fiscal year. Rising yields increased
municipal issuers' cost of funds, eliminating the economic rationale for
refundings that bloated supply last year. Other factors held equal, the drop in
new supply enhances the value of existing tax-exempt securities, particularly
in higher tax states where investor demand is greater.
PURSUING THE DIVIDEND
As we mentioned in our last Semi-Annual Report, a reduction in average maturity
prior to the recent bear market enhanced our relative fund performance. The
State Insured Long-Term Portfolios focused on the slightly lower-yielding but
less volatile securities maturing in the 15- to 20-year range. This strategy
provided a moderate amount of insulation as bond prices fell. Over the next six
months, the Portfolios will pursue 25- to 30-year securities, effecting a
gradual extension of average maturity to a more normal historical range. The
commensurate benefit will be an anticipated increase in dividend, as current
yields on longer securities have reached substantially higher levels.
Looking forward at year end, various market sources estimate that anywhere
from $45 to $60 billion in proceeds will be received by tax-exempt participants
by January 1, 1995. Barring a significant increase in new issuance, this bodes
well for adequate liquidity and should continue to provide more attractive
returns for municipal bonds than their taxable brethren.
STATE MONEY MARKET PORTFOLIOS
WEATHERING THE STORM . . .
The fiscal year can be characterized as one of protracted economic strength. In
an attempt to curb inflation and target a moderate economic growth rate, the
Federal Reserve Board tightened money supply. During 1994, the Federal Reserve
was forced to raise the Federal funds rate (the rate banks charge each other
for overnight loans) six times, for a total increase of 2.50%. The most recent
change occurred on November 15, when the Fed increased rates 0.75%, the largest
single move by the Fed since 1981. The markets reacted accordingly, with yields
on 1-year U.S. Treasury bills rising 3.3 percentage points over the fiscal
year, to 6.9%, and yields on comparable 1-year municipal notes rising 2.1
percentage points, to 4.5%.
The relative underperformance of municipal versus taxable yields can be
attributed to the dwindling supply of short-term municipal securities. The
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<PAGE> 11
reduction was a result of municipalities extending issuance beyond one year,
and economic strength reducing the amount of borrowing necessary to finance
their cash needs. This filtered down to the fund level, as yields on state
tax-exempt money market funds increased a mere 1.0% over the fiscal year, while
taxable money fund yields increased 2.0%. For investors in lower tax brackets,
this differential meant that taxable money market funds became a viable
alternative.
The Vanguard State Tax-Free Money Market Portfolios were prepared for the
rise in interest rates early in the year, as we positioned average weighted
maturities in a bearish range of 45-60 days. This strategy enabled us to take
advantage of rising rates while further assuring our $1.00 net asset value. Our
low expense ratios also helped us to outperform our competitors on a net yield
basis, despite the fact that many of them continue to inflate their gross
yields through quality differentials and securities subject to the alternative
minimum tax (AMT).
HISTORICAL EVENT???
Much has been written this past year about the risks of "derivative securities"
in taxable money market funds. Most notably, Community Banker's U.S. Government
Money Market Fund went down in history as being the first money fund to "break
the buck." The fund sacrificed its net asset value in exchange for higher
returns by investing in certain types of exotic and inappropriate derivative
securities. While it is true that some derivatives can be dangerous when used
inappropriately, not all derivatives are "evil." In fact, certain derivatives
can be used safely and may even improve the total quality of one's portfolio.
The definition of a derivative (a security whose return is derived from
another security) is broad, and encompasses instruments that are "exotic" as
well as "plain vanilla." The Vanguard State Tax-Free Money Market Portfolios do
invest in securities which fall under the derivative definitional "umbrella,"
but those securities do not even remotely resemble the exotic instruments used
in the now defunct Community Banker's Fund. The derivative structures held in
our Portfolios are floating rate or "put" securities, with minimum ratings of
AA or better. In addition, all of our derivatives have coupons that reset
frequently to ensure that their market prices remain close to par (100), and
they contain the option to tender or sell them at par (100). These securities,
more commonly referred to as tender option bonds, are designed to imitate the
same characteristics of non-derivative variable rate securities. The indexes
used to determine the coupon reset are the same as those used to determine
non-derivative variable rate securities.
In contrast, the derivatives responsible for the recent taxable money fund
problems utilized indexes not directly related to short-term money market
rates. This is a dangerous game to play, particularly in the rising interest
rate environment experienced in 1994. The U.S. Securities and Exchange
Commission (SEC) has clearly outlined the types of derivative securities that
are inappropriate for money market funds. We affirm to our investors that at no
time has any Vanguard Portfolio invested in securities deemed inappropriate by
the SEC.
It is unfortunate that all derivatives are being branded as speculative,
when indeed many are used to enhance the overall quality of a portfolio. Unlike
Vanguard, some money market funds may engage in investments that fail to adhere
to conservative guidelines. Consequently, investors should remember that there
is no such thing as a "free lunch." When money market funds are offering yields
too good to be true, they probably are too good to be true, unless a fund has
the advantage of low expenses. We have this advantage. Our extremely low
expense ratios permit us to take and maintain the "high ground" with respect to
both liquidity and quality.
Sincerely,
<TABLE>
<S> <C>
Ian A. MacKinnon Jerome J. Jacobs
Senior Vice President Vice President
Pamela W. Tynan David E. Hamlin
Vice President Assistant Vice President
Reid O. Smith Danine A. Mueller
Assistant Vice President Portfolio Manager
December 12, 1994
</TABLE>
9
<PAGE> 12
STATEMENT OF NET ASSETS
<TABLE>
<CAPTION>
Face Market
Amount Value
INSURED LONG-TERM PORTFOLIO (000) (000)+
- --------------------------------------------------------------------------------
<S> <C> <C>
MUNICIPAL BONDS (96.3%)
- --------------------------------------------------------------------------------
ISSUER INSURED (87.8%)
Allegheny County GO
0.00%, 5/1/03 (2) $ 12,315 $ 7,275
6.00%, 5/1/10 (2) 3,030 2,849
6.00%, 5/1/12 (2) 3,000 2,786
Allegheny County Hosp.
Development Auth.
(Children's Hosp. of Pittsburgh)
VRDO 3.625%, 1/1/95 (1) 200 200
(Magee Women's Hosp.)
6.00%, 10/1/10 (3) 4,235 3,871
(Mercy Hosp.)
6.75%, 4/1/21 (2) 4,500 4,334
(Presbyterian Univ. Hosp.)
6.00%, 11/1/12 (1) 3,000 2,750
7.125%, 7/1/99 (1) (Prere.) 6,835 7,340
7.60%, 3/1/08 (1) 5,000 5,394
Allegheny County Sanitation Auth.
5.50%, 12/1/13 (3) 20,295 17,350
5.50%, 12/1/16 (3) 23,66 519,896
6.25%, 12/1/14 (1) 9,660 9,074
6.50%, 12/1/11 (3) 8,000 7,847
Altoona City Auth.
6.50%, 11/1/19 (3) 20,000 19,076
Beaver County Industrial
Development Auth.
(Ohio Edison)
7.00%, 6/1/21 (3) 22,715 22,815
7.10%, 6/1/18 (3) 5,000 5,020
Berks County GO
0.00%, 11/15/13 (3) 7,250 1,928
0.00%, 11/15/14 (3) 8,615 2,120
0.00%, 11/15/15 (3) 6,250 1,428
5.75%, 11/15/12 (3) 15,500 13,767
Berks County Hosp. Rev.
(Reading Hosp.)
5.70%, 10/1/14 (1) 4,500 3,886
6.10%, 10/1/23 (1) 16,500 14,631
Bethlehem Water Rev.
6.00%, 11/15/02 (1) (Prere.) 6,000 6,007
6.25%, 11/15/01 (1) (Prere.) 10,775 10,981
Blair County Hosp. Auth.
(Altoona Hosp.)
6.50%, 7/1/22 (2) 8,500 7,954
Boyertown Area School Dist.
6.10%, 3/1/15 (2) 6,000 5,541
Bucks County Water & Sewer Auth.
9.10%, 12/1/95 (3) (Prere.) 1,200 1,252
9.20%, 12/1/95 (3) (Prere.) 1,200 1,253
Butler County GO
6.00%, 7/15/12 (3) 5,185 4,772
Center Township Sewer Auth.
5.50%, 4/15/11 (2) $ 2,375 $ 2,057
Central Dauphin County
School Dist. GO
0.00%, 6/1/04 (2) 4,800 2,616
Central Greene School Dist.
6.50%, 2/15/24 (1) 5,500 5,198
Chester County Hosp. Auth.
(Chester County Hosp.)
7.00%, 7/1/16 (1) 11,500 11,486
Coatesville Area School Dist. GO
7.25%, 5/1/00 (2) (Prere.) 2,200 2,362
Cornwall Lebanon Suburban
Joint School Dist.
5.875%, 3/1/14 (3) 5,635 5,038
5.90%, 3/1/11 (3) 3,270 2,992
Corry Area School Dist. GO
5.50%, 12/15/10 (1) 4,600 3,981
Dauphin County General Auth.
(West Pennsylvania Hosp.)
5.50%, 7/1/13 (1) 5,000 4,226
Dauphin County Hosp. Auth.
(Harrisburg Hosp.)
8.125%, 7/1/07 (1) 3,000 3,178
Delaware County Auth. College Rev.
(Haverford College)
5.40%, 11/15/13 (1) 1,750 1,462
Delaware County Hosp. Auth.
(Crozer Chester Medical Center)
5.30%, 12/15/11 (1) 4,660 3,866
(Delaware County Memorial Hosp.)
7.125%, 8/15/09 (1) 5,160 5,285
7.20%, 8/15/19 (1) 8,000 8,028
Delaware River Joint
Toll Bridge Comm.
6.00%, 7/1/18 (3) 3,040 2,723
Delaware River Port Auth.
6.50%, 1/1/09 (2) 4,500 4,479
7.375%, 1/1/07 (2) 13,500 14,194
Erie County GO
5.25%, 9/1/12 (3) 2,875 2,378
Erie County Hosp. Auth.
(St. Vincent Health Care)
6.125%, 7/1/13 (1) 3,900 3,601
Erie County Prison Auth.
Commonwealth Lease
6.25%, 11/1/01 (1) (Prere.) 25,140 25,604
Fort LeBoeuf School Dist. GO
5.80%, 1/1/13 (1) 5,500 4,901
Garnet Valley School Dist. GO
5.70%, 4/1/11 (2) 3,000 2,674
</TABLE>
10
<PAGE> 13
<TABLE>
<CAPTION>
Face Market
Amount Value
(000) (000)+
- --------------------------------------------------------------------------------
<S> <C> <C>
Governor Mifflin School Dist. GO
6.50%, 2/1/02 (2) (Prere.) $ 7,330 $ 7,549
Greensburg Salem School Dist. GO
6.45%, 9/15/18 (1) 7,500 7,065
Hampden Township Sewer Auth.
8.875%, 10/1/05 (1) 500 515
9.00%, 4/1/11 (1) 500 518
Haverford Township School Dist.
6.25%, 6/1/19 (3) 11,500 10,559
Hempfield School Dist. GO
6.00%, 8/15/02 (3) (Prere.) 6,000 5,985
Lancaster Higher Education Auth.
(Franklin & Marshall College)
6.60%, 4/15/10 (1) 4,940 4,928
6.70%, 4/15/12 (1) 4,000 4,004
Lehigh County GO
6.00%, 10/15/99 (2) (Prere.) 2,000 2,028
7.00%, 7/1/16 (1) 4,415 4,504
7.25%, 1/1/98 (3) (Prere.) 3,000 3,206
Lewisburg Area School Dist. GO
6.20%, 6/1/12 (1) 3,500 3,307
6.25%, 6/1/15 (1) 3,685 3,466
Ligonier Valley School Dist. GO
6.00%, 3/1/19 (1) 6,000 5,335
Lycoming County College Auth.
5.40%, 11/1/08 (2) 6,000 5,222
Lycoming County Hosp. Auth.
(Williamsport Hosp.)
6.875%, 11/1/04 (2) 4,450 4,574
7.00%, 11/1/15 (2) 3,000 3,004
Manheim Central School Dist. GO
6.85%, 3/1/08 (3) 2,705 2,768
Mars Area School Dist. GO
6.25%, 9/1/19 (3) 4,000 3,671
Meadville Area Water Auth.
6.00%, 7/1/22 (4) (Prere.) 3,750 3,754
Montgomery County Higher
Education & Health Auth.
(Abington Memorial Hosp.)
6.00%, 6/1/22 (2) 10,160 8,905
6.10%, 6/1/12 (2) 5,000 4,659
Montgomery County Industrial
Development Auth. PCR (PECO)
6.70%, 12/1/21 (1) 12,000 11,524
Mount Lebanon Hosp.
Development Auth.
(St. Clair Memorial Hosp.)
6.25%, 7/1/06 (3) 9,250 9,092
Neshaminy School Dist. GO
6.30%, 2/15/13 (3) 10,000 9,592
North Penn Water Auth.
6.125%, 11/1/10 (3) $ 5,140 $ 4,887
North Wales Water Auth.
(Montgomery County)
6.125%, 11/1/12 (3) 3,000 2,830
6.125%, 11/1/22 (3) 8,300 7,460
Northampton County Higher
Education Auth.
(Lehigh Univ.)
7.10%, 11/15/09 (1) 7,035 7,216
Northampton County Hosp. Auth.
(Easton Hosp.)
6.25%, 1/1/19 (1) 10,000 9,078
7.875%, 1/1/19 (6) 285 298
Northumberland County
Commonwealth Lease
6.25%, 10/15/01 (1) (Prere.) 13,600 13,606
Penn Hills GO
5.80%, 12/1/13 (2) 11,735 10,482
Penn Trafford School Dist. GO
5.85%, 5/1/14 (1) 2,435 2,168
Pennsylvania Convention
Center Auth.
0.00%, 9/1/04 (3) 5,000 2,692
6.00%, 9/1/19 (3) 12,600 11,554
6.25%, 9/1/95 (3) 3,000 3,038
6.70%, 9/1/16 (3) 19,150 19,169
Pennsylvania GO
5.00%, 4/15/09 (2) 9,985 8,240
Pennsylvania Higher
Education Auth.
(College and Univ. Rev.)
7.20%, 1/1/04 (2) 2,500 2,530
(Drexel Univ.)
5.625%, 5/1/14 (1) 11,755 10,186
(State System)
4.00%, 6/15/95 (2) 1,250 1,247
5.375%, 6/15/18 (2) 8,845 7,189
(Temple Univ.)
5.75%, 4/1/31 (1) 22,580 18,775
6.50%, 4/1/21 (1) 6,000 5,682
Pennsylvania Turnpike Comm.
5.50%, 12/1/17 (3) 29,000 24,287
5.75%, 12/1/12 (2) 10,000 8,919
6.00%, 6/1/15 (1) 28,800 26,301
6.25%, 6/1/11 (2) 10,000 9,555
Pennsylvania Turnpike Comm.
Oil Franchise
6.00%, 12/1/19 (2) 7,450 6,616
Philadelphia Airport Rev.
9.875%, 6/15/06 (1) 2,215 2,274
</TABLE>
11
<PAGE> 14
STATEMENT OF NET ASSETS (continued)
<TABLE>
<CAPTION>
Face Market
Amount Value
(000) (000)+
- --------------------------------------------------------------------------------
<S> <C> <C>
Philadelphia Gas Works
6.00%, 5/15/12 (2) $ 14,250 $ 13,027
6.75%, 1/1/99 (2) (Prere.) 3,570 3,768
6.75%, 1/1/15 (2) 13,930 13,600
7.25%, 1/1/99 (2) (Prere.) 2,615 2,806
7.25%, 1/1/10 (2) 10,085 10,322
Philadelphia GO TOB VRDO
3.50%, 5/15/95 (3) 15,000 15,000
6.00%, 11/15/10 (3) 2,810 2,596
6.00%, 11/15/11 (3) 3,025 2,781
6.00%, 11/15/12 (3) 3,355 3,076
6.00%, 11/15/13 (3) 1,885 1,731
Philadelphia Municipal Auth. Rev.
5.55%, 11/15/08 (3) 3,040 2,708
5.60%, 11/15/09 (3) 2,100 1,857
5.60%, 11/15/10 (3) 6,755 5,878
5.625%, 11/15/18 (3) 8,750 7,300
7.10%, 11/15/05 (1) 3,000 3,190
Philadelphia Parking Auth. Rev.
7.375%, 9/1/18 (2) 12,065 12,291
Philadelphia School Dist. GO
0.00%, 7/1/01 (2) 11,750 7,874
4.25%, 7/1/95 (1) 5,380 5,369
5.30%, 7/1/04 (2) 3,500 3,189
5.375%, 7/1/05 (1) 7,500 6,776
5.85%, 7/1/09 (1) 1,500 1,365
Philadelphia Water &
Waste Auth. Rev.
5.50%, 6/15/07 (1) 1,000 897
7.00%, 6/15/10 (3) 33,865 34,802
7.00%, 6/15/11 (3) 35,685 36,564
Pittsburgh GO
5.20%, 9/1/06 (2) 1,175 1,039
5.30%, 9/1/07 (2) 1,000 879
5.50%, 9/1/14 (2) 9,500 7,995
6.00%, 3/1/14 (2) 3,515 3,189
6.25%, 9/1/16 (1) 11,030 10,227
7.00%, 3/1/07 (3) 2,135 2,198
7.00%, 3/1/06 (3) 18,265 18,833
Pittsburgh Public Parking Auth.
5.875%, 12/1/12 (3) 8,200 7,388
Pittsburgh School Dist. GO
6.75%, 8/1/01 (2) (Prere.) 3,250 3,409
Pittsburgh Water & Sewer System
7.25%, 9/1/14 (3) (ETM) 25,175 26,891
7.625%, 9/1/04 (3) (ETM) 5,370 5,894
Pocono Mountain School Dist. GO
5.75%, 10/1/09 (2) 6,000 5,437
Reading GO (Berks County)
5.875%, 11/15/12 (2) 18,000 16,270
6.00%, 11/15/22 (2) 4,350 3,843
St. Mary's Hosp. Auth.
(Franciscan Health System)
7.00%, 7/1/09 (6) $ 1,000 $ 1,017
7.00%, 7/1/13 (6) 5,050 5,081
7.00%, 6/15/15 (6) 1,770 1,768
9.40%, 7/1/14 (6) 2,125 2,229
Sayre Health Care
Facilities Auth Pooled Loan VRDO
3.65%, 12/1/94 (2) 800 800
(Guthrie Health Care System)
6.00%, 3/1/21 (2) 10,710 9,372
7.00%, 3/1/11 (2) 2,000 2,031
Seneca Valley School Dist. GO
5.50%, 7/1/14 (3) 9,965 8,487
5.75%, 7/1/10 (3) 6,000 5,373
Souderton Area School Dist. GO
7.00%, 9/1/12 (2) 2,200 2,218
South Fork Hosp. Auth.
(Conemaugh Valley Hosp.)
5.625%, 7/1/10 (7) 2,300 1,969
5.75%, 7/1/18 (7) 7,000 5,801
Spring-Ford Area School Dist. GO
6.50%, 2/1/18 (2) 8,260 7,889
Univ. of Pittsburgh
6.125%, 6/1/21 (1) 21,400 19,275
Washington County Auth.
5.625%, 6/1/22 (3) 2,650 2,183
Washington County Hosp. Auth.
(Shadyside Hosp.)
5.875%, 12/15/09 (2) 22,000 19,871
(Washington Hosp.)
6.75%, 7/1/12 (2) 10,000 9,808
Wayne County Hosp. &
Health Facility
7.125%, 7/1/96 (1) (Prere.) 1,500 1,549
West Allegheny School Dist.
6.25%, 8/1/14 (2) 6,155 5,820
West Jefferson Hills School Dist. GO
5.90%, 8/1/10 (3) 3,160 2,897
5.95%, 8/1/14 (3) 7,180 6,437
Westmoreland County Auth.
6.125%, 7/1/17 (1) (ETM) 8,205 7,587
Westview Municipal Auth. Water Rev.
7.50%, 11/15/17 (3) 2,860 2,882
York County Southwestern
School Dist. GO
6.40%, 6/15/12 (3) 3,825 3,704
---------
GROUP TOTAL 1,140,046
---------
- --------------------------------------------------------------------------------
</TABLE>
12
<PAGE> 15
<TABLE>
<CAPTION>
Face Market
Amount Value
(000) (000)+
- --------------------------------------------------------------------------------
<S> <C> <C>
PORTFOLIO INSURED (1.0%)
Allegheny County Hosp.
Development Auth.
(Mercy Hosp.)
7.375%, 4/1/15 $ 3,650 $ 3,679
(St. Margaret's Hosp.)
9.80%, 7/1/10 1,500 1,566
Pennsylvania Hosp. & Higher
Education Facilities Auth.
(Pennsylvania Hosp.)
7.25%, 7/1/14 8,535 8,446
--------
GROUP TOTAL 13,691
--------
- --------------------------------------------------------------------------------
SECONDARY MARKET INSURED (.1%)
Allegheny County Hosp.
Development Auth.
(Mercy Hosp.)
7.375%, 4/1/15 (1) 1,350 1,368
- --------------------------------------------------------------------------------
NON-INSURED (7.4%)
Allegheny County Higher
Education Building Auth. VRDO
(Univ. of Pittsburgh)
3.525%, 1/1/95 (LOC) 750 750
Allegheny County Hosp.
Development Auth. VRDO
(Allegheny Hosp.)
3.50%, 12/1/94 (LOC) 1,200 1,200
(Presbyterian Univ. Health)
3.65%, 12/1/94 450 450
Cambria County Hosp. Auth.
(Conemaugh Valley Hosp.)
10.125%, 7/1/95 (Prere.) 2,000 2,103
Delaware County Industrial
Development Auth. VRDO
(United Parcel Service)
3.45%, 12/1/94 3,300 3,300
Pennsylvania GO
3.80%, 4/15/95 13,035 13,029
Pennsylvania Higher Education
Facilities Auth.
(Carnegie Mellon Univ.) VRDO
3.50%, 12/1/94 800 800
(Univ. of Pennsylvania)
9.125%, 6/1/95 (Prere.) 6,725 6,883
Pennsylvania Housing Single
Family Mortgage Finance Agency
6.90%, 4/1/17 7,500 7,243
7.55%, 4/1/16 9,670 9,828
Pennsylvania Infrastructure
Investment Auth. VRDO
(Pennvest Pooled Loan)
3.45%, 12/1/94 400 400
Pennsylvania State Univ.
9.00%, 9/1/95 (Prere.) $ 1,000 $ 1,051
Pennsylvania TAN
4.75%, 6/30/95 8,000 8,030
Philadelphia Auth. for
Industrial Development VRDO
(Institute for Cancer Research)
3.50%, 12/1/94 (LOC) 300 300
Philadelphia GO CP
4.00%, 2/14/95 (LOC) 5,000 5,000
Philadelphia Hosp. & Higher
Education Facilities Auth.
(Albert Einstein Medical Center)
10.00%, 4/1/95 (Prere.) 1,000 1,041
(Children's Hosp.) VRDO
3.50%, 12/1/94 (LOC) 1,100 1,100
Philadelphia School Dist. TRAN
4.75%, 6/30/95 12,000 12,036
Philadelphia TRAN
4.75%, 6/15/95 (LOC) 18,500 18,549
Swarthmore Borough Auth.
College Rev.
7.375%, 9/15/18 2,200 2,251
Univ. of Pittsburgh VRDO
3.525%, 1/1/95 (LOC) 600 600
----------
GROUP TOTAL 95,944
----------
- --------------------------------------------------------------------------------
TOTAL MUNICIPAL BONDS
(Cost $1,302,426) 1,251,049
- --------------------------------------------------------------------------------
OTHER ASSETS AND LIABILITIES (3.7%)
- --------------------------------------------------------------------------------
Other Assets--Note B 55,072
Liabilities (7,266)
--------
47,806
- --------------------------------------------------------------------------------
NET ASSETS (100%)
- --------------------------------------------------------------------------------
Applicable to 129,005,932 outstanding
shares of beneficial interest
(unlimited authorization--no par value) $1,298,855
- --------------------------------------------------------------------------------
NET ASSET VALUE PER SHARE $10.07
- --------------------------------------------------------------------------------
</TABLE>
+See Note A to Financial Statements.
For explanations of abbreviations and other references, see page 16.
13
<PAGE> 16
STATEMENT OF NET ASSETS (continued)
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
AT NOVEMBER 30, 1994,
NET ASSETS CONSISTED OF:
- --------------------------------------------------------------------------------
Amount Per
(000) Share
---------- -------
<S> <C> <C>
Paid in Capital $1,352,885 $10.49
Undistributed Net
Investment Income -- --
Accumulated Net Realized
Losses--Note C (73) --
Unrealized Depreciation
of Investments--Note D (53,957) (.42)
- --------------------------------------------------------------------------------
NET ASSETS $1,298,855 $10.07
- --------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
Face Market
Amount Value
MONEY MARKET PORFOLIO (000) (000)+
- --------------------------------------------------------------------------------
MUNICIPAL BONDS (99.1%)
- --------------------------------------------------------------------------------
<S> <C> <C>
Allegheny County GO
VRDO 3.75%, 12/8/94 $ 31,200 $ 31,200
7.00%, 2/15/95 1,000 1,009
Allegheny County Higher Education
Building Auth.
(Univ. of Pittsburgh)
3.574%, 12/8/94 (LOC) 38,380 38,380
Allegheny County Hosp.
Development Auth. CP
(Health Center Development)
3.60%, 1/24/95 (LOC) 5,000 5,000
3.85%, 1/30/95 (LOC) 10,200 10,200
Allegheny County Hosp.
Development Auth. VRDO
(Allegheny Health System)
3.50%, 12/7/94 (LOC) 20,100 20,100
(Children's Hosp.-Pittsburgh)
3.675%, 12/8/94 (1) 25,300 25,300
(Magee Women's Hosp.)
TOB 3.85%, 12/8/94 (3) 2,890 2,890
(Presbyterian Univ. Health)
3.75%, 12/8/94 (1) 4,500 4,500
(South Hills Health System)
3.50%, 12/7/94 (LOC) 10,650 10,650
Allegheny County Industrial
Development Auth. PCR CP
(Duquesne Light & Power Co.)
3.85%, 3/27/95 (LOC) 5,000 5,000
Beaver County Industrial
Development Auth. PCR CP
(Duquesne Light & Power Co.)
3.65%, 1/26/95 (LOC) 5,000 5,000
3.90%, 2/9/95 (LOC) 5,450 5,450
4.50%, 10/10/95 (LOC) 10,000 10,000
Berks County TRAN
2.70%, 12/30/94 2,800 2,800
Dauphin County General
Auth. VRDO
(Reading Hosp. & Medical Center)
3.75%, 12/7/94 8,000 8,000
Delaware County GO
6.40%, 12/1/94 1,000 1,000
Delaware County Industrial
Development Auth. VRDO
(United Parcel Service)
3.45%, 12/2/94 34,700 34,700
Delaware County PCR CP
(PECO)
3.45%, 12/9/94 (3) 18,000 18,000
3.55%, 12/15/94 (3) 10,150 10,150
3.55%, 1/19/95 (3) 6,800 6,800
</TABLE>
14
<PAGE> 17
<TABLE>
<CAPTION>
Face Market
Amount Value
(000) (000)+
- --------------------------------------------------------------------------------
<S> <C> <C>
3.65%, 1/23/95 (3) $ 8,500 $ 8,500
3.85%, 1/26/95 (3) 3,000 3,000
Delaware County PCR VRDO
(PECO)
3.60%, 12/7/94 (LOC) 24,125 24,125
Delaware River Port Auth.
9.375%, 1/1/95 (2) (Prere.) 7,450 7,713
Emmaus General Auth. Pooled
Local Govt. VRDO
3.60%, 12/7/94 (LOC) 7,400 7,400
(North Penn School Dist.)
3.60%, 12/7/94 (LOC) 7,600 7,600
Erie County GO TOB VRDO
3.50%, 12/8/94 (3) (Prere.) 6,955 6,955
Geisinger Health Systems Auth. VRDO
(Montour County)
3.50%, 12/2/94 21,700 21,700
Lehigh County General Purpose
Auth. CP
(Hosp. Central Services)
3.60%, 1/26/95 (1) 7,500 7,500
3.65%, 1/26/95 (1) 3,700 3,700
3.75%, 2/1/95 (1) 2,000 2,000
Northeastern Pennsylvania Hosp.
Auth. CP
(Hosp. Central Services)
3.65%, 1/26/95 (1) 5,500 5,500
3.80%, 2/1/95 (1) 9,950 9,950
3.80%, 2/13/95 (1) 10,000 10,000
Pennsylvania COP
4.20%, 6/1/95 (2) 2,960 2,960
Pennsylvania GO
4.75%, 6/15/95 23,190 23,343
Pennsylvania GO TOB VRDO
3.70%, 12/8/94 (2) 9,125 9,125
Pennsylvania TAN
4.75%, 6/30/95 9,845 9,887
5.00%, 6/30/95 24,500 24,645
Pennsylvania Higher Education
Assistance Agency Student Loan Rev.
VRDO
3.70%, 12/7/94 (LOC) 31,700 31,700
Pennsylvania Higher Education
Facilities Auth. Pooled Loan VRDO
3.60%, 12/7/94 (LOC) 21,900 21,900
(Carnegie Mellon Univ.)
3.50%, 12/7/94 63,800 63,800
(Temple Univ.)
3.50%, 12/2/94 (LOC) 30,300 30,300
(Univ. of Pennsylvania)
3.55%, 12/7/94 67,200 67,200
(Univ. of Pennsylvania
Health System)
3.60%, 12/7/94 $ 17,300 $ 17,300
(Univ. of Pittsburgh)
3.625%, 12/8/94 (LOC) 20,800 20,800
Pennsylvania Infrastructure
Investment Auth. VRDO
(Pennvest Pooled Loan)
3.45%, 12/7/94 49,600 49,600
Pennsylvania State Univ. Notes RAN
4.00%, 5/4/95 8,000 8,016
Pennsylvania State Univ. Notes
3.00%, 12/5/94 10,000 10,000
Pennsylvania Turnpike Auth. TOB VRDO
3.70%, 12/8/94 (Prere.) 12,000 12,000
Philadelphia Auth. for
Industrial Development VRDO
(Franklin Institute)
3.80%, 12/8/94 (LOC) 11,225 11,225
(Institute for Cancer Research)
3.50%, 12/2/94 (LOC) 4,400 4,400
Philadelphia Gas Works CP
3.60%, 1/27/95 (LOC) 7,200 7,200
8.75%, 5/15/95 (2) (Prere.) 1,500 1,569
9.125%, 3/15/95 (Prere.) 5,230 5,443
Philadelphia Hosp. & Higher
Education Facilities Auth.
(Albert Einstein Medical Center)
9.75%, 4/1/95 (Prere.) 3,460 3,594
10.00%, 4/1/95 (Prere.) 6,275 6,533
(Children's Hosp.)
VRDO 3.50%, 12/2/94 (LOC) 25,250 25,250
TOB VRDO 3.50%, 12/8/94 2,700 2,700
(Pennsylvania Hosp.)
VRDO 3.60%, 12/7/94 (3) 20,000 20,000
3.75%, 7/1/95* (3) 21,715 21,715
Philadelphia School Dist. TRAN
4.75%, 6/30/95 10,000 10,027
Philadelphia TRAN
4.75%, 6/15/95 (LOC) 31,500 31,648
Red Lion Area School Dist. TRAN
4.75%, 6/30/95 2,900 2,915
St. Mary's Hosp. Auth. Langhorne
(Franciscan Health System)
VRDO 3.45%, 12/2/94 (LOC) 18,230 18,230
Sayre Health Care Facilities
Auth. Pooled Loan VRDO
3.65%, 12/7/94 (2) 73,720 73,720
Scranton Lackawanna Health &
Welfare Auth. (Univ. of Scranton)
4.25%, 5/1/95* (LOC) 5,340 5,340
</TABLE>
15
<PAGE> 18
STATEMENT OF NET ASSETS (continued)
<TABLE>
<CAPTION>
Face Market
Amount Value
(000) (000)+
- --------------------------------------------------------------------------------
<S> <C> <C>
Somerset County General Auth.
TOB VRDO
3.50%, 12/8/94 (Prere.) $ 15,540 $ 15,540
Temple Univ. Notes
4.50%, 5/24/95 19,700 19,764
York County Industrial
Development Auth. PCR VRDO
(PECO)
3.60%, 12/7/94 (LOC) 14,440 14,440
OUTSIDE PENNSYLVANIA:
Puerto Rico Govt.
Development Bank VRDO
3.45%, 12/7/94 (LOC) 9,600 9,600
- --------------------------------------------------------------------------------
TOTAL MUNICIPAL BONDS
(Cost $1,095,201) 1,095,201
- --------------------------------------------------------------------------------
OTHER ASSETS AND LIABILITIES (.9%)
- --------------------------------------------------------------------------------
Other Assets--Note B 14,540
Liabilities (4,760)
--------
9,780
- --------------------------------------------------------------------------------
NET ASSETS (100%)
- --------------------------------------------------------------------------------
Applicable to 1,105,020,712 outstanding
shares of beneficial interest
(unlimited authorization--no par value) $1,104,981
- --------------------------------------------------------------------------------
NET ASSET VALUE PER SHARE $1.00
================================================================================
</TABLE>
+See Note A to Financial Statements.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
AT NOVEMBER 30, 1994,
NET ASSETS CONSISTED OF:
- --------------------------------------------------------------------------------
Amount Per
(000) Share
---------- ----------
<S> <C> <C>
Paid in Capital $1,105,020 $1.00
Undistributed Net
Investment Income -- --
Accumulated Net
Realized Losses (39) --
Unrealized Appreciation
of Investments -- --
- --------------------------------------------------------------------------------
NET ASSETS $1,104,981 $1.00
- --------------------------------------------------------------------------------
</TABLE>
CP=Commercial Paper
COP=Certificate of Participation
GO=General Obligation
IDR=Industrial Development Revenue
PCR=Pollution Control Revenue
TAN=Tax Anticipation Note
TOB=Tender Option Bond
TRAN=Tax Revenue Anticipation Note
VRDO=Variable Rate Demand Obligation
(ETM)=Escrowed to Maturity
(Prere.)=Prerefunded
*Put Option Obligation.
Scheduled principal and interest payments are guaranteed by:
(1) MBIA (Municipal Bond Insurance Association)
(2) AMBAC (AMBAC Indemnity Corporation)
(3) FGIC (Financial Guaranty Insurance Company)
(4) FSA (Financial Security Assurance)
(5) CGI (Capital Guaranty Insurance)
(6) BIGI (Bond Investors Guaranty Insurance)
(7) Connie Lee Inc.
(8) FHA (Federal Housing Authority)
The insurance does not guarantee the market value of the
municipal bonds.
(LOC)=Scheduled principal and interest payments are guaranteed by
bank letter of credit.
16
<PAGE> 19
STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
INSURED LONG-TERM MONEY MARKET
PORTFOLIO PORTFOLIO
- ---------------------------------------------------------------------------------------------------------------------
Year Ended Year Ended
November 30, 1994 November 30, 1994
(000) (000)
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
INVESTMENT INCOME
INCOME
Interest . . . . . . . . . . . . . . . . . . . $ 85,812 $28,266
- ---------------------------------------------------------------------------------------------------------------------
Total Income . . . . . . . . . . . . 85,812 28,266
- ---------------------------------------------------------------------------------------------------------------------
EXPENSES
The Vanguard Group--Note B
Investment Advisory Services . . . . . . . . $ 167 $ 114
Management and Administrative . . . . . . . 2,355 1,623
Marketing and Distribution . . . . . . . . . 304 2,826 272 2,009
------ -------
Insurance Expense . . . . . . . . . . . . . . . 43 --
Auditing Fees . . . . . . . . . . . . . . . . . 8 7
Shareholders' Reports . . . . . . . . . . . . . 38 25
Annual Meeting and Proxy Costs . . . . . . . . 10 5
Trustees' Fees and Expenses . . . . . . . . . . 7 5
- ---------------------------------------------------------------------------------------------------------------------
Total Expenses . . . . . . . . . . . 2,932 2,051
- ---------------------------------------------------------------------------------------------------------------------
Net Investment Income . . . . . . 82,880 26,215
- ---------------------------------------------------------------------------------------------------------------------
REALIZED NET GAIN (LOSS)
Investment Securities Sold . . . . . . . . . . (5,506) (22)
Futures Contracts . . . . . . . . . . . . . . . 9,606 --
- ---------------------------------------------------------------------------------------------------------------------
Realized Net Gain (Loss) . . . . . . 4,100 (22)
- ---------------------------------------------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION
(DEPRECIATION)
Investment Securities . . . . . . . . . . . . . (163,264) --
Futures Contracts . . . . . . . . . . . . . . . (4,404) --
- ---------------------------------------------------------------------------------------------------------------------
Change in Unrealized
Appreciation (Depreciation) . . . (167,668) --
- ---------------------------------------------------------------------------------------------------------------------
Net Increase (Decrease) in Net Assets
Resulting from Operations . . . . $ (80,688) $26,193
=====================================================================================================================
</TABLE>
17
<PAGE> 20
STATEMENT OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
INSURED LONG-TERM PORTFOLIO MONEY MARKET PORTFOLIO
- -------------------------------------------------------------------------------------------------------------------------------
YEAR ENDED Year Ended YEAR ENDED Year Ended
NOVEMBER 30, November 30, NOVEMBER 30, November 30,
1994 1993 1994 1993
(000) (000) (000) (000)
- -------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
INCREASE (DECREASE) IN NET ASSETS
OPERATIONS
Net Investment Income . . . . . . . . . . . . . . . $ 82,880 $ 76,083 $ 26,215 $ 19,740
Realized Net Gain (Loss). . . . . . . . . . . . . . 4,100 7,978 (22) (1)
Change in Unrealized Appreciation
(Depreciation) . . . . . . . . . . . . . . . . . (167,668) 63,080 -- --
- -------------------------------------------------------------------------------------------------------------------------------
Net Increase (Decrease) in Net Assets
Resulting from Operations . . . . . . . . (80,688) 147,141 26,193 19,739
- -------------------------------------------------------------------------------------------------------------------------------
DISTRIBUTIONS (1)
Net Investment Income . . . . . . . . . . . . . . . (82,880) (76,083) (26,215) (19,740)
Realized Net Gain . . . . . . . . . . . . . . . . . (10,361) (23,306) -- --
- -------------------------------------------------------------------------------------------------------------------------------
Total Distributions . . . . . . . . . . . . (93,241) (99,389) (26,215) (19,740)
- -------------------------------------------------------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS (2)
Issued -- Regular . . . . . . . . . . . . . . . 234,511 395,311 928,054 789,488
-- In Lieu of Cash Distributions . . . . 66,482 74,696 24,394 18,282
-- Exchange . . . . . . . . . . . . . . . 100,416 157,533 333,652 258,067
Redeemed -- Regular . . . . . . . . . . . . . . . (208,799) (176,200) (820,445) 674,563)
-- Exchange . . . . . . . . . . . . . . . (216,183) (132,803) (295,925) (238,098)
- -------------------------------------------------------------------------------------------------------------------------------
Net Increase (Decrease) from Capital
Share Transactions . . . . . . . . . . . (23,573) 318,537 169,730 153,176
- -------------------------------------------------------------------------------------------------------------------------------
Total Increase (Decrease) . . . . . . . . . (197,502) 366,289 169,708 153,175
- -------------------------------------------------------------------------------------------------------------------------------
NET ASSETS
Beginning of Year . . . . . . . . . . . . . . . . . 1,496,357 1,130,068 935,273 782,098
- -------------------------------------------------------------------------------------------------------------------------------
End of Year . . . . . . . . . . . . . . . . . . . . $1,298,855 $1,496,357 $1,104,981 $ 935,273
===============================================================================================================================
(1) Distributions Per Share
Net Investment Income . . . . . . . . . . . . $.625 $.631 $.025 $.024
Realized Net Gain . . . . . . . . . . . . . . $.079 $.224 -- --
- -------------------------------------------------------------------------------------------------------------------------------
(2) Shares Issued and Redeemed
Issued . . . . . . . . . . . . . . . . . . . . 30,537 49,414 1,261,706 1,047,555
Issued in Lieu of Cash Distributions . . . . . 6,106 6,721 24,394 18,282
Redeemed . . . . . . . . . . . . . . . . . . . (39,341) (27,522) (1,116,370) (912,661)
- -------------------------------------------------------------------------------------------------------------------------------
(2,698) 28,613 169,730 153,176
- -------------------------------------------------------------------------------------------------------------------------------
</TABLE>
18
<PAGE> 21
FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
INSURED LONG-TERM PORTFOLIO
- ------------------------------------------------------------------------------------------------------------------------------
Year Ended November 30,
------------------------------------------------------------------
For a Share Outstanding Throughout Each Year 1994 1993 1992 1991 1990
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF YEAR . . . . . . . . . . . $11.36 $10.96 $10.47 $10.19 $10.16
------ ------ ------ ------ ------
INVESTMENT OPERATIONS
Net Investment Income . . . . . . . . . . . . . . . . .625 .631 .664 .667 .679
Net Realized and Unrealized Gain (Loss)
on Investments . . . . . . . . . . . . . . . . . . (1.211) .624 .520 .286 .030
------ ------ ------ ------ ------
TOTAL FROM INVESTMENT OPERATIONS . . . . . . . (.586) 1.255 1.184 .953 .709
- ------------------------------------------------------------------------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income . . . . . . . . . (.625) (.631) (.664) (.667) (.679)
Distributions from Realized Capital Gains . . . . . . (.079) (.224) (.030) (.006) --
------ ------ ------ ------ ------
TOTAL DISTRIBUTIONS . . . . . . . . . . . . . . (.704) (.855) (.694) (.673) (.679)
- ------------------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR . . . . . . . . . . . . . . $10.07 $11.36 $10.96 $10.47 $10.19
==============================================================================================================================
TOTAL RETURN . . . . . . . . . . . . . . . . . . . . . . -5.44% +11.90% +11.65% +9.65% +7.27%
- ------------------------------------------------------------------------------------------------------------------------------
RATIOS/SUPPLEMENTAL DATA
- ------------------------
Net Assets, End of Year (Millions) . . . . . . . . . . . $1,299 $1,496 $1,130 $828 $556
Ratio of Expenses to Average Net Assets . . . . . . . . . . 20% .20% .24%+ .25%+ .25%+
Ratio of Net Investment Income to
Average Net Assets . . . . . . . . . . . . . . . . . . 5.76% 5.61% 6.17% 6.46% 6.77%
Portfolio Turnover Rate . . . . . . . . . . . . . . . . . 16% 14% 17% 2% 9%
- ------------------------------------------------------------------------------------------------------------------------------
</TABLE>
+ Insurance expense represents .01%, .01%, and .02%.
19
<PAGE> 22
FINANCIAL HIGHLIGHTS (continued)
<TABLE>
<CAPTION>
MONEY MARKET PORTFOLIO
- -------------------------------------------------------------------------------------------------------------------
Year Ended November 30,
----------------------------------------------------
For a Share Outstanding Throughout Each Year 1994 1993 1992 1991 1990
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF YEAR . . . . . . . . . . . $1.00 $1.00 $1.00 $1.00 $1.00
----- ----- ----- ----- -----
INVESTMENT OPERATIONS
Net Investment Income . . . . . . . . . . . . . . . . .025 .024 .029 .045 .057
Net Realized and Unrealized Gain (Loss)
on Investments . . . . . . . . . . . . . . . . . . -- -- -- -- --
----- ----- ----- ----- -----
TOTAL FROM INVESTMENT OPERATIONS . . . . . . . .025 .024 .029 .045 .057
- -------------------------------------------------------------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income . . . . . . . . . (.025) (.024) (.029) (.045) (.057)
Distributions from Realized Capital Gains . . . . . . -- -- -- -- --
TOTAL DISTRIBUTIONS . . . . . . . . . . . . . . . (.025) (.024) (.029) (.045) (.057)
- -------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR . . . . . . . . . . . . . . $1.00 $1.00 $1.00 $1.00 $1.00
===================================================================================================================
TOTAL RETURN . . . . . . . . . . . . . . . . . . . . . . +2.57% +2.38% +2.96% +4.59% +5.85%
- -------------------------------------------------------------------------------------------------------------------
RATIOS/SUPPLEMENTAL DATA
- ------------------------
Net Assets, End of Year (Millions) . . . . . . . . . . . $1,105 $935 $782 $818 $730
Ratio of Expenses to Average Net Assets . . . . . . . . . . 20% .20% .24% .24% .23%
Ratio of Net Investment Income to
Average Net Assets . . . . . . . . . . . . . . . . . . 2.55% 2.35% 2.93% 4.48% 5.68%
Portfolio Turnover Rate . . . . . . . . . . . . . . . . . N/A N/A N/A N/A N/A
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
20
<PAGE> 23
NOTES TO FINANCIAL STATEMENTS
Vanguard Pennsylvania Tax-Free Fund is registered under the Investment Company
Act of 1940 as an open-end investment company and consists of the Insured
Long-Term and Money Market Portfolios. Each Portfolio invests in debt
instruments of municipal issuers whose ability to meet their obligations may be
affected by economic and political developments in the Commonwealth of
Pennsylvania.
A. The following significant accounting policies are in conformity with
generally accepted accounting principles for investment companies. Such
policies are consistently followed by the Fund in the preparation of financial
statements.
1. SECURITY VALUATION: Money Market Portfolio: investment securities are
stated at amortized cost which approximates market value. Insured
Long-Term Portfolio: municipal bonds are valued utilizing primarily
the latest bid prices or, if bid prices are not available, on the
basis of valuations based on a matrix system (which considers such
factors as security prices, yields, maturities and ratings), both as
furnished by an independent pricing service.
2. FEDERAL INCOME TAXES: Each Portfolio of the Fund intends to continue
to qualify as a regulated investment company and distribute all of
its income. Accordingly, no provision for Federal income taxes is
required in the financial statements.
3. FUTURES: The Insured Long-Term Portfolio utilizes Municipal Bond
Index, U.S. Treasury Bond, and U.S. Treasury Note futures contracts
to a limited extent, with the objectives of enhancing returns,
managing interest rate risk, maintaining liquidity, diversifying
credit risk and minimizing transaction costs. The Portfolio may
purchase futures contracts instead of municipal bonds when futures
contracts are believed to be priced more attractively than municipal
bonds. The Portfolio may also seek to take advantage of price
differences among bond market sectors by simultaneously buying
futures (or bonds) of one market sector and selling futures (or
bonds) of another sector. Futures contracts may also be used to
simulate a fully invested position in the underlying bonds while
maintaining a cash balance for liquidity.
The primary risks associated with the use of futures contracts are
imperfect correlation between changes in market values of bonds held
by the Portfolio and the prices of futures contracts, and the
possibility of an illiquid market. Futures contracts are valued based
upon their quoted daily settlement prices. Fluctuations in the values
of futures contracts are recorded as unrealized appreciation
(depreciation) until terminated at which time realized gains (losses)
are recognized. Unrealized appreciation (depreciation) related to
open futures contracts is required to be treated as realized gain
(loss) for Federal income tax purposes.
4. DISTRIBUTIONS: Distributions from net investment income are declared
on a daily basis payable on the first business day of the following
month. Annual distributions from realized gains, if any, are recorded
on the ex-dividend date. Capital gain distributions are determined on
a tax basis and may differ from realized capital gains for financial
reporting purposes due to differences in the timing of realization of
gains.
5. OTHER: Security transactions are accounted for on the date the
securities are purchased or sold. Costs used in determining realized
gains and losses on the sale of investment securities are those of
specific securities sold. Premiums and original issue discounts are
amortized and accreted, respectively, to interest income over the
lives of the respective securities.
B. The Vanguard Group, Inc. furnishes at cost investment advisory,
corporate management, administrative, marketing and distribution services. The
costs of such services are allocated to the Fund under methods approved by the
Board of Trustees. At November 30, 1994, the Fund had contributed capital
aggregating $372,000 to Vanguard (included in Other
21
<PAGE> 24
NOTES TO FINANCIAL STATEMENTS (continued)
Assets), representing 1.9% of Vanguard's capitalization. The Fund's officers
and trustees are also officers and directors of Vanguard.
The Fund's investment advisers may direct certain new issue portfolio trades,
subject to obtaining the best price and execution, to underwriters who have
agreed to rebate or credit to the Fund a portion of the underwriting fees
generated. Such rebates or credits are used solely to reduce the Fund's
administrative expenses. For the year ended November 30, 1994, directed
brokerage arrangements reduced expenses of the Insured Long-Term Portfolio by
$128,000 (an annual rate of .01 of 1% of average net assets).
C. During the year ended November 30, 1994, the Insured Long-Term Portfolio
made purchases of $208,477,000 and sales of $254,840,000 of investment
securities other than temporary cash investments. At November 30, 1994, the
Insured Long-Term Portfolio had available a capital loss carryforward of
$970,000 to offset future net capital gains through November 30, 2002.
D. At November 30, 1994, unrealized depreciation of investment securities
of the Insured Long-Term Portfolio for financial reporting and Federal income
tax purposes aggregated $51,377,000 of which $12,520,000 related to appreciated
securities and $63,897,000 related to depreciated securities.
At November 30, 1994, the Insured Long-Term Portfolio had long positions in
Municipal Bond Index futures contracts expiring through March, 1995, with an
aggregate settlement value and net unrealized depreciation of $99,998,000 and
$2,580,000, respectively. The market value of securities deposited as initial
margin for open futures contracts was $3,461,000.
22
<PAGE> 25
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders and Board of Trustees
Vanguard Pennsylvania Tax-Free Fund
In our opinion, the accompanying statements of net assets and the related
statements of operations and of changes in net assets and the financial
highlights present fairly, in all material respects, the financial position of
the Insured Long-Term Portfolio and the Money Market Portfolio (constituting
the Vanguard Pennsylvania Tax-Free Fund, hereafter referred to as the "Fund")
at November 30, 1994, the results of each of their operations, the changes in
each of their net assets and the financial highlights for each of the
respective periods presented, in conformity with generally accepted accounting
principles. These financial statements and financial highlights (hereafter
referred to as "financial statements") are the responsibility of the Fund's
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these financial
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits, which included
confirmation of securities by correspondence with the custodian and brokers and
the application of alternative auditing procedures where confirmations from
brokers were not received, provide a reasonable basis for the opinion expressed
above.
PRICE WATERHOUSE LLP
Thirty South Seventeenth Street
Philadelphia, Pennsylvania 19103
December 30, 1994
23
<PAGE> 26
TRUSTEES AND OFFICERS
JOHN C. BOGLE, Chairman and Chief Executive Officer Chairman and Director of
The Vanguard Group, Inc., and of each of the investment companies in The
Vanguard Group.
JOHN J. BRENNAN, President
President and Director of The Vanguard Group, Inc., and of each of the
investment companies in The Vanguard Group.
ROBERT E. CAWTHORN, Chairman and Chief Executive Officer of Rhone-Poulenc Rorer
Inc.; Director of Sun Company, Inc.
BARBARA BARNES HAUPTFUHRER, Director of The Great Atlantic and Pacific Tea
Company, Alco Standard Corp., Raytheon Company, Knight- Ridder, Inc., and
Massachusetts Mutual Life Insurance Co.
BURTON G. MALKIEL, Chemical Bank Chairman's Professor of Economics, Princeton
University; Director of Prudential Insurance Co. of America, Amdahl
Corporation, Baker Fentress & Co., The Jeffrey Co., and Southern New England
Communications Company.
ALFRED M. RANKIN, JR., Chairman, President, and Chief Executive Officer of
NACCO Industries, Inc.; Director of NACCO Industries, The BFGoodrich Company,
Reliance Electric Company, and The Standard Products Company.
JOHN C. SAWHILL, President and Chief Executive Officer of The Nature
Conservancy; formerly, Director and Senior Partner of McKinsey & Co. and
President of New York University; Director of Pacific Gas and Electric Company
and NACCO Industries.
JAMES O. WELCH, JR., Retired Chairman of Nabisco Brands, Inc.; retired Vice
Chairman and Director of RJR Nabisco; Director of TECO Energy, Inc.
J. LAWRENCE WILSON, Chairman and Chief Executive Officer of Rohm & Haas
Company; Director of Cummins Engine Company; Trustee of Vanderbilt University
and the Culver Educational Foundation.
OTHER FUND OFFICERS
RICHARD F. HYLAND, Treasurer; Treasurer of The Vanguard Group, Inc., and of
each of the investment companies in The Vanguard Group.
RAYMOND J. KLAPINSKY, Secretary; Senior Vice President and Secretary of The
Vanguard Group, Inc.; Secretary of each of the investment companies in The
Vanguard Group.
KAREN E. WEST, Controller; Vice President of The Vanguard Group, Inc.;
Controller of each of the investment companies in The Vanguard Group.
OTHER VANGUARD GROUP OFFICERS
<TABLE>
<S> <C>
JEREMY G. DUFFIELD VINCENT S. MCCORMACK
Senior Vice President Senior Vice President
Planning & Development Operations
JAMES H. GATELY RALPH K. PACKARD
Senior Vice President Senior Vice President
Institutional Chief Financial Officer
IAN A. MACKINNON
Senior Vice President
Fixed Income Group
</TABLE>
24
<PAGE> 27
THE VANGUARD VOYAGE...STAYING THE COURSE
(continued from inside front cover)
* We set specific standards for each Fund's investment policies and
principles.
* We adhere to the highest standards of investment quality, consistent
with each Fund's objectives.
* We offer candor in our Fund descriptions (including full disclosure
of risk) to prospective investors, and in our description to
shareholders of each Fund's success (or, sometimes, lack of
the same).
These principles make at least as much sense today as they did in 1929, perhaps
even more. For we live in an era when many fund organizations have become
asset-gathering machines, capitalizing on past performance that is unrepeatable
and investment fads that today, as yesterday, will come and go. The new
marketing policy is too often "if investors want it, we'll sell it to them."
But our principle remains "if it makes sound investment sense, we'll offer it,
even if it takes years to attract substantial assets."
FOUNDING CORPORATE VALUES
With the founding of The Vanguard Group in 1974, a new concept of values was
brought to bear on mutual fund management. Unlike other fund organizations,
Vanguard alone is structured to serve only its Funds' shareholders. Vanguard's
corporate structure places not the fund management company, but the fund
shareholders, "at the top" of the organizational chart. Vanguard Fund
shareholders are literally the owners of the firm and are entitled to all of
the benefits that, at other fund firms, accrue to the owners of the management
company.
Because of this unique structure, Vanguard has become best known for its
low costs, which we believe are just as essential a consideration in investing
in mutual funds as risk potential and total return. We call this relationship
between risk, return, and cost the "eternal triangle" of mutual fund investing.
We take special pride in our position as (by far) the lowest-cost provider
of financial services in the world. Under our "no- load" offering structure,
shareholders begin their Vanguard investment program with $1,000 of assets
(not, say, $950) for each $1,000 investment. Then, under our "at-cost"
operating structure, each $1,000 is managed for only about $3 per year; our
competitors may charge three, four, or even five times that amount.
In all, Vanguard has distinguished itself by providing Funds with sound
and durable goals to investors with long-term time horizons, and doing so at
the fairest financial terms available. We believe that the unique Vanguard
structure "promotes a healthy and viable mutual fund complex within which each
Fund can better prosper; enables the Funds to realize substantial savings from
advisory fee reductions; promotes savings from economies of scale; and provides
the Funds with direct and conflict-free control over distribution functions."
We are not alone in this belief. Indeed, the quotation is taken verbatim from
the unanimous decision of the U.S. Securities and Exchange Commission when, in
1981, it approved our application for the structure under which we operate
today.
A CLOSING THOUGHT
We are proud of what Wellington Fund, the other Vanguard Funds, and The
Vanguard Group have come to represent, and we are grateful for the success and
growth with which we have been blessed. We are an industry leader, and, as a
competitor observed a few years ago, we are "the standard by which all fund
organizations are judged."
In battle terms, "the vanguard" is the first wave of troops or ships, and
Vanguard surely is in the first wave of the battle for investment survival. As
we look behind us, however, the "second wave" is not in sight. No fund
organization has followed our lead, leaving ours a lonely course. No matter. We
have an organization that places the interests of our Fund shareholders first.
We have Funds that shall endure the vicissitudes of the future. Come what may,
we intend to "stay the course," and we shall do our very best to continue to
deserve your confidence and loyalty. We hope that you will stay the course with
us.
[LOGO]
THE ETERNAL TRIANGLE
OF INVESTING
<PAGE> 28
THE VANGUARD FAMILY OF FUNDS
FIXED INCOME FUNDS
MONEY MARKET FUNDS
Vanguard Admiral Funds
U.S. Treasury Money Market Portfolio
Vanguard Money Market Reserves
TAX-EXEMPT MONEY MARKET FUNDS
Vanguard Municipal Bond Fund
Money Market Portfolio
Vanguard State Tax-Free Funds
Money Market Portfolios (CA, NJ, OH, PA)
TAX-EXEMPT INCOME FUNDS
Vanguard Municipal Bond Fund
Vanguard State Tax-Free Funds
Insured Longer-Term Portfolios
(CA, FL, NJ, NY, OH, PA)
INCOME FUNDS
Vanguard Admiral Funds
Vanguard Fixed Income Securities Fund
Vanguard Preferred Stock Fund
EQUITY AND BALANCED FUNDS
GROWTH AND INCOME FUNDS
Vanguard Convertible Securities Fund
Vanguard Equity Income Fund
Vanguard Quantitative Portfolios
Vanguard/Trustees' Equity Fund
U.S. Portfolio
Vanguard/Windsor Fund
Vanguard/Windsor II
BALANCED FUNDS
Vanguard Asset Allocation Fund
Vanguard STAR Fund
Vanguard/Wellesley Income Fund
Vanguard/Wellington Fund
GROWTH FUNDS
Vanguard/Morgan Growth Fund
Vanguard/PRIMECAP Fund
Vanguard U.S. Growth Portfolio
AGGRESSIVE GROWTH FUNDS
Vanguard Explorer Fund
Vanguard Specialized Portfolios
INTERNATIONAL FUNDS
Vanguard International Growth Portfolio
Vanguard/Trustees' Equity Fund
International Portfolio
INDEX FUNDS
Vanguard Index Trust
Total Stock Market Portfolio
500 Portfolio
Extended Market Portfolio
Growth Portfolio
Value Portfolio
Small Capitalization Stock Portfolio
Vanguard International Equity Index Fund
European Portfolio
Pacific Portfolio
Emerging Markets Portfolio
Vanguard Bond Index Fund
Vanguard Tax-Managed Fund
Vanguard Balanced Index Fund
[VANGUARD LOGO]
<TABLE>
<S> <C>
Vanguard Financial Center Valley Forge, Pennsylvania 19482
New Account Information: 1-(800) 662-7447 Shareholder Account Services: 1-(800) 662-2739
</TABLE>
This Report has been prepared for shareholders and may be distributed to others
only if preceded or accompanied by a current prospectus. All Funds in
the Vanguard Family are offered by prospectus only.
Q770-11/94
<PAGE> 29
EDGAR APPENDIX
This appendix describes the components of the printed version of this
report that do not translate into a format acceptable to the EDGAR system.
The front cover of the printed version of this report features the
Vanguard ship in the crashing sea.
A small picture of a rear view of the Vanguard ship crashing through
the sea appears at the top of the inside covers of the report.
A running head featuring a sextant appears on pages one through six.
A photograph of John C. Bogle appears at the lower-right of page one.
A cumulative performance line chart for the period April 30, 1986, to
November 30, 1994 appears at the top of page two.
Two line charts appear at the upper-left of page three--the top chart
depicts the month-end yields of a 30-Year Prime Municipal Bond and a 90-Day
MIG 1 Note for the fiscal years 1990 through 1994, and the bottom chart
indicates the yield spread for the same periods.
A running head featuring a coiled rope appears on page seven.
A running head featuring a map and telescope appears on pages eight
and nine.
A running head featuring a log book and pen appears on pages ten
through twenty-three.
A running head featuring a compass appears on page twenty-four.
At the bottom of the back cover there appears a triangle with the
sides labeled "risk," "cost," and "return."
A seagull in flight is featured at the top of the outside back cover
of the report.
