<PAGE>
================================================================================
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM N-1A
REGISTRATION STATEMENT (NO. 33-2907) UNDER
THE SECURITIES ACT OF 1933
PRE-EFFECTIVE AMENDMENT NO. [X]
POST-EFFECTIVE AMENDMENT NO. 13 [X]
AND
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY
ACT OF 1940
AMENDMENT NO. 15
[X]
VANGUARD PENNSYLVANIA TAX-FREE FUND
(EXACT NAME OF REGISTRANT AS SPECIFIED IN CHARTER)
P.O. BOX 2600,
VALLEY FORGE, PA 19482
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICE)
REGISTRANT'S TELEPHONE NUMBER (610) 669-1000
RAYMOND J. KLAPINSKY, ESQUIRE
P.O. BOX 876
VALLEY FORGE, PA 19482
It is hereby requested that this filing become effective on March 29, 1996,
pursuant to paragraph (b) of Rule 485.
Approximate Date of Proposed Public Offering: As soon as practicable after
this Registration Statement becomes effective.
Registrant elects to register an indefinite number of shares pursuant to
Regulation 24f-2 under the Investment Company Act of 1940. Registrant filed
its Rule 24f-2 Notice for the year ended November 30, 1995 on January 25,
1996.
================================================================================
<PAGE>
VANGUARD PENNSYLVANIA TAX-FREE FUND
CROSS REFERENCE SHEET
<TABLE>
<CAPTION>
Form N-1A
Item Number Location in Prospectus
<S> <C> <C>
Item 1. Cover Page .............................. Cover Page
Item 2. Synopsis ................................ Not Applicable
Item 3. Condensed Financial Information ......... Financial Highlights
Item 4. General Description of Registrant ....... Investment Objective; Investment
Limitations; Investment Policies;
General Information
Item 5. Management of the Fund .................. Management of the Fund;
Investment Adviser
Item 6. Capital Stock and Other Securities ...... Opening an Account and Purchasing
Shares; Selling Your Shares; The
Share Price of Each Portfolio; Dividends,
Capital Gains and Taxes; General
Information
Cover Page; Opening an Account and
Item 7. Purchase of Securities Being Offered .... Purchasing Shares
Item 8. Redemption or Repurchase ................ Selling Your Shares
Item 9. Pending Legal Proceedings ............... Not Applicable
Form N-1A Location in Statement
Item Number of Additional Information
Item 10. Cover Page .............................. Cover Page
Item 11. Table of Contents ....................... Cover Page
Item 12. General Information and History ......... Management of the Fund
Item 13. Investment Objective and Policies ....... Investment Limitations; Investment
Policies
Item 14. Management of the Fund .................. Management of the Fund;
Investment Management
Item 15. Control Persons and Principal Holders of
Securities .............................. Management of the Fund
Item 16. Investment Advisory and Other Services .. Management of the Fund;
Investment Management
Item 17. Brokerage Allocation .................... Not Applicable
Item 18. Capital Stock and Other Securities ...... Financial Statements
Item 19. Purchase, Redemption and Pricing of
Securities Being Offered ................ Purchase of Shares; Redemption of
Shares
Item 20. Tax Status .............................. Appendix
Item 21. Underwriters ............................ Not Applicable
Item 22. Calculations of Yield Quotations of
Money Market Fund ....................... Calculation of Yield
Item 23. Financial Statements .................... Financial Statements
</TABLE>
<PAGE>
===============================================================================
Vanguard
PENNSYLVANIA
TAX-FREEE FUND A Member of The Vanguard Group
===============================================================================
PROSPECTUS-March 29, 1996
- -----------------------------------------------------------------------------
NEW ACCOUNT INFORMATION: Investor Information Department-1-800-662-7447 (SHIP)
- ------------------------------------------------------------------------------
SHAREHOLDER ACCOUNT SERVICES: Client Services Department-1-800-662-2739 (CREW)
- --------------------------------------------------------------------------------
INVESTMENT
OBJECTIVE &
POLICIES Vanguard Pennsylvania Tax-Free Fund (the "Fund") is an
open-end non- diversified investment company that 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 securities 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 policies. The
Portfolios are available only to Pennsylvania residents. The
Money Market Portfolio seeks to maintain, but does not
guarantee, a constant net asset value of $1.00 per share.
Although the Money Market Portfolio invests in high-quality
instruments, an investment in the Portfolio is neither
insured nor guaranteed by any agency of the U.S. Government,
including the FDIC.
- --------------------------------------------------------------------------------
OPENING AN
ACCOUNT Please complete and return the Account Registration Form. If
you need assistance in completing this Form, please call the
Investor Information Department, 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 $1,000 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, administrative, and
distribution services.
- --------------------------------------------------------------------------------
ABOUT THIS
PROSPECTUS This Prospectus is designed to set forth concisely the
information you should know about the Fund before 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 Commission. This Statement is dated
March 29, 1996 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
Department.
- --------------------------------------------------------------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page Page
<S> <C> <C> <C>
Fund Expenses .............................. 2 Dividends, Capital Gains and Taxes ......... 18
Financial Highlights ....................... 2 The Share Price of Each
Yield and Total Return ..................... 4 Portfolio ................................ 20
FUND INFORMATION General Information ........................ 22
Investment Objective ....................... 4 SHAREHOLDER GUIDE
Investment Policies ........................ 5 Opening an Account and
Investment Risks ........................... 7 Purchasing Shares ........................ 23
Who Should Invest .......................... 10 When Your Account Will Be Credited ......... 26
How to Compare Tax-Free and Taxable Yields . 10 Selling Your Shares ........................ 27
Implementation of Policies ................. 11 Exchanging Your Shares ..................... 30
Investment Limitations ..................... 16 Important Information About Telephone
Management of the Fund ..................... 17 Transactions ............................. 31
Investment Adviser ......................... 17 Transferring Registration .................. 32
Other Vanguard Services .................... 32
</TABLE>
- ----------------------------------------------------------------------------
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
ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL
OFFENSE.
- -----------------------------------------------------------------------------
<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 1995 fiscal
year.
Money Insured
Market Long-Term
Shareholder Transaction Expenses Portfolio Portfolio
- --------------------------------------------------------------------------------
Sales Load Imposed on Purchases .... None None
Sales Load Imposed on Reinvested
Dividends ........................... None None
Redemption Fees* ................... None None
Exchange Fees ...................... None None
Money Insured
Market Long-Term
Annual Fund Operating Expenses Portfolio Portfolio
- --------------------------------------------------------------------------------
Management & Administrative Expenses ... 0.15% 0.16%
Investment Advisory Expenses ........... 0.01 0.01
12b-1 Fees ............................. None None
Other Expenses .........................
Distribution Costs .................... 0.03% 0.02%
Miscellaneous Expenses ................ 0.01 0.01
Fund Insurance ........................ None 0.00
----------- -----------
Total Other Expenses ................... 0.04% 0.03%
----------- -----------
Total Operating Expenses .......... 0.20% 0.20%
=========== ===========
*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.
1 Year 3 Years 5 Years 10 Years
-------- --------- --------- ----------
Money Market Portfolio .... $2 $6 $11 $26
Insured Long-Term Portfolio $2 $6 $11 $26
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.
- --------------------------------------------------------------------------------
FINANCIAL
HIGHLIGHTS The following financial highlights for a share outstanding
throughout each period insofar as they relate to each of the
five years in the period ended November 30, 1995, 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, together with the
remaining portions of the Fund's 1995 Annual Report to
Shareholders, 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 1995 Annual Report to Shareholders. The Fund's
1995 Annual Report to Shareholders, which may be obtained
without charge by writing to the Fund or by calling our
Investor Information Department at 1-800-662-7447.
2
<PAGE>
<TABLE>
<CAPTION>
-------------------------------
MONEY MARKET PORTFOLIO
-------------------------------
Year Ended November 30,
-------------------------------
1995 1994 1993
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net Asset Value, Beginning of Period ................ $1.00 $1.00 $1.00
------ ------ ------
Investment Operations ...............................
Net Investment Income ............................. .036 .025 .024
Net Realized and Unrealized Gain (Loss) on
Investments .................................... -- -- --
------ ------ ------
Total from Investment Operations ............... .036 .025 .024
- ---------------------------------------------------------------------------------------
Distributions .......................................
Dividends from Net Investment Income ..............(.036) (.025) (.024)
Distributions from Realized Capital Gains ......... -- -- --
------ ------ ------
Total Distributions ............................(0.36) (.025) (.024)
- ---------------------------------------------------------------------------------------
Net Asset Value, End of Period ...................... $1.00 $1.00 $1.00
=======================================================================================
Total Return ........................................ 3.69% 2.57% 2.38%
=======================================================================================
Ratios/Supplemental Data ............................
Net Assets, End of Period (Millions) ................$1,200 $1,105 $935
Ratio of Expenses to Average Net Assets ............. .20% .20% .20%
Ratio of Net Investment Income to Average Net Assets 3.62% 2.55% 2.35%
Portfolio Turnover Rate ............................. N/A N/A N/A
</TABLE>
(RESTUBBED TABLE CONTINUED FROM ABOVE)
<TABLE>
<CAPTION>
----------------------------------------
MONEY MARKET PORTFOLIO
---------------------------------------- June 13**
Year Ended November 30, to
---------------------------------------- Nov. 30,
1992 1991 1990 1989 1988
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Period ................ $1.00 $1.00 $1.00 $1.00 $1.00
-------- -------- -------- -------- -----------
Investment Operations ...............................
Net Investment Income ............................. .029 .045 .057 .062 .025
Net Realized and Unrealized Gain (Loss) on
Investments .................................... -- -- -- -- --
-------- -------- -------- -------- -----------
Total from Investment Operations ............... .029 .045 .057 .062 .025
- -----------------------------------------------------------------------------------------------------------------
Distributions .......................................
Dividends from Net Investment Income .............. (.029) (.045) (.057) (.062) (.025)
Distributions from Realized Capital Gains ......... -- -- -- -- --
-------- -------- -------- -------- -----------
Total Distributions ............................ (.029) (.045) (.057) (.062) (.025)
- -----------------------------------------------------------------------------------------------------------------
Net Asset Value, End of Period ...................... $1.00 $1.00 $1.00 $1.00 $1.00
=================================================================================================================
Total Return ........................................ 2.96% 4.59% 5.85% 6.38% 2.54%
=================================================================================================================
Ratios/Supplemental Data ............................
Net Assets, End of Period (Millions) ................ $782 $818 $730 $448 $173
Ratio of Expenses to Average Net Assets ............. .24% .24% .23% .23% .33%*
Ratio of Net Investment Income to Average Net Assets 2.93% 4.48% 5.68% 6.19% 5.59%*
Portfolio Turnover Rate ............................. N/A N/A N/A N/A N/A
</TABLE>
*Annualized.
**Commencement of operations.
<PAGE>
----------------------------------
INSURED LONG-TERM PORTFOLIO
----------------------------------
Year Ended November 30,
----------------------------------
1995 1994 1993
- -------------------------------------------------------------------------------
Net Asset Value, Beginning of Period ..... $10.07 $11.36 $10.96
------- ------- -------
Investment Operations ....................
Net Investment Income .................. .612 .625 .631
Net Realized and Unrealized Gain (Loss)
on Investments ...................... 1.210 (1.211) .624
------- ------- -------
Total from Investment Operations .... 1.822 (.586) 1.255
------- ------- -------
- -------------------------------------------------------------------------------
Distributions ............................
Dividends from Net Investment Income ... (.612) (.625) (.631)
Distributions from Realized Capital
Gains ............................... -- (.079) (.224)
------- ------- -------
Total Distributions ................. (.612) (.704) (.855)
- -------------------------------------------------------------------------------
Net Asset Value, End of Period ...........$ 11.28 $ 10.07 $ 11.36
===============================================================================
Total Return ............................. 18.48% (5.44)% 11.90%
===============================================================================
Ratios/Supplemental Data .................
Net Assets, End of Period (Millions) ......$ 1,569 $ 1,299 $ 1,496
Ratio of Expenses to Average Net Assets .20% .20% .20%
Ratio of Net Investment Income to
Average Net Assets .................... 5.63% 5.76% 5.61%
Portfolio Turnover Rate ................... 12% 16% 14%
(RESTUBBED TABLE CONTINUED FROM ABOVE)
<TABLE>
<CAPTION>
-----------------------------------------------------------------
INSURED LONG-TERM PORTFOLIO
----------------------------------------------------------------- April 7**
Year Ended November 30, to
----------------------------------------------------------------- Nov. 30,
1992 1991 1990 1989 1988 1987 1986
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Period ..... $10.47 $10.19 $10.16 $9.70 $9.28 $10.30 $10.00
-------- -------- -------- -------- -------- --------- -----------
Investment Operations ....................
Net Investment Income .................. .664 .667 .679 .687 .670 .678 .410
Net Realized and Unrealized Gain (Loss)
on Investments ...................... .520 .286 .030 .460 .420 (1.020) .300
-------- -------- -------- -------- -------- --------- -----------
Total from Investment Operations .... 1.184 .953 .709 1.147 1.090 (.342) .710
-------- -------- -------- -------- -------- --------- -----------
- ------------------------------------------------------------------------------------------------------------------------------
Distributions ............................
Dividends from Net Investment Income ... (.664) (.667) (.679) (.687) (.670) (.678) (.410)
Distributions from Realized Capital
Gains ............................... (.030) (.006) -- -- -- -- --
-------- -------- -------- -------- -------- --------- -----------
Total Distributions ................. (.694) (.673) (.679) (.687) (.670) (.678) (.410)
- ------------------------------------------------------------------------------------------------------------------------------
Net Asset Value, End of Period ........... $10.96 $10.47 $10.19 $10.16 $9.70 $9.28 $10.30
==============================================================================================================================
Total Return ............................. 11.65% 9.65% 7.27% 12.16% 12.01% (3.33)% 7.65%
==============================================================================================================================
Ratios/Supplemental Data .................
Net Assets, End of Period (Millions) ... $1,130 $828 $556 $416 $270 $194 $122
Ratio of Expenses to Average Net Assets .24%+ .25%+ .25%+ .26%+ .33%+ .31%+ .33%+*
Ratio of Net Investment Income to
Average Net Assets .................. 6.17% 6.46% 6.77% 6.87% 6.95% 7.06% 6.65%*
Portfolio Turnover Rate ................ 17% 2% 9% 8% 3% 15% 0%
</TABLE>
*Annualized.
+Insurance expense represents .01%, .01%, .02%, .03%, .04%, .05%, and .05%,
respectively.
**Commencement of operations.
- -------------------------------------------------------------------------------
3
<PAGE>
YIELD AND
TOTAL RETURN From time to time a Portfolio of the Fund may advertise its
yield and total return. Both yield and total return figures
are based on historical earnings and are not intended to
indicate 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 Portfolio (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 distributions.
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 expenses and all recurring and nonrecurring
charges that have been applied to all shareholder accounts.
The yield calculation 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
Portfolio reflects the income earned by a hypothetical
account in the Portfolio during a seven-day period,
expressed as an annual percentage rate. The "effective
yield" of the 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
differ 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 an investor's
account or the yield reported in the Fund's Annual Report to
Shareholders.
- --------------------------------------------------------------------------------
INVESTMENT
OBJECTIVE The Fund consists of the Pennsylvania Money Market Portfolio
and the Pennsylvania Insured Long-Term Portfolio, each of
The Fund seeks to which pursues a distinct investment objective:
provide income that
is exempt from
federal and o The objective of the Pennsylvania Money Market Portfolio
Pennsylvania income is to provide investors with income that is exempt from
taxes both federal and Pennsylvania personal income taxes. The
Portfolio also seeks to maintain, but does not guarantee,
a constant net asset value of $1.00 per share. An
investment in the Portfolio is neither insured nor
guaranteed by the U.S. Government.
o The objective of the Pennsylvania Insured Long-Term
Portfolio is to provide investors with a high level of
income that is exempt from federal and Pennsylvania
personal income taxes.
The two Portfolios of the Fund are available only to
investors who reside in Pennsylvania. There is no assurance
that either Portfolio of the Fund will achieve its stated
objective.
4
<PAGE>
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
POLICIES Each Portfolio of the Fund will invest at least 80% of its
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 seek to provide interest
income that is exempt from both federal and Pennsylvania
personal income taxes. The Pennsylvania municipal 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 Market
Portfolio will invest
in short-term
Pennsylvania
municipal
securities Under normal circumstances, the Pennsylvania Money Market
Portfolio will invest at least 80% of its net assets in the
following high quality, short-term Pennsylvania municipal
securities:
o Municipal notes and variable rate demand instruments,
including derivative securities, rated MIG-1 or VMIG-1, or
P-1 by Moody's Investors Service, Inc. ("Moody's") or
SP-1+, SP-1, A-1+, or A-1 by Standard & Poor's Corporation
("Standard & Poor's");
o Tax-exempt commercial paper rated P-1 by ("Standard &
Poor's"); Moody's or A-1+ or A-1 by Standard & Poor's;
o Municipal bonds, including derivative Poor's; securities,
with an effective maturity of 13 months or less rated a
minimum of Aa by Moody's or AA by Standard & Poor's; and
o Unrated municipal notes considered by the and 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 addition, up to 10% of the Pennsylvania Poor's. Money
Market Portfolio's net assets may be invested in
"restricted" money market securities, which are not freely
marketable or which are subject to restrictions on
disposition under the Securities Act of 1933.
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,
under certain circumstances, such as a temporary decline in
the issuance of Pennsylvania obligations, the Portfolio may
invest up to 20% of its assets in the following: short-term
municipal securities issued outside of Pennsylvania (the
5
<PAGE>
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 taxes).
Subject to the same 20% limit, the Portfolio is also
authorized to invest in short- term Pennsylvania AMT bonds.
The income from Pennsylvania AMT bonds is exempt from
regular federal and Pennsylvania income taxes, but may be a
tax preference item for purposes of the federal AMT. 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
Pennsylvania Money Market Portfolio will seek to avoid such
holdings in an effort to provide income that is fully exempt
from federal and Pennsylvania personal income taxes.
The Insured Long
Term Portfolio
invests in insured
Pennsylvania
municipal
securities Under normal circumstances, the Pennsylvania Insured
Long-Term Portfolio will invest at least 80% of its net
assets in insured Pennsylvania municipal securities.
Insured municipal bonds are those in which scheduled
payments of interest and principal are guaranteed by a
private (non-governmental) insurance company. The insurance
feature does 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
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 dollarweighted 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
Pennsylvania municipal obligations. However, under certain
circumstances, the Portfolio may invest up to 20% of its
assets in any combination of the following securities:
o Uninsured, long-term Pennsylvania municipal securities
rated a minimum of Aa by Moody's or AA by Standard &
Poor's;
o Uninsured, short-term municipal securities, issued in
Pennsylvania or in other states, with the same quality
standards that apply for the Pennsylvania Money Market
Portfolio;
o Certain taxable fixed-income securities, including U.S.
Government securities; and
o Certain tax-exempt municipal securities issued by other
states that have similar characteristics to the securities
typically purchased by the Portfolio.
6
<PAGE>
In such cases, a portion of the Portfolio's income may be
subject to Pennsylvania income taxes, federal income taxes,
or both. (See page ).
Subject to the same 20% limit, the Portfolio is also
authorized to invest in Pennsylvania AMT bonds. The income
from Pennsylvania AMT bonds is exempt from federal and
Pennsylvania income taxes, but may be a tax preference 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
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
will iversify
its holdings Although the Fund is organized as a non-diversified
investment company, each Portfolio of the Fund intends to
diversify its holdings of Pennsylvania municipal securities
by complying with Subchapter M of the Internal Revenue Code
(the "Code"). In part, Subchapter M requires that, at the
close of each quarter of the taxable year, those issuers
which represent more than 5% of each Portfolio's assets be
limited in aggregate to 50% of each Portfolio, and that no
one issuer exceeds 25% of a Portfolio's total assets. As of
November 30, 1995, the Pennsylvania Money Market Portfolio
held securities of 44 issuers, with the largest holding
representing 6.3% of the Portfolio's assets; the
Pennsylvania Insured Long- Term Portfolio held securities of
114 issuers, with the largest holding representing 2.7% 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
approval.
The Fund is responsible for voting the shares of all
securities it holds.
The investment policies described above are not fundamental
and so may be changed by the Board of Trustees without
shareholder approval.
- -------------------------------------------------------------------------------
INVESTMENT
RISKS As mutual funds investing in municipal securities, both
Portfolios of the Fund are subject to interest rate, credit,
The Fund is subject call, income and manager risk. However, the risk
to interest rate, characteristics of the two Portfolios vary because of
credit, call, differing maturity and credit quality standards.
income and manager
risk Interest rate risk is the potential for fluctuations in the
price of a Portfolio's investments due to changes in
interest 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 addition, for a given change in interest
rates, longer-maturity bonds exhibit greater price
fluctuations than shorter-maturity bonds. To compensate
investors for this risk, longer-maturity bonds generally
offer higher yields than shorter-maturity bonds, other
7
<PAGE>
factors, including credit quality, being equal. Interest
rate risk may be increased or decreased when a portfolio
purchases derivative Pennsylvania municipal securities. Such
derivative securities rely on sophisticated interest rate
calculation mechanisms. For certain types of derivative
bonds, the magnitude of increases and decreases 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
Portfolio. 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 maturity, being equal.
Call risk is the possibility that, during periods of falling
interest rates, a municipal security with a high stated
interest rate will be prepaid (or "called") prior to its
expected maturity date. As a result, a Portfolio will be
required to invest the unanticipated proceeds at lower
interest rates, and the Portfolio's income may decline. Call
provisions are most common for intermediate- and long-term
municipal bonds.
Income risk is the potential for a decline in a Portfolio's
income due to falling market interest rates. Because a
Portfolio's income is based on interest rates, which can
fluctuate substantially over short periods, income risk is
expected to vary from Portfolio to Portfolio
The Fund is subject
to manager risk Finally, the investment adviser manages the Fund's
Portfolios according to the traditional methods of "active"
investment management, which involve the buying and selling
of securities 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,
interest rate risk for the Pennsylvania Money Market
Portfolio is expected to be negligible. The Money Market
Portfolio is expected to maintain a stable share price of
$1.00. In contrast, interest rate risk for the Pennsylvania
Insured Long-Term Portfolio may be high. The average
weighted maturity of the Insured Long-Term Portfolio will
generally exceed 15 years, meaning that the Portfolio's
share price will fluctuate, 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
single bond with the same yield and maturity characteristics
as the Insured Long-Term Portfolio on December 29, 1995,
assuming a 1% and 2% point increase or decrease in interest
rates:
8
<PAGE>
<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 4.94% 9.2 years $920 $1,067 $856 $1,150
</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 illustrative 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
expected to be
low Credit risk depends on the average quality of a Portfolio's
underlying securities and its degree of diversification. The
Pennsylvania Money Market Portfolio invests primarily in
high-quality, short-term Pennsylvania municipal securities,
and the Pennsylvania Insured Long-Term Portfolio invests
primarily 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
investments 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 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 Code. (See "Investment Policies" for a description of
the requirements of Subchapter M.) In addition, the
high-quality instruments held by the Pennsylvania Money
Market Portfolio and the use of municipal bond insurance in
the Pennsylvania Insured Long-Term Portfolio should minimize
the credit risk associated with the Fund.
As of November 30, 1995, the top ten portfolio holdings,
based on market value, represented 54.2% of the Money Market
Portfolio's net assets and 18.7% 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:
Credit Interest Income Prepayment/
Portfolio Risk Rate Risk Risk Call Risk
--------------------- ------------ ------------- --------- -----------
Money Market Low Low High Very Low
Insured Long-Term Very Low High Low Medium
--------------------- ------------ ------------- --------- -----------
9
<PAGE>
WHO SHOULD
INVEST The Fund is intended for Pennsylvania residents seeking
income that is exempt from federal and Pennsylvania personal
Pennsylvania income taxes. As a rule, tax-free income is attractive to
residents seeking investors in high federal tax brackets. You can determine
tax-exempt income whether tax-exempt or taxable income is more attractive in
your own case by comparing a Portfolio's tax-free yield with
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
investors who are seeking a stable share price and minimal
credit risk. The yield on the Portfolio is expected to
fluctuate 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
durable streams of income and who can tolerate sometimes
sharp fluctuations in share price in pursuit of their income
objectives. 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.
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 movement. Investors who
engage in an excessive amount of account activity generate
additional costs that are borne by all of the Fund's
shareholders. In order to minimize such costs, the Fund has
adopted the following policies. 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 portfolio management either
because of the timing of the investment or previous
excessive trading by the investor. Additionally, the Fund
has adopted exchange privilege limitations as described in
the section "Exchange Privilege Limitations." Finally, the
Fund reserves the right to suspend the offering of its
shares.
- -------------------------------------------------------------------------------
HOW TO COMPARE
TAX-FREE AND
TAXABLE YIELDS Before choosing a specific tax-exempt investment, such as a
Portfolio of the Fund, you should determine if you would be
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.
10
<PAGE>
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
calculated 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%
2. Calculate your taxable equivalent yield. The taxable
equivalent yield for a Portfolio is based upon the
Portfolio'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
taxable yield from a comparable investment (e.g., a taxable
bond fund of comparable maturity and credit quality).
- -------------------------------------------------------------------------------
IMPLEMENTATION
OF POLICIES The Fund's adviser uses a variety of investment vehicles to
achieve the objective of the Fund. Each Portfolio of the
Fund invests principally in tax-exempt Pennsylvania
The Fund invests municipal securities, which are debt obligations issued by
in municipal Pennsylvania state and local governments and public
bonds, notes and financing authorities (and by certain U.S. territories) that
securities derived provide interest income that is exempt from federal and
from municipal Pennsylvania personal income taxes. Municipal securities
bonds and notes include both municipal bonds (those securities
11
<PAGE>
with maturities of five years or more) municipal notes
(those securities with maturities of less than five years)
and derivative securities (those securities in which a
maturity may have been shortened by a demand 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 municipal 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
issuer'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. Industrial development bonds are ordinarily
dependent on the credit quality of a private company.
Municipal notes are issued to meet the short-term funding
requirements of local, regional and state governments.
Municipal notes include tax anticipation notes, bond
anticipation notes, revenue anticipation notes, tax and
revenue anticipation 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 accrued interest upon a specified
number of days' notice.
The Fund may invest
in AMT bonds Each Portfolio of the Fund is authorized to invest up to 20%
of its assets in so-called "AMT" bonds. AMT bonds are
tax-exempt "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
preference item for purposes of the federal AMT. The
alternative minimum tax is a special separate tax that
applies to a limited number of taxpayers who have certain
adjustments to income or tax preference items.
The Fund may invest
in Market Discount
bonds The Fund may invest in "Market Discount" bonds when, in the
opinion of the Fund's adviser, the investment will be
advantageous to the Fund's shareholders. A Market Discount
bond is 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, disposition of a Market Discount bond will
result in taxable ordinary income to the extent of any gain
realized.
12
<PAGE>
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
expects that the purchase of these investments on an
after-tax basis will enhance the Fund's total return.
Three types of
insurance may be
used in the Insured
Long-Term
Portfolio To provide an added level of credit protection, the
Pennsylvania Insured Long- Term Portfolio uses three types
of insurance: new issue, mutual fund and secondary market
insurance. A new issue insurance policy is purchased by a
bond issuer who wishes to increase the credit rating of a
security. By paying a premium and meeting the insurer's
underwriting standards, the bond issuer is able to obtain a
high credit rating for the security (usually Aaa from
Moody's or AAA from Standard & 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
specific 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
investor (such as the Insured Long-Term Portfolio)
subsequent to the bond's original issuance and generally
insures a particular bond for the remainder of its term. The
Portfolio may purchase bonds that have already been insured
under a secondary 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 at the time the
insurance contract was obtained. The purchase of insurance
from such companies will have the effect of making the
insured bonds equivalent in quality to AAA-rated bonds.
The Insured Long-
Term Portfolio may
report an effective
average weighted
maturity Each Portfolio of the Fund observes strict maturity
guidelines as set forth in detail under "Investment
Policies." These maturity standards are specified in terms
of a Portfolio's average weighted maturity. From time to
time, however, the Fund may also report an effective average
weighted maturity for the Insured Long-Term Portfolio, which
reflects, among other items, the likelihood that a municipal
bond or 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.
13
<PAGE>
A Portfolio's effective average weighted maturity will be
influenced 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 securities may be subject to call (redemption)
prior to their stated maturity. As a result, reflecting this
increased 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 pages 5 and 6, each Portfolio will
not invest in securities other than municipal bonds, except
that each Portfolio may make temporary investments for
defensive purposes 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 deposits; (b) investment companies investing
in such securities which have investment objectives
consistent with those of the Portfolio to the extent
permitted by the Investment Company Act of 1940; and (c) any
such securities or municipal bonds subject to repurchase
agreements.
The Fund may
purchase
when-issued
securities Each Portfolio may purchase tax-exempt securities on a
"when-issued" basis. In buying "when-issued" securities, a
Portfolio commits to buy securities at a certain price even
though the securities may not be delivered for a certain
period. 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 lend
its securities Each Portfolio may lend its investment securities on either
a short-term or long- term basis to qualified institutional
investors for the purpose of realizing additional net
investment income. Loans of securities by a Portfolio will
be collateralized 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 lending 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 investment objective.
The Fund may invest
in municipal lease
obligations Each Portfolio may purchase municipal lease obligations,
which are securities issued by state and local governments
to acquire land, equipment and facilities. These obligations
typically are not backed by the issuing municipality's full
authority to assess taxes to meet its debt obligations. If
the issuing authority fails to make the appropriations
necessary to cover lease payments, then the lease may
terminate. In certain circumstances, the issuer could
default on the lease obligation and thereby cause a loss to
investors. Also, in certain circumstances, such as a default
or a termination of the lease, or all or a portion of the
payments attributable to the lease may be taxable as
ordinary income.
Derivative
Investing Derivatives are instruments whose values are linked to or
derived from an underlying security or index. The most
common and conventional types of derivative securities are
futures and options.
14
<PAGE>
The Insured
Long-Term Portfolio
may invest in
derivative
securities The Insured Long-Term Portfolio may invest in conventional
derivative securities, including futures contracts and
options, but only to a limited extent. The Portfolio may
enter into futures contracts provided that not more than 5%
of its assets are required as a futures contract deposit; in
addition, the Portfolio may enter into futures contracts and
options transactions only to the extent that obligations
under such contracts or transactions represent not more than
20% of the Portfolio's assets.
Futures contracts and options may be used for several common
fund management strategies: to maintain cash reserves while
simulating full investment, to facilitate trading, to reduce
transaction costs, or to seek higher investment returns when
a specific futures contract is priced more attractively than
other futures contracts or the underlying security or index.
The Fund may not use futures contracts or options
transactions to leverage its assets.
For example, in order to remain fully invested in bonds
while maintaining liquidity to meet potential shareholder
redemptions, 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 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 investing in bonds directly, it is expected
that the use of futures contracts and options may reduce the
Portfolio's total transaction costs.
The Portfolio may use futures contracts for bona fide
"hedging" purposes. In executing a hedge, a manager sells,
for example, municipal bond futures contracts to protect
against a decline in the bond market. If the market drops,
the value of the futures position will rise, thereby
offsetting the decline in value of the portfolio's bond
holdings.
The Portfolio may invest in partnerships and grantor trust
derivative products. However, prior to the purchase of such
security, a determination must be made by the Portfolio that
the inherent risk of the partnership or grantor trust
derivative product is minimal.
Futures contracts
and options pose
risks The primary risks associated with the use of futures
contracts and options are: (i) imperfect correlation between
the change in market value of the bonds held by a Portfolio
and the prices of futures contracts and options; and (ii)
possible lack of a liquid secondary market for a futures
contract and the resulting inability to close a futures
position prior to its maturity date. The risk of imperfect
correlation will be minimized by investing in those
contracts whose price fluctuations are expected to resemble
those of the Portfolio's underlying securities. The risk
that the Portfolio will be unable to close out a futures
position will be minimized by entering into such
transactions on a national exchange with an active and
liquid secondary market.
The risk of loss in trading futures contracts in some
strategies can be substantial, due both to the low margin
deposits required and the extremely high degree of
15
<PAGE>
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, the Portfolio
will segregate cash or cash equivalents in the amount of the
underlying obligation.
Partnerships and
grantor trusts pose
certain risks The primary risks associated with partnerships and grantor
trust derivative products are (i) the possibility of a tax
ruling which affects the status of the state or federal
opinions which are necessary to support the issuance of the
derivative; (ii) the possibility that the tender option on a
security could be withdrawn upon the occurrence of certain
events; and (iii) the possible lack of a liquid secondary
market for the securities. The Portfolio will attempt to
minimize the risks of partnership and grantor trust
derivative products by carefully selecting which securities
to purchase and by constantly monitoring securities held by
the Portfolio.
- --------------------------------------------------------------------------------
INVESTMENT
LIMITATIONS The Fund has adopted certain limitations designed to reduce
its exposure to specific situations. These limitations
The Fund has include the following:
adopted
certain fundamental a) The Pennsylvania Insured Long-Term Portfolio will invest
limitations a minimum of 80% of its net assets in insured municipal
bonds, 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."
b) The Pennsylvania Money Market Portfolio will invest a
minimum of 80% of its net assets in short-term municipal
securities, 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
issuers which represent more than 5% of a Portfolio's
assets 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 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
Portfolio's total assets. For the purposes of this
limitation, identification of the issuer will be based on
a determination 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.
16
<PAGE>
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 majority of the Fund's
shareholders.
- -------------------------------------------------------------------------------
MANAGEMENT
OF THE FUND The Fund is a member of The Vanguard Group of Investment
Companies, a family of more than 30 investment companies
with more than 90 distinct investment portfolios and total
Vanguard assets in excess of $190 billion. Through their
administers and jointly-owned subsidiary, The Vanguard Group, Inc.
distributes the ("Vanguard"), the Fund and the other funds in the Group
Fund obtain at cost virtually all of their corporate management,
administrative, shareholder accounting 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 1995, the average expense
ratio (annual costs including advisory fees divided by total
net assets) for the Vanguard funds amounted to approximately
.31% compared to an average of 1.11% 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
Information.
Vanguard employs a supporting staff of management and
administrative personnel 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 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 no-load
basis (i.e., there are no sales commissions or 12b-1 fees).
However, each fund bears its share of the Group's
distribution costs.
- -------------------------------------------------------------------------------
INVESTMENT
ADVISER The two Portfolios of the Fund receive all investment
advisory services on an at-cost basis from Vanguard's Fixed
Income Group. The Group provides investment advisory
Vanguard manages services to more than 40 Vanguard money market and bond
the Fund's portfolios, both taxable and tax-exempt. Total assets under
investments management by Vanguard's Fixed Income Group were
approximately $66 billion as of December 31, 1995. The Fixed
Income Group is supervised by the Officers of the Fund. Ian
A. MacKinnon, Senior Vice President of Vanguard, has been in
charge of the Group since its inception in 1981.
17
<PAGE>
o Reid Smith, a Principal 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
reinvestment of the assets of the Fund's Portfolios and
continuously reviews, supervises and administers each
Portfolio's investment program, subject to the maturity and
quality standards specified in this Prospectus, and
supplemental guidelines approved 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 between different
fixed-income securities and money market instruments; and
(c) actual or anticipated movements in the general level of
interest rates.
Vanguard's Fixed Income Group places all orders for
purchases and sales of portfolio securities. Purchases of
portfolio securities are made either directly from the
issuer or from municipal securities dealers. The investment
management staff may sell portfolio securities prior to
their maturity if circumstances 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 Portfolio 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, CAPITAL
GAINS AND TAXES Dividends consisting of virtually all of the ordinary income
of each Portfolio are declared daily and are payable to
shareholders of record at the close of the previous business
The Fund pays day. Such dividends are paid on the first business day of
month-end each month. Capital gains distributions, if any, will be
dividends made annually.
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
requirements of the Tax Reform Act of 1986, each Portfolio
may declare special year-end dividend and capital gains
distributions 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 be
exempt from federal
and Pennsylvania
income taxes Each Portfolio of the Fund intends to continue to qualify
for taxation as a "regulated investment company" under the
Internal Revenue Code so that each Portfolio will not be
subject to federal income tax to the extent its income is
distributed to shareholders. In addition, each Portfolio
intends to invest 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
18
<PAGE>
gross income for federal tax purposes. The Revenue
Reconciliation Act enacted during 1993 provides that market
discount on tax-exempt bonds purchased after April 30, 1993
must be taxed as ordinary income. Accordingly, to the extent
that the Fund purchases such discounted securities, taxable
income may result. Furthermore, each Portfolio expects to
invest substantially all of its assets 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 income taxes.
Net long-term capital gains realized by a Portfolio from the
sale of securities will be distributed as taxable capital
gains distributions for federal income tax purposes. Any
short-term capital gains or any taxable interest income will
be distributed as a taxable ordinary dividend distribution
for federal income tax purposes. In general, such taxable
income distributions 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 Pennsylvania 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
"Investment Policies.") However, were a Portfolio to invest
in such bonds, all or a portion of the Portfolio's
dividends, while exempt from the regular federal income tax,
would be a tax preference item for purposes of the federal
alternative minimum tax.
A capital gain or loss
may be realized upon
exchange or
redemption A sale of shares in the Insured Long-Term Portfolio is a
taxable event and may result in a capital gain or loss. A
capital gain or loss may be realized from an ordinary
redemption of shares, a checkwriting redemption, or an
exchange of shares between two mutual funds (or two
portfolios of a mutual 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
will generally be subject to state and local taxes.
The Fund is required to withhold 31% of any taxable
dividends, capital gains distributions, and redemptions paid
to shareholders who have not complied with IRS taxpayer
identification regulations. You may avoid this withholding
requirement 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,
total tax-exempt income, including any tax-exempt dividend
income from Portfolios of the Fund, is used to calculate the
taxable portion of Social Security benefits.
19
<PAGE>
Shares of the Portfolio are not subject to Pennsylvania
county personal property taxes. Further, distributions from
the Portfolios will be exempt from the Philadelphia School
District investment net income tax to the extent that such
distributions are derived from interest on Pennsylvania
obligations, or to the extent that such distributions are
designated as capital gain dividends for federal income tax
purposes.
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
investment in the Fund.
- -------------------------------------------------------------------------------
THE SHARE
PRICE OF EACH
PORTFOLIO The share price or "net asset value" per share of each
Portfolio is determined daily by dividing the total value of
the investments and other assets of each Portfolio, less any
liabilities, by the total outstanding shares of such
Portfolio.
Pennsylvania Money Market Portfolio. For the purpose of
calculating 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 instrument at its 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 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
Pennsylvania Money Market Portfolio's per share net asset
value at $1.00 is based on its election to operate under the
provisions 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 average portfolio maturity of 90 days or
less, purchase only instruments 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 Trustees to be of comparable
quality.
The Trustees have established procedures designed to
stabilize the net asset value per share, as computed for the
purposes 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 market 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
20
<PAGE>
price or quoted yield equivalent for such securities or for
securities of comparable 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 determined in good faith by the
Trustees.
In the event of a deviation of over 1/2 of 1% between a
Portfolio's net asset value based upon available market
quotations or market equivalents and $1.00 per share based
on amortized cost, the Trustees will promptly consider what
action, if any, should be taken. The Trustees will also take
such action as they deem appropriate to eliminate or to
reduce, to the extent reasonably practicable, any material
dilution 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,
selling instruments prior to maturity to realize capital
gains or losses or to shorten average maturity, withholding
dividends, paying distributions from capital or capital
gains, or utilizing a new asset value per share based upon
available market quotations.
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 the Portfolio 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 pricing 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 reviewed by the Officers of
the Fund under the general supervision of Trustees. There
are a number of pricing services available and the Trustees,
on the basis of on-going evaluation 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
valuation 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
newspapers under the heading of Vanguard.
- --------------------------------------------------------------------------------
21
<PAGE>
GENERAL
INFORMATION Vanguard Pennsylvania Tax-Free Fund is a Pennsylvania
business trust. 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 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,
distributions 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
applicable law. An annual meeting 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.
22
<PAGE>
SHAREHOLDER GUIDE
OPENING AN
ACCOUNT AND
PURCHASING
SHARES To open a new account, either by mail or by wire, simply
complete and return an Account Registration Form and any
required legal documentation. Please indicate the Portfolio
you 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 ($1,000 for Uniform
Gift/Transfer to Minors 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., corporations, associations,
other organizations, trusts or powers of attorney), please
call us to determine which additional forms you may need.
Each Portfolio's shares generally 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).
Purchase
Restrictions 1) 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 reserves the right to reject any specific purchase
(and exchange purchase) request. The Fund also reserves the
right to suspend the offering of shares for a period of
time.
2) Vanguard will not accept third-party checks to purchase
shares of the Fund. Please be sure your purchase check is
made payable to the Vanguard Group.
Additional
Investments Subsequent investments may be made by mail ($100 minimum per
Portfolio), wire ($1,000 minimum per Portfolio), exchange
from another Vanguard Fund account, or Vanguard Fund
Express.
------------------------------------------------------------
ADDITIONAL INVESTMENTS
NEW ACCOUNT TO EXISTING ACCOUNTS
Purchasing By Please include the amount of Additional investments
Mail Complete and your initial investment and should include the
sign the enclosed the name of the Portfolios you Invest-by-Mail remittance
Account have selected on the form attached to your
Registration Form registration form, make your Fund confirmation
check payable to The Vanguard statements. Please make
Group--(Portfolio Number). See your check payable to The
page 24 for appropriate Vanguard Group--(Portfolio
Portfolio number, and mail to Number). See page 24 for
appropriate Portfolio
Vanguard Financial Center number, write your
P.O. Box 2600 account number on your
Valley Forge, PA 19482 check and, using the
return envelope provided,
For express or Vanguard Financial Center mail to the address
registered mail, 455 Devon Park Drive indicated on the
send to: Wayne, PA 19087 Invest-by-Mail Form.
All written requests
should be mailed to one
of the addresses
indicated for new
accounts. Do not send
registered or express
mail to the post office
box address.
- -------------------------------------------------------------------------------
23
<PAGE>
VANGUARD PENNSYLVANIA TAX-FREE PORTFOLIOS:
Pennsylvania Money Market Portfolio--63
Pennsylvania Insured Long-Term Portfolio--77
-----------------------------------------------------------
Purchasing By Wire CORESTATES BANK, N.A.
Money should be ABA 031000011
wired to: CORESTATES NO. 0141 1274
ATTN VANGUARD
Before Wiring VANGUARD PENNSYLVANIA TAX-FREE FUND
Please contact Client NAME OF PORTFOLIO
Services ACCOUNT NUMBER
(1-800-662-2739) ACCOUNT REGISTRATION
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
Registration Form and mail it to the "New Account" address
above after 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
Exchange (from a
Vanguard account) You may open an account or purchase additional shares of the
Fund by making an exchange from an existing Vanguard Fund
account. Accounts opened by exchange will have the same
registration as the existing account. Please note: the Fund
reserves the right to reject any exchange purchase request.
For more information, please call our Client Services
Department at 1-800-662-2739.
- -------------------------------------------------------------------------------
Purchasing By
Fund Express The Fund Express Special Purchase option lets you move money
from your bank account to your Vanguard account on an "as
Special Purchase needed" basis. Or if you choose the Automatic Investment
and Automatic option, money will be moved automatically from your bank
Investment account to your Vanguard account on the schedule (monthly,
bimonthly [every other month], quarterly or yearly) you
select. 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
DISTRIBUTION
OPTION You must select one of three distribution options:
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. 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
distributions will be paid in cash.
You may change your option by calling our Client Services
Department (1-800- 662-2739).
24
<PAGE>
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 dividends 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. These distributions are made to all
Investors should shareholders who own Fund shares as of the distribution's
ask about the record date, regardless of how long the shares have been
timing of capital owned. Purchasing shares just prior to the record date could
gains and dividend have a significant impact on your tax liability for the
distributions year. For example, if you purchase shares immediately prior
before investing to the record date of a sizable capital gain, you will be
assessed taxes on the amount of the capital gain
distribution later paid even though you owned the Fund
shares for just a short period of time. (Taxes are due on
the distributions even if the capital gain is reinvested in
additional Fund shares.) While the total value of your
investment will be the same after the capital gain
distribution--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
potential distributions before investing. The Fund's annual
capital gains distribution normally occurs in December,
while income 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
INFORMATION The easiest way to establish optional Vanguard services on
your account is to select the options you desire when you
Establishing complete your Account Registration Form. If you wish to add
Optional Services shareholder options later, you may need to provide Vanguard
with additional information and a signature guarantee.
Please call our Client Services Department (1-800-662-2739)
for further assistance.
Signature
Guarantees For our mutual protection, we may require a signature
guarantee 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 guarantee cannot be provided by a notary public.
Certificates With the exception of the Money Market Portfolio, share
certificates will be issued upon request. If a certificate
is lost, you may incur an expense to replace it.
Broker-Dealer
Purchases If you purchase shares in Vanguard funds through a
registered broker-dealer or investment adviser, the
broker-dealer or adviser may charge a service fee.
25
<PAGE>
Cancelling Trades The Fund will not cancel any trade (e.g., a purchase,
exchange or redemption) believed to be authentic, received
in writing or by telephone, once the trade request has been
received.
Electronic
Prospectus
Delivery If you would prefer to receive a prospectus for the Fund or
any of the Vanguard Funds in an electronic format, please
call 1-800-231-7870 for additional information. If you elect
to do so, you may also receive a paper copy of the
prospectus, by calling 1-800-662-7447.
- -------------------------------------------------------------------------------
WHEN YOUR
ACCOUNT WILL
BE CREDITED The trade date is the date on which your account is
credited. It is generally the day on which the Fund receives
your investment 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 receipt of your check.
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
purchase 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
purchase 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
foreign check which has been drawn in U.S. dollars and has
been issued by a foreign bank with a U.S. correspondent
bank.
The name of the U.S. correspondent bank must be printed on
the face of the foreign check.
- -------------------------------------------------------------------------------
26
<PAGE>
SELLING YOUR
SHARES You may withdraw any portion of the funds in your account by
redeeming shares at any time. You generally may initiate a
request by writing or by telephoning. Your redemption
proceeds are normally 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 Writing
A Check You may withdraw funds from your account by writing a check
payable in the amount of $250 or more. When a check is
presented 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
account, 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)
2. The Fund does not allow an account to be is a taxable
event.
3. Vanguard cannot guarantee a stop payment closed through
the checkwriting option. on any check. If you wish to
reverse a stop payment order, you must do so in
4. Shares held in certificate form cannot be writing.
5. The Fund reserves the right to terminate redeemed using
the checkwriting option. or alter this service at any
time.
-----------------------------------------------------------
Selling By Mail Requests should be mailed 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, 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 Good Order means that the request includes the following:
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.
27
<PAGE>
5. Other supporting legal documentation that might be
required in the case of estates, corporations, trusts,
and certain other
6. Any certificates you are holding for the accounts.
account.
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
Telephone To sell shares by telephone, you or your pre-authorized
representative may call our Client Services Department at
1-800-662-2739. For telephone redemptions, you may have the
proceeds sent to you by mail or by wire. In addition to the
details, please see "Important Information About Telephone
Transactions."
By Mail: Telephone mail redemption is automatically
established on your account unless you indicate otherwise on
your Account Registration Form. You may redeem any amount by
calling Vanguard. The proceeds will be paid to the
registered shareholders and mailed to the address of record.
Please Note: As a protection against fraud, your telephone
mail redemption privilege will be suspended for 10 calendar
days following any expedited address change to your account.
An expedited address change is one that is made by
telephone, by Vanguard Online or, in writing, without the
signatures of all account owners.
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
Registration Form. If you do not presently have telephone
wire redemption and wish to establish it, please contact our
Client Services Department.
With the wire redemption option, you may withdraw a minimum
of $1,000 and have the amount wired directly to your bank
account. 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
redemption 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 Fund
Express If you select the Fund Express Automatic Withdrawal option,
money will be automatically moved from your Vanguard Fund
Automatic account to your bank account according to the schedule you
Withdrawal & have selected. The Special Redemption option lets you move
Special Redemption money from your Vanguard account to your bank account on an
"as needed" basis. 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.
------------------------------------------------------------
Selling By
Exchange You may sell shares of a Portfolio by making an exchange to
another Vanguard Fund account. Please see "Exchanging Your
Shares" for details.
-----------------------------------------------------------
28
<PAGE>
Important
Redemption
Information Shares purchased by check or Fund Express may be redeemed at
any time. However, your redemption proceeds will not be paid
until payment for the purchase is collected, which may take
up to ten calendar days.
-----------------------------------------------------------
Delivery of
Redemption
Proceeds Redemption requests received by telephone prior to the close
of regular trading on the New York Stock Exchange (generally
4:00 p.m. Eastern time) are processed on the day of receipt
and the redemption proceeds are normally sent on the
following business day.
Redemption requests received by telephone after the close of
the Exchange are processed on the business day following
receipt and the proceeds are normally sent on the second
business day following receipt.
Redemption proceeds must be sent to you within seven days of
receipt of your request in Good Order, except as described
in "Important Redemption Information".
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 Order. 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.
-----------------------------------------------------------
Vanguard's Average
Cost Statement If you make a redemption from a qualifying account, Vanguard
will send you an Average Cost Statement which provides you
with the tax basis of the shares you redeemed. Please see
"Statements and Reports" for additional information.
-----------------------------------------------------------
Low Balance Fee and
Minimum Account
Balance
Requirement Due to the relatively high cost of maintaining smaller
accounts, the Fund will automatically deduct a $10 annual
fee from accounts with balances falling below $2,500 ($1,000
for Uniform Gifts/Transfers to Minors Act accounts). This
fee deduction will occur mid-year, beginning in 1996. The
fee generally will be waived for investors whose aggregate
Vanguard assets exceed $50,000.
In addition, the Fund reserves the right to liquidate any
non-retirement account that is below the minimum initial
investment amount of $3,000. If at any time your total
investment does not have a value of at least $3,000, you may
be notified that your account is below the Fund's minimum
account balance requirements. You would then be allowed 60
days to make an additional investment before the account is
liquidated. Proceeds would be promptly paid to the
registered shareholder.
Vanguard will not liquidate your account if it has fallen
below $3,000 solely as a result of declining markets (i.e.,
a decline in a Portfolio's asset value).
- -------------------------------------------------------------------------------
29
<PAGE>
EXCHANGING
YOUR SHARES Should your investment goals change, you may exchange your
shares of Vanguard Pennsylvania Tax-Free Fund for those of
other available Vanguard Funds.
Exchanging By
Telephone When exchanging shares by telephone, please have ready the
Portfolio name, account number, Social Security Number or
Call Client Employer Identification number listed on the account, and
Services exact name and address in which the account is registered.
(1-800-662-2739) Only the registered shareholder may complete such an
exchange. Requests for telephone exchanges received prior to
the close of trading on the New York Stock Exchange
(generally 4:00 p.m. Eastern time) are processed at the
close of business that same day. Requests 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 Quantitative Portfolios. If
you experience difficulty in making a telephone exchange,
your exchange request may be made by regular or express
mail, and it will be implemented at the closing net asset
value on the date received by Vanguard provided the request
is received in Good Order.
------------------------------------------------------------
Exchanging By Mail Please be sure to include the name and account number of
your current fund, and the name of the fund you wish to
exchange 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, Vanguard Pennsylvania Tax-Free Fund, 455
Devon Park Drive, Wayne, PA 19087.)
------------------------------------------------------------
Important Exchange
Information Before you make an exchange, you should consider the
following:
o Please read the fund's prospectus before making an
exchange. For a copy and for answers to any questions you
may have, call our Investor Information Department
(1-800-662-7447).
o An exchange is treated as a redemption and a purchase.
Therefore, you could realize a taxable gain or loss on the
transaction.
o Exchanges are accepted only if the registrations and
Taxpayer Identification numbers of the two accounts are
identical.
o The shares to be exchanged must be on deposit and not held
in certificate form.
o New accounts are not currently accepted in
Vanguard/Windsor Fund or Vanguard/PRIMECAP Fund.
o 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.
o When opening a new account by exchange, you must meet the
minimum investment requirement of the new fund.
30
<PAGE>
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
Pennsylvania, the only state in which the Fund's shares are
registered for sale.
- -------------------------------------------------------------------------------
EXCHANGE
PRIVILEGE
LIMITATIONS The Fund's exchange privilege is not intended to afford
shareholders a way to speculate on short-term movements in
the market. Accordingly, in order to prevent excessive use
of the exchange privilege that may potentially disrupt the
management of the Fund and increase transaction costs, the
Fund has established a policy of limiting excessive exchange
activity.
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 portfolio management.
- -------------------------------------------------------------------------------
IMPORTANT
INFORMATION
ABOUT TELEPHONE
TRANSACTIONS The ability to initiate redemptions (except wire
redemptions) and exchanges by telephone is automatically
established on your account unless you request in writing
that telephone transactions on your account not be
permitted. The ability to initiate wire redemptions by
telephone will be established on your account only if you
specifically elect this option in writing.
To protect your account from losses resulting from
unauthorized 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
telephone redemption by wire, the wire transfer will be made
only in accordance with the shareowner's prior written
instructions.
Neither the Fund nor Vanguard will be responsible for the
authenticity of transaction instructions received by
telephone, provided that reasonable security procedures have
been followed. Vanguard believes that the security
procedures described 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 account. If Vanguard fails to follow
reasonable security procedures, it may be liable for any
losses resulting from unauthorized or fraudulent telephone
transactions on your account.
- -------------------------------------------------------------------------------
31
<PAGE>
TRANSFERRING
REGISTRATION You may transfer the registration of any of your Fund shares
to another person by completing a transfer form and sending
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.
- -------------------------------------------------------------------------------
STATEMENTS AND
REPORTS Vanguard will send you a confirmation statement each time
you initiate a transaction in your account except for
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 statement will be a year-end statement,
listing all transaction activity for the entire calendar
year.
Vanguard's Average Cost Statement provides you with the
average cost of shares redeemed from your account, using the
average 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 along with their Portfolio Summary
Statement. Please call our Client Services Department
(1-800-662-2739) for information.
Financial reports on the Fund will be mailed to you
semiannually, according to the Fund's fiscal year-end.
- -------------------------------------------------------------------------------
OTHER VANGUARD
SERVICES For more information about any of these services, please
call our Investor Information Department at 1-800-662-7447.
Vanguard
Direct Deposit
Service With Vanguard's Direct Deposit Service, most U.S. Government
checks (including Social Security and military pension
checks) and private payroll checks may be automatically
deposited into your Vanguard Fund account. Separate
brochures and forms are available for direct deposit of U.S.
Government and private payroll checks.
Vanguard Automatic
Exchange Service Vanguard's Automatic Exchange Service allows you to move
money automatically among your Vanguard Fund accounts. For
instance, the service can be used to "dollar cost average"
from a money market portfolio into a stock or bond fund, or
to contribute to an IRA or other retirement plan. Please
contact our Client Services Department at 1-800-662-2739 for
additional information.
Vanguard Fund
Express Vanguard's Fund Express allows you to transfer money between
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.
Special rules govern how your Fund Express purchases or
redemptions are credited to your account. In addition, some
services of Fund Express cannot be used with specific
Vanguard Funds. For more information, please refer to the
Vanguard Fund Express brochure.
32
<PAGE>
Vanguard
Dividend Express Vanguard's Dividend Express allows you to transfer your
dividends and/or capital gains distributions automatically
from your Fund account, one business day after the Fund's
payable date, to 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
Vanguard Dividend Express application.
Vanguard
Tele-Account Vanguard's Tele-Account is a convenient, automated service
that provides share price, price change and yield quotations
on Vanguard funds through any TouchTone(TR) 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 offering detailed operating instructions is
available from our Investor Information Department
(1-800-662-7447).
- -------------------------------------------------------------------------------
33
<PAGE>
[THIS PAGE INTENTIONALLY LEFT BLANK]
<PAGE>
[THIS PAGE INTENTIONALLY LEFT BLANK]
<PAGE>
Vanguard Vanguard
PENNSAYLVANIA PENNSAYLVANIA
YAX-FREE FUND YAX-FREE FUND
The Vanguard Group
of Investment
Companies
Vanguard Financial Center P R O S P E C T U S
P.O. Box 2600
Valley Forge, PA 19482
Investor Information
Department: MARCH 29, 1996
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
A member of
TheVanguardGROUP
PO77
<PAGE>
PART B
VANGUARD PENNSYLVANIA TAX-FREE FUND
STATEMENT OF ADDITIONAL INFORMATION
MARCH 29, 1996
This Statement is not a prospectus but should be read in conjunction with
the Fund's current Prospectus dated March 29, 1996. To obtain this
Prospectus, please call:
VANGUARD'S INVESTOR INFORMATION DEPARTMENT
1-800-662-7447
TABLE OF CONTENTS
Page
--------
Investment Limitations ....................................... B-1
Investment Policies .......................................... B-3
Risks Factors ................................................ B-5
Yield and Total Return ....................................... B-6
Calculation of Yield ......................................... B-7
Comparative Indexes .......................................... B-7
Investment Management ........................................ B-9
Purchase of Shares ........................................... B-9
Redemption of Shares ......................................... B-10
Valuation of Shares .......................................... B-10
Management of the Fund ....................................... B-12
Description of Shares and Voting Rights ...................... B-15
Financial Statements ......................................... B-15
Appendix A--Description of Municipal Bonds and their Ratings . B-16
Appendix B--Municipal Lease Obligations ...................... B-18
INVESTMENT LIMITATIONS
The following limitations cannot be changed without the consent of the
holders of a majority of the Fund's outstanding shares (as defined in the
Investment 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 issuers (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
issuer (except U.S. government and cash items, as defined in the Code) to a
maximum of 25% of the Portfolio's total assets. For the purposes of this
limitation, identification of the issuer will be based on a determination of
the source of assets and revenues committed to meeting interest and principal
payments 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
total 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;
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 technically be deemed an underwriter under the Securities Act of 1933, as
amended, in disposing of portfolio securities;
B-1
<PAGE>
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
purchase of bonds, debentures or similar obligations which are publicly
distributed 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
securities, together own more than 5% of the securities of such issuer:
12. Each Portfolio will not purchase or sell commodities or commodities
contracts, 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 deposit 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
investment companies except as they may be part of a merger, consolidation,
reorganization or acquisition of assets or otherwise to the extent permitted
by Section 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
deposit; (b) investment companies investing in such securities which have
investment 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 repurchase 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
result of such purchase (i) more than 5% of the Portfolio's total assets,
determined at market value at the time of the proposed investment, would be
invested 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 industrial development bonds. These restrictions do not apply to
municipal obligations where the payment of principal and interest is the
responsibility of a government or the political subdivision of a government.
The above-mentioned investment limitations are considered at the time
investment 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 description of
such securities.
B-2
<PAGE>
INVESTMENT POLICIES
Lending of Securities. Each Portfolio may lend its investment securities to
qualified institutions who need to borrow securities in order to complete
certain transactions, such as covering short sales, avoiding failures to
deliver securities or completing arbitrage operations. By lending its
investment securities, the Portfolio attempts to increase its income through
the receipt of interest on the loan. Anygain 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 qualified 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
Portfolio investing any cash collateral in interest bearing short- term
investments), any distribution on the loaned securities and any increase in
their market value. A Portfolio will not lend its investment securities, if as a
result, the aggregate of such loans exceeds 10% of the value of its total
assets. Loan arrangements made by the Portfolio will comply with all other
applicable regulatory requirements, including the rules of the New York Stock
Exchange, which rules presently require the borrower, after notice, to redeliver
the securities within the normal settlement time of three business days. All
relevant facts and circumstances, including the creditworthiness of the broker,
dealer or institution, will be considered in making decisions with respect 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 contracts 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 exchanges. Futures exchanges and trading are
regulated under the Commodity Exchange Act by the Commodity Futures Trading
Commission ("CFTC"), a U.S. Government Agency.
Although futures contracts by their terms call for actual delivery or
acceptance of the underlying securities, in most cases the contracts are
closed out before the settlement date without the making or taking of
delivery. Closing out an open futures position is done by taking an opposite
position ("buying" a contract which has previously been "sold," or "selling"
a contract previously purchased) in an identical contract to terminate the
position. Brokerage 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 deposit is intended to assure
completion of the contract (delivery or acceptance of the underlying
security) if it is not terminated prior to the specified delivery date.
Minimal initial margin requirements are established by the futures exchange
and may be changed. Brokers may establish deposit requirements which are
higher than the exchange minimums. Futures contracts are customarily
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
excess 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 expects 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
unfavorable 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 contracts only for bona fide hedging purposes.
B-3
<PAGE>
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
increase 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
exposure. 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, immediately thereafter, the sum of its initial margin deposits on open
contracts exceeds 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 outstanding 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 securities to meet daily margin requirements at a time when it may
be disadvantageous 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 the Portfolio.
The Insured Long-Term Portfolio will minimize the risk that it will be
unable 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
liquid secondary market.
The risk of loss in trading futures contracts in some strategies 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 (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 Adviser does not believe that the Portfolio is subject
to the risks of loss frequently 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
portfolio 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 margin deposits in the event of bankruptcy of a broker with whom
the Portfolio has an open position in a futures contract or related option.
B-4
<PAGE>
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 unfavorable 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
contracts held as of the end of the year as well as those actually realized
during 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
required 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
securities 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 contracts will be considered gain from the sale of securities and
therefore be qualifying income for purposes 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
transactions. 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 provisions in debt documents that protect debt holders.
Credit risk is usually lower wherever the economy is strong, growing and
diversified; financial operations 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
Corporation, respectively. Against this measure and the criteria listed
above, the credit risk associated with direct obligations of Pennsylvania and
B-5
<PAGE>
State agencies, including general obligation and revenue bonds, lease debt, and
notes, compares somewhat unfavorably. During most of the last two decades,
Pennsylvania's general obligation bonds have been rated just below this average
by both rating agencies. Nonetheless, during this period Pennsylvania's
obligations could still be characterized as providing upper medium grade
security, with a strong capacity for timely repayment 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
burden has improved considerably in Pennsylvania, and debt continues to be
rapidly 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 18.2% of total employment in 1994,
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
averages. The positive change in the economy has not been without costs.
Growth levels in employment, population and personal income lagged behind
U.S. averages 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.
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. Pennsylvania has
subsequently experienced economic recovery in line with the U.S.
Fiscally, Pennsylvania has historically maintained balanced budgets, a
result of sound and conservative budgeting policies. During the period of
economic 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 and healthy.
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, face continuing fiscal stress,
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
period ended November 30, 1995 was +5.09%. 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
Portfolio for the one-year and five-year period ending November 30, 1995 and
since its inception on April 7, 1986 was +18.48%, +8.95% and +8.28%,
respectively. The average total return of the Pennsylvania Money Market
Portfolio for the one-year and five-year period ending November 30, 1995 and
since its inception on June 13, 1988 was +3.69%, +3.24% and +4.15%,
B-6
<PAGE>
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
calculation 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 dividends 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 result.
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, 1995.
<TABLE>
<CAPTION>
Money Market Portfolio
----------------------
11/30/95
--------
<S> <C>
Value of account at beginning of period ........................... $1.00000
Value of same account at end of period* ........................... 1.00070
--------
Net Change in account value ....................................... $.00070
Annualized Current Net Yield (Net Change X 365/7 )/average net
asset value ...................................................... 3.64%
Effective Yield [(Net Change) +1] 365/7 -1 ........................ 3.73%
Average Weighted Maturity of Investments .......................... 36 Days
</TABLE>
- ------
* Exclusive of any capital changes.
The Pennsylvania Money Market Portfolio seeks to maintain, but does not
guarantee, a constant net asset value of $1.00. The yield of the Portfolio will
fluctuate. The Money Market Portfolio seeks to maintain, but does not guarantee,
a constant 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 insured or guaranteed by the U.S. Government. The annualization of a week's
dividend 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 factors set forth in the preceding sentence, differences in the time periods
compared, and differences in the methods used in valuing portfolio instruments,
computing net asset value and calculating yield.
COMPARATIVE INDEXES
Vanguard may use reprinted material discussing The Vanguard Group, Inc. or
any of the member funds of The Vanguard Group of Investment Companies.
Each of the investment company members of the Vanguard Group, including
Vanguard 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
securities, covering all stocks in the U.S. for which daily pricing is
available.
B-7
<PAGE>
Wilshire 4500 Equity Index--consists of all stocks in the Wilshire 5000
except 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
capitalization 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.
Goldman Sachs 100 Convertible Bond Index--currently includes 71 bonds and 29
preferreds. The original list of names was generated by screening for
convertible issues of $100 million or greater in market capitalization. The
index is priced monthly.
Salomon Brothers GNMA Index--includes pools of mortgages originated by
private lenders and guaranteed by the mortgage pools of the Government
National Mortgage Association.
Salomon Brothers High-Grade Corporate Bond Index--consists of publicly
issued, 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.
Treasury, Agency and investment grade corporate bonds.
Lehman Corporate (Baa) Bond Index--all publicly offered fixed-rate,
nonconvertible 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.
Lehman Brothers Long-Term Corporate Bond Index--is a subset of the Lehman
Corporate Bond Index covering all corporate, publicly issued, fixed-rate,
nonconvertible U.S. debt issuers rated at least Baa, with at least $50
million principal outstanding and maturity greater than 10 years.
Bond Buyer Municipal Index (20 Year) Bond--is a yield index on current coupon
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
include income.
Composite Index--70% Standard & Poor's 500 Index and 30% NASDAQ Industrial
Index.
Composite Index--35% Standard & Poor's 500 Index and 65% Lehman Long-term
Corporate 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
contains individually priced U.S. Treasury, agency, corporate, and mortgage
pass-through securities corporate rated Baa-- 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.
B-8
<PAGE>
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
between 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
market-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.
Lipper Small Company Growth Fund Average--the average performance of small
company growth funds as defined by Lipper Analytical Services, Inc. Lipper
defines 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
performance 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 results of the Lipper Small Company Growth category were estimated
using the returns 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 average
government money market funds with similar investment objectives and
policies, 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
specified 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
commissions and other transaction costs on the sales of securities as well as
on the reinvestment of the proceeds in other securities. The annual portfolio
turnover 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 securities. It is impossible to predict whether or not the portfolio
turnover rate in future years will vary significantly from the rates in
recent years.
During the fiscal years ended November 30, 1993, 1994 and 1995, the Fund did
not pay any brokerage commissions.
PURCHASE OF SHARES
The Fund reserves the right in its sole discretion (i) to suspend the
offering of its shares, (ii) to reject purchase orders when in the judgment
of management such rejection is in the best interest of the Fund, and (iii)
to reduce or waive the minimum investment for or any other restrictions on
initial and subsequent investments under circumstances 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 statement of shares owned at the time of each transaction. This saves the
shareholders the trouble of safekeeping the certificates and saves the Fund
B-9
<PAGE>
the cost of issuing certificates. Share certificates for the Pennsylvania
Insured Long-Term Portfolio are, of course, available at any time upon written
request at no additional cost to shareholders. 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 reasonably 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 conformity 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
authorized a redemption from your account. Signature guarantees are required
in connection with: (1) all redemptions, regardless of the amount involved,
when the proceeds are to be paid to someone other than the registered owners;
and (2) 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.
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
redemptions. 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 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 valuing 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 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
B-10
<PAGE>
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 estimates 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 conditions. 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
quotations 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
initiated. In the event the Trustees determine that a deviation exists which
may result in material dilution or other unfair results to investors or
existing shareholders, they 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 distribution; redemptions of shares in kind; or establishing a net
asset value per share by using available market quotations.
B-11
<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,
1995, 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 and Trustee*
Chairman and Director of The Vanguard Group, Inc., and of each of the
investment companies in The Vanguard Group. Director of The Mead Corporation
and General Accident Insurance.
JOHN J. BRENNAN, President, Chief Executive Officer & Trustee*
President, Chief Executive Officer and Director of the Fund, The Vanguard
Group, Inc. and of each of the investment companies in The Vanguard Group.
ROBERT E. CAWTHORN, Trustee
Chairman of Rhone-Poulenc Rorer, Inc.; Direc- tor of Sun Company, Inc.
BARBARA BARNES HAUPTFUHRER, Trustee
Director of The Great Atlantic and Pacific Tea Company, Alco Standard Corp.,
Raytheon Company, Knight-Ridder, Inc., and Massachusetts Mutual Life
Insurance Co. and Trustee Emerita of Wellesley College.
BURTON G. MALKIEL, Trustee
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, Trustee
Chairman, President, and Chief Executive Officer of NACCO Industries, Inc.;
Director of The BFGoodrich Company, and The Standard Products Company..
JOHN C. SAWHILL, Trustee
President and Chief Executive Officer, The Nature Conservancy; formerly,
Director and Senior Partner, McKinsey & Co., President, New York University;
Director of Pacific Gas and Electric Company and NACCO Industries.
JAMES O. WELCH, JR., Trustee
Retired Chairman of Nabisco Brands Inc. retired Vice Chairman and Director
of RJR Nabisco; Director of TECO Energy, Inc. and Director of Kmart
Corporation.
J. LAWRENCE WILSON, Trustee
Chairman and Chief Executive Officer of Rohm & Haas Company; Director of
Cummins Engine Company; and Trustee of Vanderbilt University.
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.
RICHARD F. HYLAND, Treasurer*
Treasurer of The Vanguard Group, Inc. and of each of the investment
companies in The Vanguard Group.
KAREN E. WEST, Controller*
Principal of The Vanguard Group, Inc.; Controller of each of the investment
companies in The Vanguard Group.
- ------
* Officers of the Fund are "interested persons" as defined in the Investment
Company Act of 1940.
THE VANGUARD GROUP
Vanguard Pennsylvania Tax-Free Fund is a member of The Vanguard Group of
Investment 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
distribution services. Vanguard also provides investment advisory services on
an at-cost basis to several of the Vanguard Funds, including the Vanguard
Pennsylvania Tax-Free Fund.
B-12
<PAGE>
Vanguard employs a supporting staff of management and administrative
personnel 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 administrative 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 adviser 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
prevent 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 permitted to engage in personal securities transactions. However,
such transactions 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 has 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, 1995 Vanguard Pennsylvania Tax-Free Fund
had contributed capital of $329,000 to Vanguard representing 1.6% of
Vanguard's capitalization. The Funds' Service Agreement provides as follows:
(a) each Vanguard Fund may invest 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 Vanguard'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
relationships; (6) shareholder reporting; and (7) review and evaluation of
advisory and other services provided to the Funds by third parties. During
the fiscal year ended November 30, 1995, the Funds share of Vanguard's actual
net costs of operations relating to management and administrative services
(including transfer agency) totaled approximately $4,077,000.
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
materials and marketing personnel. Distribution services may also include
organizing and offering to the public, from time to time, one or more new
investment companies which will become members of the Group. The Trustees
(Directors) and officers of Vanguard determine the amount to be spent
annually on distribution activities, 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
remaining 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
nature 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, 1995 the Fund paid approximately $611,000 of the Group's
distribution and marketing expenses.
B-13
<PAGE>
Investment Advisory Services. Vanguard also provides investment advisory
services to the Fund; Vanguard Municipal Bond Fund; Vanguard Money Market
Reserves; Vanguard Admiral Funds; the several Portfolios of Vanguard Fixed
Income Securities Fund; Vanguard Institutional 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 International Equity Index Fund; Vanguard
Tax-Managed Fund; the Aggressive Growth Portfolio of Vanguard Horizon 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, 1993, 1994 and 1995 the
Fund paid approximately $204,000, $281,000, and $339,000 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, 1995 the Fund
paid $9,000 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, 1995, the Fund's
proportionate share of remuneration paid to all Officers of the Fund, as a
group, was approximately $88,292.
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 annually 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. Under its Thrift Plan, all eligible Officers are permitted to
make pre-tax contributions 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 proportionate share of retirement contributions made by
Vanguard under its Retirement and Thrift Plans on behalf of all Officers of
the Fund, as a group, during the 1995 fiscal year was approximately $2,400.
The following table provides detailed information with respect to the
amounts paid or accrued for the Trustees for the fiscal year ended November
30, 1995.
VANGUARD PENNSYLVANIA TAX-FREE FUND
COMPENSATION TABLE
<TABLE>
<CAPTION>
Pension or Total
Retirement Estimated Compensation
Aggregate Benefits Accrued Annual From All Vanguard
Compensation As Part of Benefits Upon Funds Paid
Names of Trustees From Fund Fund Expenses Retirement to Trustees(3)
- -------------------------- -------------- ---------------- --------------- -----------------
<S> <C> <C> <C> <C>
John C. Bogle(1), (2) .... -- -- -- --
John J. Brennan(2) ....... -- -- -- --
Barbara Barnes Hauptfuhrer $1,111 $194 $15,000 $60,000
Robert E. Cawthorn ....... $1,111 $162 $13,000 $60,000
Burton G. Malkiel ........ $1,111 $129 $15,000 $60,000
Alfred M. Rankin, Jr. .... $1,111 $102 $15,000 $60,000
John C. Sawhill .......... $1,111 $121 $15,000 $60,000
James O. Welch, Jr. ...... $1,111 $149 $15,000 $60,000
J. Lawrence Wilson ....... $1,111 $108 $15,000 $60,000
</TABLE>
- ------
(1) For the period reported in this table, Mr. Bogle was the Fund's Chief
Executive Officer, and therefore an "Interested Trustee."
(2) As "Interested Trustees," Messrs. Bogle and Brennan receive no
compensation for their service as Trustees.
(3) The amounts reported in this column reflect the total compensation paid
to each Trustee for their service as Director or Trustee of 34 Vanguard
Funds.
B-14
<PAGE>
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
conversion, 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 shareholders, 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
outstanding, 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
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
obligations 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 request, 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
liable for errors of judgment or mistakes of fact or law, but nothing in the
Declaration of Trust protects a Trustee against any liability to which he
would otherwise be subject by reason of willful misfeasance, bad faith, gross
negligence, or reckless disregard of the duties involved in the conduct of
his office.
FINANCIAL STATEMENTS
The Fund's financial statements for the year ended November 30, 1995,
including the financial highlights for each of the five years in the period
ended November 30, 1995, appearing in the Vanguard Pennsylvania Tax-Free Fund
1995 Annual Report to Shareholders, and the report thereon of Price
Waterhouse LLP, independent accountants, also appearing therein, are
incorporated by reference in this Statement of Additional Information. The
Fund's 1995 Annual Report to Shareholders is enclosed with this Statement of
Additional Information.
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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 authorities, not-for-profit corporations, and corporations, 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 facilities.
The two principal classifications of Municipal Bonds are "general
obligation" and "revenue" or "special tax" bonds. General obligation bonds
are secured 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
payable only from the revenues derived from a particular facility or class of
facilities or, in some cases, from the proceeds of a special excise or other
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 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 municipal obligations
issued by states, cities, municipalities or municipal agencies, include Tax
Anticipation Notes, Revenue Anticipation Notes, Bond Anticipation Notes,
Construction Loan Notes and Short-Term Discount Notes. Project Notes are
instruments issued by the Department of Housing and Urban Development but
issued by a state or local housing agency. While the issuing agency has the
primary obligation on such Project notes, they 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
obligations are secured by letters of credit or other credit support
arrangements provided by banks. The issuer of such notes normally has a
corresponding right, after a given period, to repay in its discretion the
outstanding principal 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
particular offering, the maturity of the obligation, and the rating of the
issue. The ratings of Moody's Investors Service, Inc. and Standard & Poor's
Corporation 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 absolute standards of quality. Consequently, Municipal Bonds with the
same maturity, 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 issuance 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
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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 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 each Portfolio to achieve its respective
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. (For more
information please refer to "Risk Factors" on page B-6.)
Ratings. Excerpts from Moody's Investors Service, Inc.'s Municipal Bond
ratings; 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
stable margin and principal is secure; Aa--judged to be of "high quality by
all 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 medium 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--considered as medium grade obligations; i.e., they are neither
highly protected nor poorly secured; interest payments and principal security
appear adequate for the present but certain protective elements may be
lacking or may be characteristically unreliable over any great length of
time; Ba--protection of principal and interest payments may be very moderate;
judged to have speculative 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 principal and interest; Ca--speculative in a high
degree; often in default; C--lowest 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 although 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
principal 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 conditions 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 default, 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
issues: SP-1+ --very strong capacity to pay principal and interest;
SP-1--strong capacity to pay principal and interest.
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Description of S&P's highest commercial papers ratings: A-1+ --This
designation 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
established by the Board of Trustees.
1. The obligation has been rated "investment grade" by at least one
NRSRO and is considered to be investment grade by the investment adviser.
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
institutional investors.
4. The investment adviser has determined that the obligation, or a
comparable lessee security, trades in the institutional marketplace at
least periodically, 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
property 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
opinion from recognized bond counsel that lease payments would not be
considered property of the lessor's estate in the event of lessor's
bankruptcy.
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