<PAGE>
A Member of The Vanguard Group
================================================================================
PROSPECTUS -- March 7, 1997
- --------------------------------------------------------------------------------
NEW ACCOUNT INFORMATION: Investor Information Department - 1-800-662-7447 (SHIP)
- --------------------------------------------------------------------------------
SHAREHOLDER ACCOUNT SERVICES: Client Services Department - 1-800-662-2739 (CREW)
- --------------------------------------------------------------------------------
INVESTMENT Vanguard Convertible Securities Fund, Inc. (the "Fund") is an
OBJECTIVE AND open-end diversified investment company that seeks to provide
POLICIES current income and long-term growth of capital. The Fund invests
primarily in corporate bonds and preferred stocks that are
convertible into shares of common stock. Although the Fund is
designed principally for equity-oriented investors, you should be
aware that a majority of the Fund's assets may be invested in
convertible securities rated Ba or B by Moody's Investors Service
or BB or B by Standard & Poor's Corporation. Corporate bonds with
such ratings are commonly referred to as "junk bonds" and are
considered speculative by the major ratings agencies. There is no
assurance that the Fund will achieve its stated objectives.
Shares of the Fund are neither insured nor guaranteed by any
agency of the U.S. Government, including the FDIC.
- --------------------------------------------------------------------------------
OPENING AN To open a regular (non-retirement) account, please complete and
ACCOUNT return the Account Registration Form. If you need assistance in
completing this Form, please call the Investor Information
Department. To open an Individual Retirement Account (IRA),
please use a Vanguard IRA Adoption Agreement. To obtain a copy of
this form, call 1-800-662-7447, 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, 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 This Prospectus is designed to set forth concisely the
PROSPECTUS 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 7, 1997, 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>
<S> <C> <C> <C> <C> <C>
Page Page Page
Fund Expenses ............ 2 Investment Limitations ... 9 SHAREHOLDER GUIDE
Financial Highlights ..... 2 Management of the Fund ... 10 Opening an Account and
Yield and Total Return ... 3 Investment Adviser ....... 10 Purchasing Shares ...... 16
FUND INFORMATION Performance Record ....... 12 When Your Account Will Be
Investment Objective ..... 4 Dividends, Capital Gains Credited ............... 19
Investment Policies ...... 4 and Taxes .............. 12 Selling Your Shares ...... 19
Investment Risks ......... 5 The Share Price of the Exchanging Your Shares ... 22
Who Should Invest ........ 6 Fund ................... 14 Important Information
Implementation of Policies 7 General Information ...... 14 About Telephone
Transactions ........... 23
Transferring Registration 23
Other Vanguard Services .. 24
</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 set
forth below are for the 1996 fiscal year.
<TABLE>
<CAPTION>
Shareholder Transaction Expenses
-----------------------------------------------------------------------------
<S> <C>
Sales Load Imposed on Purchases .............. None
Sales Load Imposed on Reinvested Dividends ... None
Redemption Fees .............................. None
Exchange Fees ................................ None
</TABLE>
<TABLE>
<CAPTION>
Annual Fund Operating Expenses
-----------------------------------------------------------------------------
<S> <C> <C>
Management & Administrative Expenses ... 0.28%
Investment Advisory Fees ............... 0.35
12b-1 Fees ............................. None
Other Expenses
Distribution Costs ..................... 0.02%
0.04
Miscellaneous Expenses ................. ------
0.06
Total Other Expenses ................... ----
Total Operating Expenses ........... 0.69%
====
</TABLE>
The purpose of this table is to assist you in
understanding the various costs and expenses that you
would bear directly or indirectly as an investor in
the Fund.
The following example illustrates the expenses that
you would incur on a $1,000 investment over various
periods, assuming (1) a 5% annual rate of return and
(2) redemption at the end of each period. As noted in
the table above, the Fund charges no redemption fees
of any kind.
<TABLE>
<CAPTION>
1 Year 3 Years 5 Years 10 Years
-------- --------- --------- ----------
<S> <C> <C> <C>
$7 $22 $38 $ 86
</TABLE>
This example should not be considered a
representation of past or future expenses or
performance. Actual expenses may be higher or lower
than those shown.
FINANCIAL The following financial highlights for a share
HIGHLIGHTS outstanding throughout each period, insofar as they
relate to each of the five years in the period ended
November 30, 1996, 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 1996 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 1996
Annual Report to Shareholders. For a more complete
discussion of the Fund's performance, please see the
Fund's 1996 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>
Year Ended November 30,
--------------------------------------------------------
1996 1995 1994 1993 1992
-------- -------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of
Year ............................. 12.03 $10.94 $12.89 $11.77 $ 9.82
-------- -------- --------- --------- ---------
Investment Operations
Net Investment Income ........... .43 .52 .53 .56 .56
Net Realized and Unrealized Gain
(Loss) on Investments ........ 1.29 1.26 (1.04) 1.03 1.92
-------- -------- --------- --------- ----------
Total from Investment
Operations ................... 1.72 1.78 (.51) 1.59 2.48
-------- -------- --------- --------- ---------
Distributions
Dividends from Net Investment
Income ....................... (.54) (.51) (.53) (.47) (.53)
Distributions from Realized
Capital Gains ................ (.14) (.18) (.91) -- --
-------- -------- --------- --------- ---------
Total Distributions ............ (.68) (.69) (1.44) (.47) (.53)
-------- -------- --------- --------- ---------
Net Asset Value, End of Period .... $13.07 $12.03 $10.94 $12.89 $11.77
======== ======== ========= ========= =========
Total Return ...................... 14.88% 17.10% (4.35)% 13.87% 26.01%
======== ======== ========= ========= =========
Ratios/Supplemental Data
Net Assets, End of Year (Millions) $ 170 $ 172 $ 175 $ 202 $ 120
Ratio of Expenses to Average Net
Assets .......................... 0.69% 0.75% 0.73% 0.71% 0.85%
Ratio of Net Investment Income to
Average Net Assets .............. 3.43% 4.63% 4.68% 4.44% 4.80%
Portfolio Turnover Rate ........... 97% 46% 52% 81% 55%
Average Commission Rate Paid ...... $.0594 N/A N/A N/A N/A
</TABLE>
[RESTUBBED FROM TABLE ABOVE]
<TABLE>
<CAPTION>
Year Ended November 30,
------------------------------------------------------------
1991 1990 1989 1988 1987
-------- ---------- -------- -------- ----------
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of
Year ............................. $ 8.07 $ 9.64 $ 8.71 $ 7.94 $ 9.80
-------- ---------- -------- -------- ----------
Investment Operations
Net Investment Income ........... .53 .57 .51 .55 .60
Net Realized and Unrealized Gain
(Loss) on Investments ........ 1.77 (1.58) .99 .90 (1.95)
-------- ---------- -------- -------- ----------
Total from Investment
Operations ................... 2.30 (1.01) 1.50 1.45 (1.35)
-------- ---------- -------- -------- ----------
Distributions
Dividends from Net Investment
Income ....................... (.55) (.56) (.57) (.56) (.51)
Distributions from Realized
Capital Gains ................ -- -- -- (.12) --
-------- ---------- -------- -------- ----------
Total Distributions ............ (.55) (.56) (.57) (.68) (.51)
-------- ---------- -------- -------- ----------
Net Asset Value, End of Period .... $ 9.82 $ 8.07 $ 9.64 $ 8.71 $ 7.94
======== ========== ======== ======== ==========
Total Return ...................... 29.25% (10.95)% 17.70% 18.85% (14.82)%
======== ========== ======== ======== ==========
Ratios/Supplemental Data
Net Assets, End of Year (Millions) $ 55 $ 44 $ 58 $ 69 $ 73
Ratio of Expenses to Average Net
Assets .......................... 0.81% 0.88% 0.84% 0.88% 0.85%
Ratio of Net Investment Income to
Average Net Assets .............. 5.72% 6.35% 5.60% 6.52% 6.13%
Portfolio Turnover Rate ........... 57% 55% 55% 24% 45%
Average Commission Rate Paid ...... N/A N/A N/A N/A N/A
</TABLE>
<PAGE>
- --------------------------------------------------------------------------------
YIELD AND From time to time the Fund may advertise its yield and
TOTAL RETURN 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 the
Fund refers to the average annual compounded rates of
return over one-, five- and ten-year periods or the
life of the Fund (as stated in the advertisement) that
would equate 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 Fund 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 Fund'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.
Methods used to calculate advertised yields are
standardized for all stock and bond mutual funds.
However, these methods differ from the accounting
methods used by the Fund to maintain its books and
records, and so the advertised 30-day yield may not
fully reflect the income paid to an investor's account
or the yield reported in the Fund's reports to
shareholders.
3
<PAGE>
INVESTMENT Vanguard Convertible Securities Fund, Inc. (the
OBJECTIVE "Fund") is an open-end diversified investment
company. The objective of the Fund is to provide
The Fund seeks to current income and long-term growth of capital by
provide current investing primarily in convertible securities. There
income and is no assurance that the Fund will achieve its
long-term growth objective.
The investment objective of the Fund is fundamental
and so cannot be changed without the approval of a
majority of the Fund's shareholders.
- --------------------------------------------------------------------------------
INVESTMENT Under normal circumstances, at least 80% of the
POLICIES Fund's assets will be invested in convertible
securities. Convertible securities include corporate
The Fund invests in bonds and preferred stocks which are convertible int
convertible securities common stock, as well as debt instruments with
warrants or common stock attached. See
"Implementation of Policies" for a description of
convertible securities.
The remaining 20% of the Fund's assets may be
invested in non-convertible corporate or U.S.
Government fixed-income securities, common stocks,
and selected money market instruments. Within this
20% limit, the Fund is authorized to write covered
call options on its investments, although it does not
presently intend to do so. The Fund may also invest
more than 20% of its assets in money market
instruments when the Fund's investment adviser
determines that a temporary defensive position is
warranted.
In seeking to provide both current income and
long-term capital appreciation, the adviser will
emphasize the securities of companies with
above-average growth potential whose convertible
securities offer attractive yields. In general, each
security selected for the Fund will, in the opinion
of the adviser, be priced at a reasonable premium
relative to the price at which it can be converted
into common stock. In addition, the underlying common
stock will tend to be priced attractively on a
relative price-to-earnings ratio basis.
The Fund will predominantly invest in convertible
obligations which have been assigned a rating of B or
better by Moody's Investors Service, Inc. ("Moody's")
or Standard & Poor's Corporation ("Standard &
Poor's"). The Fund may also invest in non-rated
securities that, in the opinion of the Fund's
adviser, are equivalent in quality to a B rating or
better.
While the Fund will invest predominately in
securities of U.S.-based companies, up to 20% of the
Fund's assets may be invested in dollar-denominated
securities issued by foreign companies. See
"Implementation of Policies" for a description of
other investment practices of the Fund. The Fund is
responsible for voting the shares of all securities
it holds.
These policies are not fundamental and so may be
changed by the Board of Directors without shareholder
approval.
4
<PAGE>
INVESTMENT RISKS Convertible securities are hybrid securities,
combining the investment characteristics of both
bonds and common stocks. Like a bond (or preferrede
The Fund is subject stock), a convertibl security pays a fixed interest
to stock and bond rate (dividend), but may be converted into common
market risk stock at a specific price or conversion rate.
When the convertible's conversion price is
significantly above the price of the issuer's common
stock, a convertible security takes on the risk
characteristics of a bond. At such times, the price
of a convertible security will vary inversely with
changes in the level of interest rates. In other
words, when interest rates rise, convertible
securities prices will generally fall; conversely,
when interest rates fall, convertible securities
prices will generally rise. This interest rate risk
is in part offset by the income paid by the
convertible securities.
In contrast, when the conversion price of a
convertible security and the common stock price are
close to one another, a convertible security will
behave like a common stock. In such cases, the prices
of convertible securities may exhibit the short-term
price volatility characteristic of common stocks.
For these reasons, investors in the Fund must be
willing to accept the market risks of both bonds and
stocks. However, because convertible securities have
characteristics of both stocks and bonds, they tend
to be less sensitive to interest rate changes than
bonds of comparable maturity and quality, and less
sensitive to stock market changes than fully invested
common stock portfolios. Because of these factors and
the hybrid nature of convertibles, investors should
recognize that convertible securities are likely to
perform quite differently than broadly-based
measures of the stock and bond markets.
Credit Quality may The market for convertible securities includes a
be low larger proportion of small-to-medium size companies
than the broad stock market (as measured by such
indices as the Standard & Poor's 500 Composite Stock
Price Index). Companies which issue convertible
securities are often lower in credit quality.
Moreover, the credit rating of a company's
convertible issue is generally lower than the rating
of the company's conventional debt issues since the
convertible is normally a "junior" security. The
average credit quality of the Fund is expected to be
on a par with the universe of convertible securities
as a whole, and the Fund may invest up to 100% of its
assets in securities rated Ba (BB) or less.
Securities with such ratings are considered
speculative, and thus pose a greater risk of default
than investment grade securities. The following are
excerpts from the Moody's and Standard & Poor's
definitions for speculative debt obligations:
Moody's: Ba-rated bonds have "speculative elements,"
their future "cannot be considered assured," and
protection of principal and interest is "moderate"
and "not well safeguarded." B-rated bonds "lack
characteristics of a desirable investment" and the
assurance of interest or principal payments "may be
small."
Caa-rated bonds are "of poor standing" and "may be in
default" or may have "elements of danger with respect
to principal or interest."
5
<PAGE>
Standard & Poor's: BB-rated bonds have "less
near-term vulnerability to default" than B- or
CCC-rated securities but face "major ongoing
uncertainties . . . which may lead to inadequate
capacity" to pay interest or principal. B-rated bonds
have a "greater vulnerability to default" than
BB-rated bonds and the ability to pay interest or
principal will likely be impaired by adverse business
conditions. CCC-rated bonds have a "currently
identifiable vulnerability to default" and, without
favorable business conditions, will be unable to
repay interest and principal.
Securities rated Ba or lower are considered to be
"high-risk" securities and the credit quality of
such securities can change suddenly and
unexpectedly, and even recently-issued credit
ratings may not fully reflect the actual risks of a
particular security. For these reasons, it is the
Fund's policy not to rely primarily on ratings
issued by established credit rating agencies, but
to utilize such ratings in conjunction with the
Portfolio adviser's own independent and ongoing
review of the companies represented in the Fund.
In the past, the high yields from a portfolio of
low-grade securities have more than compensated for
the higher default rates on such securities.
However, there can be no assurance that
diversification will protect the Fund from
widespread defaults brought about by a sustained
economic downturn, or that yields will continue to
offset default rates on high-yield securities in
the future. A long-term track record on default
rates, such as that for investment grade corporate
bonds, does not exist for the high-yield securities
market. It may be that future default rates on
high-yield securities will be more widespread and
higher than in the past, especially during periods
of deteriorating economic conditions.
The share price of the Fund will be influenced not
only by changing interest rates, but also by the
market's perception of credit quality and the
outlook for economic growth. When economic
conditions appear to be deteriorating, low- and
medium-rated securities may decline in market
value due to investors' heightened concern over
credit quality, regardless of prevailing interest
rates.
Especially at such times, trading in the secondary
market for high-yield securities may become thin
and market liquidity may be significantly reduced.
Even under normal conditions, the market of
high-yield securities may be less liquid than the
market for investment grade securities. There are
fewer securities dealers in the high-yield market,
and purchasers of high-yield securities are
concentrated among a smaller group of securities
dealers and institutional investors.
- --------------------------------------------------------------------------------
WHO SHOULD The Fund is intended for investors who are seeking a
INVEST higher level of income than is normally available
from common stocks, as well as potential long-term
Investors seeking capital appreciation. Since the Fund may own non-
current income and investment grade securities of medium-to-small-sized
long-term capital companies, greater-than-average investment risk may
growth be involved. Investors should be able to tolerate
sharp, sometimes sudden fluctuations in the value of
their investment in pursuit of higher investment
returns in the long run.
6
<PAGE>
Although convertible securities exhibit
characteristics of both stocks and bonds, the Fund
does not represent a complete investment program.
Most investors should maintain diversified holdings
of securities with different risk
characteristics--including common stocks, bonds and
money market instruments. 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. Investors who engage in
excessive account activity generate additional costs
which 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.
- --------------------------------------------------------------------------------
IMPLEMENTATION The Fund uses a number of investment vehicles to
OF POLICIES achieve its objective.
The Fund invests in The Fund invests primarily in convertible securities.
convertible securities Convertible securities include corporate bonds,
debentures, notes and preferred stocks which may be
converted into the common stock of the issuer at the
holder's option. Convertible securities obligate the
issuing company to pay a stated annual rate of
interest (or a stated dividend in the case of
convertible preferred stock) and to return the
principal amount after a specified period.
Convertible securities generally offer income yields
that are higher than the dividend yield, if any, of
the underlying common stock, but lower than the yield
of non-convertible debt securities issued by the
corporation or corporations of similar investment
quality. This fixed-income feature of convertible
securities is expected to enable the Fund to achieve
its current income objective. Convertible securities
are usually priced at a premium to their conversion
value--i.e., the value of the common stock received
if the holder were to exchange the convertible
security.
The holder of the convertible security may choose at
any time to exchange the convertible security for a
specified number of shares of the common stock of the
corporation, or occasionally a subsidiary company, at
a specified price, as defined by the corporation when
the security is issued. Accordingly, the value of the
convertible obligation may generally be expected to
increase (decrease) as the price of the associated
common stock increases (decreases). Also, the market
value of convertible securities tends to be
influenced by the level of interest rates and tends
to decline as interest rates increase and,
conversely, to increase as interest rates decline.
Convertible securities rank senior to common stocks
in an issuer's capital structure, but are junior to
non-convertible debt securities. As convertible
securities are considered junior to any
non-convertible debt securities issued by the
corporation, convertible securities are typically
rated by established credit rating services at one
level below the corporation's non-convertible debt.
7
<PAGE>
The Fund may invest Although it normally seeks to remain fully invested
in short-term fixed in convertible securities, the Fund may invest in
income securities certain short-term fixed income securities. Such
securities may be used to invest uncommitted cash
balances, to maintain liquidity to meet shareholder
redemptions, or to take a temporary defensive
position. These securities include: obligations of
the United States Government and its agencies or
instrumentalities, commercial paper, bank
certificates of deposit, and bankers' acceptances,
and repurchase agreements collateralized by these
securities.
The Fund may lend The Fund may lend its investment securities on a
its securities short-term or a long-term basis to qualified
institutional investors for the purpose of realizing
additional income. Loans of securities by the Fund
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.
The Fund may The Fund may borrow money, subject to the limits set
borrow money forth below, for temporary or emergency purposes,
including the meeting of redemption requests which
might otherwise require the untimely disposition of
securities.
Portfolio turnover is The Fund retains the right to sell securities
not expected to irrespective of how long they have been held.
exceed 100% However, depending on market conditions and other
factors, it is expected that the portfolio turnover
rate for the Fund will not normally exceed 100%.
Because of the Fund's recent change in investment
adviser, the turnover rate may exceed 100% over the
short-term. A turnover rate of 100% would occur, for
example, if all of the Fund's securities were
replaced within one year.
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.
The Fund may invest The Fund may invest in futures contracts and options,
in derivative but only to a limited extent. Specifically, the Fund
securities may enter into futures contracts provided that not
more than 5% of its assets are required as a futures
contract deposit; in addition, the Fund 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
Fund'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 use futures contracts for bona fide
"hedging" purposes. In executing a hedge, a manager
sells, for example, stock index futures to protect
against a decline in the stock market. As such, if
the market drops, the value of the futures position
will rise, thereby offsetting the decline in value of
the Fund's stock holdings.
8
<PAGE>
Futures contracts The primary risks associated with the use of futures
and options pose contracts and options are: (i) imperfect correlation
certain risks between the change in market value of the stocks held
by the Fund 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 Fund's underlying securities. The risk that the
Fund 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 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 Fund will
segregate cash or other liquid portfolio securities
in the amount of the underlying obligation.
- --------------------------------------------------------------------------------
INVESTMENT The Fund has adopted certain limitations in an
LIMITATIONS attempt to reduce its exposure to specific
situations. Some of these limitations are that the
The Fund has Fund will not:
adopted certain
fundamental (a) with respect to 75% of the value of its total
limitations assets, purchase the securities of any issuer
(except obligations of the United States
Government and its instrumentalities) if as a
result the Fund would hold more than 10% of the
outstanding voting securities of the issuer, or
more than 5% of the value of the Fund's total
assets would be invested in the securities of
such issuer;
(b) invest more than 5% of its assets in the
securities of companies that have a continuous
operating history of less than three years;
(c) invest more than 25% of its assets in any one
industry;
(d) borrow money, except that the Fund may borrow
from banks (or through reverse repurchase
agreements), for temporary or emergency (not
leveraging) purposes, including the meeting of
redemption requests which might otherwise require
the untimely disposition of securities, in an
amount not exceeding 10% of the value of the
Fund's total assets (including the amount
borrowed) at the time the borrowing is made.
Whenever borrowings exceed 5% of the value of the
Fund's total assets, the Fund will not make any
additional investments;
(e) pledge, mortgage or hypothecate any of its assets
to an extent greater than 5% of its total assets.
These investment limitations are considered at the
time investment securities are purchased. The
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.
9
<PAGE>
MANAGEMENT OF The Fund is a member of The Vanguard Group of
THE FUND Investment Companies, a family of more than 30 funds,
with more than 90 portfolios and total assets in
Vanguard excess of $240 billion. Through their jointly-owned
administers and subsidiary, The Vanguard Group, Inc. ("Vanguard"),
distributes the Fund the Fund and the other funds in the Group 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 1996, the average expense
ratio (annual costs including advisory fees divided
by total net assets) for the Vanguard funds amounted
to approximately 0.29% compared to an average of
1.22% for other mutual funds (data provided by Lipper
Analytical Services).
The Officers of the Fund manage its day-to-day
operations and are responsible to the Fund's Board of
Directors. The Directors set broad policies for the
Fund and choose its Officers. A list of the Directors
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 Directors
(Trustees) 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
service 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 Vanguard's distribution costs.
- --------------------------------------------------------------------------------
INVESTMENT The Fund employs Oaktree Capital Management, LLC
ADVISER ("Oaktree"), 550 South Hope Street, 22nd Floor, Los
Angeles, California, 90071, under an investment
Oaktree Capital advisory agreement dated November 1, 1996, to manage
Management, LLC the investment and reinvestment of the assets of the
manages the Fund's Fund and to continuously review, supervise and
investments administer the Fund's investment program. Oaktree
discharges its responsibilities subject to the
control of the Officers and Directors of the Fund.
Oaktree specializes in selected niche investment
markets. The founders of Oaktree formed the company
in April of 1995 after having managed funds in the
convertible securities, distressed debt, and high
yield bond areas of Trust Company of the West since
1985.
Larry W. Keele, Principal and one of the five
founders of Oaktree, serves as Portfolio Manager of
the Fund. Mr. Keele is supported by research and
other investment services provided by the
professional staff of Oaktree. As of November 30,
1996, Oaktree managed approximately $7.3 billion.
10
<PAGE>
The Fund pays Oaktree an advisory fee at the end of each fiscal quarter,
calculated by applying a quarterly rate, based on the following annual
percentage rates, to the Fund's average month-end net assets for the quarter
(the "Basic Fee"):
Net Assets Rate
------------------- --------
First $100 million 0.425%
Next $100 million 0.400%
Next $100 million 0.375%
Next $100 million 0.350%
Over $400 million 0.325%
The advisory fee may be increased or decreased by an
incentive/penalty fee based on the Fund's total
return performance as compared to that of the First
Boston Convertible Securities Index. Under the fee
schedule, the Basic Fee may be increased or decreased
by as much as 50%.
The incentive/penalty fee structure will not be in
full operation until the quarter ending November 30,
1999. Until then, the incentive/penalty fee will be
calculated using certain transition rules. The
incentive/penalty fee schedule and calculation
process for the Portfolio's first three years are
described in the Portfolio's Statement of Additional
Information, which can be obtained by writing to or
calling Vanguard.
During the fiscal year ended November 30, 1996, the
total advisory fees paid by the Fund to Desai Capital
Management, Inc., the Fund's previous adviser,
represented an effective annual base rate of .35 of
1% of the Fund's average net assets.
The investment advisory agreement authorizes Oaktree
to select the brokers or dealers that will execute
the purchases and sales of portfolio securities for
the Fund and directs Oaktree to use its best efforts
to obtain the best available price and most favorable
execution with respect to all transactions for the
Fund. The full range and quality of brokerage
services are considered in making these
determinations.
The Fund has authorized Oaktree to pay higher
commissions in recognition of brokerage services felt
necessary for the achievement of better execution,
provided the adviser believes this to be in the best
interest of the Fund. If more than one broker can
obtain the best available price and favorable
execution of a transaction, then Oaktree is
authorized to choose a broker who, in addition to
executing the transaction, will provide research
services to Oaktree or the Fund. However, Oaktree
will not pay higher commissions specificaly for the
purpose of obtaining research services. The Fund may
direct Oaktree to use a particular broker for certain
transactions in exchange for commission rebates or
research services provided to the Fund.
The Fund's Board of Directors may, without the
approval of shareholders, provide for: (a) the
employment of a new investment adviser pursuant to
the terms of a new advisory agreement, either as a
replacement for an existing adviser or as an
additional adviser; (b) a change in the terms of an
advisory agreement; and (c)
11
<PAGE>
the continued employment of an existing adviser on
the same advisory contract terms where a contract has
been assigned because of a change in control of the
adviser. Any such change will only be made upon not
less than 30 days' prior written notice to
shareholders of the Fund, which shall include
substantially the information concerning the adviser
that would have normally been included in a proxy
statement.
- --------------------------------------------------------------------------------
PERFORMANCE The table in this section provides investment results
RECORD for the Fund for several periods throughout the
Fund's lifetime. The results shown represent the
Fund's "total return" investment performance, which
assumes the reinvestment of all capital gains and
income dividends for the indicated periods. Also
included is comparative information with respect to
the unmanaged Standard & Poor's 500 Composite Stock
Price Index, a widely-used barometer of stock market
activity, and the Lehman Aggregate Bond Index, a
measure of the investment performance of the bond
market. The table does not make any allowance for
federal, state or local income taxes, which
shareholders must pay on a current basis.
The results should not be considered a representation
of the total return from an investment made in the
Fund today. This information is provided to help
investors better understand the Fund and may not
provide a basis for comparison with other investments
or mutual funds which use a different method to
calculate performance.
Average Annual Total Return for
Vanguard Convertible Securities Fund
<TABLE>
<CAPTION>
Lehman
Fiscal Periods Vanguard Convertible S&P 500 Aggregate Bond
Ended 11/30/96 Securities Fund Index Index
-------------- -------------------- --------- --------------
<S> <C> <C> <C>
1 Year +14.88% +27.9% +6.1%
3 Years + 8.77 +21.0 +6.5
5 Years +13.05 +18.2 +7.9
10 Years + 9.73 +15.2 +8.6
Lifetime* + 9.3 +14.9 N/A
</TABLE>
* June 17, 1986, to November 30, 1996.
- --------------------------------------------------------------------------------
DIVIDENDS, CAPITAL The Fund expects to pay quarterly dividends from net
GAINS AND TAXES investment income. Net capital gains distributions,
if any, will be made annually.
The Fund will pay
quarterly dividends Dividend and capital gains distributions may be
automatically reinvested or received in cash. See
"Choosing a Distribution Option" for a description of
these distribution methods.
In addition, in order to satisfy certain distribution
requirements of the Tax Reform Act of 1986, the Fund
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 Fund and
received by shareholders on December 31 of the prior
year.
12
<PAGE>
The Fund intends to continue to qualify for taxation
as a "regulated investment company" under the
Internal Revenue Code so that it will not be subject
to federal income tax to the extent its income is
distributed to shareholders. Dividends paid by the
Fund from net investment income, whether received in
cash or reinvested in additional shares, will be
taxable to shareholders as ordinary income. For
corporate investors, a portion of dividends from net
investment income will qualify for the intercorporate
dividends-received deduction. However, the portion of
the dividends so qualified depends on the aggregate
taxable qualifying dividend income received by the
Fund from domestic (U.S.) sources.
Distributions paid by the Fund from net long-term
capital gains, whether received in cash or reinvested
in additional shares, are taxable as long-term
capital gains, regardless of the length of time you
have owned shares in the Fund. Capital gains
distributions are made when the Fund realizes net
capital gains on sales of portfolio securities during
the year. The Fund does not seek to realize any
particular amount of capital gains during a year;
rather, realized gains are a by-product of portfolio
management activities. Consequently, capital gains
distributions may be expected to vary considerably
from year to year; there will be no capital gains
distributions in years when the Fund realizes net
capital losses.
Note that if you accept capital gains distributions
in cash, instead of reinvesting them in additional
shares, you are in effect reducing the capital at
work for you in the Fund. Also, keep in mind that if
you purchase shares in the Fund shortly before the
record date for a dividend or capital gains
distribution, a portion of your investment will be
returned to you as a taxable distribution, regardless
of whether you are reinvesting your distributions or
receiving them in cash.
The Fund will notify you annually as to the tax
status of dividend and capital gains distributions
paid by the Fund.
A Capital gain or loss A sale of shares of the Fund is a taxable event and
may be realized upon may result in a capital gain or loss. A capital gain
exchange or or loss may be realized from an ordinary redemption
redemption of shares or an exchange of shares between two mutual
funds (or two portfolios of a mutual fund).
Dividend distributions, capital gains distributions,
and capital gains or losses from redemptions and
exchanges may be subject to state and local taxes.
The Fund is required to withhold 31% of 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 certifying on your Account
Registration Form your proper Social Security or
Taxpayer Identification Number and by certifying that
you are not subject to backup withholding.
The Fund has obtained a Certificate of Authority to
do business as a foreign corporation in Pennsylvania
and does business and maintains an office in that
state. In the opinion of counsel, the shares of the
Fund will be exempt from Pennsylvania personal
property taxes.
13
<PAGE>
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
Fund is managed without regard to tax ramifications.
- --------------------------------------------------------------------------------
THE SHARE PRICE The Fund's share price or "net asset value" per share
OF THE FUND is calculated by dividing the total assets of the
Fund, less all liabilities, by the total number of
shares outstanding. The net asset value is determined
as of the close of the New York Stock Exchange
(generally 4:00 p.m. Eastern time) on each day that
the Exchange is open for trading.
The Fund's net asset value includes interest on
fixed-income securities which is accrued daily. Fund
securities which are traded both over-the-counter and
on a stock exchange will be valued according to the
broadest and most representative market, and it is
expected that for convertible securities, preferred
stock, bonds, and other fixed-income securities this
ordinarily will be the over-the-counter market.
Valuation of such securities will be at the latest
quoted bid price.
Common stocks that are listed on a securities
exchange are valued at the last quoted sales price on
the day the valuation is made. Common stocks which
are listed on an exchange but which are not traded on
the valuation date are valued at the mean between the
bid and the ask prices.
Convertible bonds and other debt instruments may be
valued on the basis of prices provided by a pricing
service when such prices are believed by the
Directors to reflect the fair market value of such
securities. The prices provided by a pricing service
may be determined without regard to bid or last sale
prices but take into account institutional size
trading in similar groups of securities and any
developments related to specific securities.
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 using methods
determined by the Board of Directors.
The Fund's price per share can be found daily in the
mutual fund section of most major newspapers under
the heading of Vanguard Group.
GENERAL The Fund is a Maryland corporation. The Fund's
INFORMATION Articles of Incorporation permit the Directors to
issue 1,000,000,000 shares of common stock, with a
$.001 par value. The Board of Directors has the power
to designate one or more classes ("Portfolios") of
shares of common stock and to classify or reclassify
any unissued shares with respect to such Portfolios.
Currently the Fund is offering one class of shares.
The shares of the Fund are fully paid and
nonassessable; have no preferences as to conversion,
exchange, dividends, retirement or other features;
and have no pre-emptive rights. Such shares have
non-cumulative voting rights, meaning that
14
<PAGE>
the holders of more than 50% of the shares voting for
the election of Directors can elect 100% of the
Directors if they so choose. A shareholder is
entitled to one vote for each full share held (and a
fractional vote for each fractional share held).
Annual meetings of shareholders will not be held
except as required by the Investment Company Act of
1940 and other applicable law. If requested in
writing by the holders of not less than 10% of the
outstanding shares of the Fund, an annual meeting
will be held to vote on the removal of a Director or
Directors 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
will audit its financial statements annually. The
Fund is not involved in any litigation.
- --------------------------------------------------------------------------------
15
<PAGE>
SHAREHOLDER GUIDE
OPENING AN You may open a regular (non-retirement) account,
ACCOUNT AND either by mail or wire. Simply complete and return an
PURCHASING Account Registration Form and any required legal
SHARES documentation, indicating 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 Gifts/Transfers to
Minors Act accounts and IRAs). You must open a new
Individual Retirement Account by mail (IRAs may not
be opened by wire) using a Vanguard IRA Adoption
Agreement. Your purchase must be equal to or greater
than the $1,000 minimum initial investment
requirement, but no more than $2,000 if you are
making a regular IRA contribution. Rollover
contributions are generally limited to the amount
withdrawn within the past 60 days from an IRA or
other qualified retirement plan. If you need
assistance with the form or have any questions about
this Fund, 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.
The Fund's shares are purchased at the
next-determined net asset value after your investment
has been received. 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 common stock
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 stock 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 Subsequent investments to regular accounts may be
investments made by mail ($100 minimum), wire ($1,000 minimum),
exchange from another Vanguard Fund account ($100
minimum), or Vanguard Fund Express. Subsequent
investments to Individual Retirement Accounts may be
made by mail ($100 minimum) or exchange from another
Vanguard Fund account. In some instances,
contributions may be made by wire or Vanguard Fund
Express. Please call us for more information on these
options.
16
<PAGE>
<TABLE>
<S> <C> <C>
ADDITIONAL INVESTMENTS
NEW ACCOUNT TO EXISTING ACCOUNTS
Purchasing By Mail Please include the amount of
Complete and sign your initial investment on Additional investments should include
the enclosed Account the registration form, make the Invest-by-Mail remittance form
Registration Form your check payable to The attached to your Fund confirmation
Vanguard Group-82 and mail statements. Please make your check
to: payable to The Vanguard Group-82,
write your account number on your
Vanguard Financial Center check and, using the return envelope
P.O. Box 2600 provided, mail to the address
Valley Forge, PA 19482-2600 indicated on the Invest-by-Mail Form.
For express Vanguard Financial Center All written requests should be mailed
or registered mail, 455 Devon Park Drive to one of the addresses indicated for
send to: Wayne, PA 19087-1815 new accounts. Do not send registered
or express mail to the post office
box address.
</TABLE>
-----------------------------------------------------
Purchasing By Wire CORESTATES BANK, N.A.
Money should be ABA 031000011
wired to: CORESTATES NO. 0101 9897
ATTN VANGUARD
Before Wiring VANGUARD CONVERTIBLE SECURITIES FUND
Please contact ACCOUNT NUMBER
Client Services ACCOUNT REGISTRATION
(1-800-662-2739)
To assure proper receipt, please be sure your bank
includes the name of the Fund selected, 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 You may open a new account or purchase additional
Exchange (from a shares by making an exchange from an existing
Vanguard account) Vanguard account. Please call our Client Services
Department at 1-800-662-2739. The new account will
have the same registration as the existing account.
However, the Fund reserves the right to refuse any
exchange purchase request.
-----------------------------------------------------
Purchasing By Fund The Fund Express Special Purchase option lets you
Express move money from your bank account to your Vanguard
Special Purchase and account on an "as needed" basis. Or if you choose the
Automatic Investment Automatic Investment option, money will be moved
automatically from your bank account to your Vanguard
account on the schedule (monthly, bimonthly [every
other month], quarterly, semi-annually or annually)
you select. To estab-
17
<PAGE>
lish 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 two weeks before using
the service.
- --------------------------------------------------------------------------------
CHOOSING A You must select one of three distribution options:
DISTRIBUTION
OPTION 1. Automatic Reinvestment Option--Both dividends and
capital gains distributions will be reinvested in
additional Fund shares. This option will be
selected for you automatically unless you specify
one of the other options.
2. Cash Dividend Option--Your dividends will be paid
in cash and your capital gains will be reinvested
in additional Fund shares.
3. All Cash Option--Both dividend and capital gains
distributions will be paid in cash.
You may change your option by calling our Client
Services Department (1-800-662-2739).
In addition, an option to invest your cash dividends
and/or capital gains distributions in another
Vanguard Fund account is available. Please call our
Client Services Department (1-800-662-2739) for
information. You may also elect Vanguard Dividend
Express which allows you to transfer your cash
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 dividend income to
Investors should ask Fund shareholders. These distributions are made to
about the timing of all shareholders who own Fund shares as of the
capital gains and distribution's record date, regardless of how long
dividend the shares have been owned. Purchasing shares just
distributions before prior to the record date could have a significant
investing impact on your tax liability for the year. For
example, if you purchase shares immediately prior to
the record date of a sizable capital gain or income
dividend distribution, you will be assessed taxes on
the amount of the capital gain and/or dividend
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 dividend or
gain is reinvested in additional Fund shares.) While
the total value of your investment will be the same
after the distribution--the amount of the
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 quarterly in March, June, September
and December. For additional information on
distributions and taxes, see the section titled
"Dividends, Capital Gains, and Taxes."
- --------------------------------------------------------------------------------
18
<PAGE>
IMPORTANT The easiest way to establish optional Vanguard
INFORMATION services on your account is to select the options you
desire when you complete your Account Registration
Establishing Optional Form. If you wish to add shareholder options later,
Services 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 that Vanguard deems
acceptable. A signature guarantee cannot be provided
by a notary public.
Certificates Share certificates will be issued upon request. If a
certificate is lost, you may incur an expense to
replace it.
Broker-Dealer If you purchase shares in Vanguard Funds through a
Purchases registered broker-dealer or investment adviser, the
broker-dealer or adviser may charge a service fee.
Cancelling Trades The Fund will not cancel any trade (e.g., purchase,
exchange or redemption) believed to be authentic,
received in writing or by telephone, once the trade
request has been received.
Electronic Prospectus You may receive a prospectus for the Fund or any of
Delivery the Vanguard Funds in an electronic format. Please
call 1-800-231-7870 for additional information or see
"Other Vanguard Services--Computer Access." You may
also receive a paper copy of the prospectus, by
calling 1-800-662-7447.
- --------------------------------------------------------------------------------
WHEN YOUR Your trade date is the date on which your account is
ACCOUNT WILL BE credited. If your purchase is made by check, Federal
CREDITED Funds wire or exchange and 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 day of receipt. If your purchase is received
after the close of regular trading on the Exchange,
your trade date is the next business day. Your shares
are purchased at the net asset value determined on
your trade date.
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.
The Fund reserves the right to suspend the offering
of shares for a period of time. The Fund also
reserves the right to reject any specific purchase
request.
- --------------------------------------------------------------------------------
SELLING YOUR You may withdraw any portion of the funds in your
SHARES account by redeeming shares at any time. (Please see
"Important Redemption Information.") You generally
may initiate a request by writing or by telephoning.
Your redemption proceeds are normally mailed within
two business days after the receipt of the request in
Good Order.
-----------------------------------------------------
19
<PAGE>
Selling By Mail Requests should be mailed to Vanguard Financial
Center, Vanguard Convertible Securities Fund, P.O.
Box 1120, Valley Forge, PA 19482. (For express or
registered mail, send your request to Vanguard
Financial Center, Vanguard Convertible Securities
Fund, 455 Devon Park Drive, Wayne, PA 19087.)
The redemption price of shares will be the Fund's net
asset value next determined after Vanguard has
received all required documents in Good Order.
-----------------------------------------------------
Definition of Good Good Order means that the request includes the
Order following:
1. The account number and Fund name.
2. The amount of the transaction (specified in
dollars or shares).
3. The signatures of all owners exactly as they are
registered on the account.
4. Any required signature guarantees.
5. Other supporting legal documentation that might be
required, in the case of estates, corporations,
trusts, and certain other accounts.
6. Any certificates that you are holding for the
account.
If you have any 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. The proceeds
will be sent to you by mail. Please Note: As a
protection against fraud, your telephone mail
redemption privilege will be suspended for 15
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. Please see "Important Information About
Telephone Transactions."
-----------------------------------------------------
Selling By Fund If you select the Fund Express Automatic Withdrawal
Express option, money will be automatically moved from your
Vanguard Fund account to your bank account according
Automatic Withdrawal & to the schedule you have selected. The Special
Special Redemption Redemption option lets you move 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 two weeks before using the service.
-----------------------------------------------------
Selling By Exchange You may sell shares of the Fund by making an exchange
to another Vanguard Fund account. Please see
"Exchanging Your Shares" for details.
-----------------------------------------------------
Important Shares purchased by check or Fund Express may be
Redemption redeemed at any time. However, your redemption
Information proceeds will not be paid until payment for the
purchase is collected, which may take up to ten
calendar days.
20
<PAGE>
Delivery of Redemption requests received by telephone prior to
Redemption Proceeds the close of regular trading on the New York Stock
Exchange 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 (generally 4:00 p.m., Eastern
time) 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 on page 20 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.
If the Board of Directors determines that it would be
detrimental to the best interests of the Fund's
remaining shareholders to make payment in cash, the
Fund may pay redemption proceeds in excess of
$250,000 in whole or in part by a distribution in
kind of readily marketable securities.
-----------------------------------------------------
Vanguard's Average If you make a redemption from a qualifying account,
Cost Statement 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 Due to the relatively high cost of maintaining
Minimum Account smaller accounts, the Fund will automatically deduct
Balance Requirement a $10 annual fee from non-retirement accounts with
balances falling below $2,500 ($500 for Uniform
Gifts/Transfers to Minors Act accounts). 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
the 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
requirement. 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 Fund's net asset
value).
21
<PAGE>
EXCHANGING YOUR Should your investment goals change, you may exchange
SHARES your shares of Vanguard Convertible Securities Fund
for those of other available Vanguard Funds.
Exchanging By
Telephone When exchanging shares by telephone, please have
Call Client Services ready the Fund name, account number, Social Security
(1-800-662-2739) Number or Employer Identification Number listed on
the account, and the exact name and address in which
the account is registered. 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
non-retirement investments in Vanguard Balanced Index
Fund, Vanguard Index Trust, Vanguard REIT Index
Portfolio, 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 on your exchange request
the name and account number of your current Fund, 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 Convertible
Securities Fund, P.O. Box 1120, Valley Forge, PA
19482. (For express or registered mail, send your
request to Vanguard Financial Center, Vanguard
Convertible Securities Fund, 455 Devon Park Drive,
Wayne, PA 19087.)
-----------------------------------------------------
Important Exchange Before you make an exchange, you should consider the
Information 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 the 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.
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.
22
<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 exchange privilege is only available in states in
which shares of the Fund are registered for sale. The
Fund's shares are currently registered for sale in
all 50 states and the Fund intends to maintain such
registration.
- --------------------------------------------------------------------------------
EXCHANGE The Fund's exchange privilege is not intended to
PRIVILEGE afford shareholders a way to speculate on short-term
LIMITATIONS 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 the Fund
during any twelve month period. 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 The ability to initiate redemptions (except wire
INFORMATION redemptions) and exchanges by telephone is
ABOUT TELEPHONE automatically established on your account unless you
TRANSACTIONS request in writing that telephone transactions on
your account not be permitted.
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 Fund; (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 made by mail will be made payable to
the registered shareowner and mailed to the
address of record, only.
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.
- --------------------------------------------------------------------------------
TRANSFERRING You may transfer the registration of any of your Fund
REGISTRATION shares to another person by completing a transfer
form and sending it to: Vanguard Financial Center,
23
<PAGE>
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 Vanguard will send you a confirmation statement each
REPORTS 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
during the calendar year, 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 in February of the
following year. Please call our Client Services
Department (1-800-662-2739) for information.
Financial reports on the Fund will be mailed to you
semi-annually, according to the Fund's fiscal
year-end.
- --------------------------------------------------------------------------------
OTHER VANGUARD For more information about any of these services,
SERVICES please call our Investor Information Department at
1-800-662-7447.
Vanguard Direct With Vanguard's Direct Deposit Service, most U.S.
Deposit Service 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 Vanguard's Automatic Exchange Service allows you to
Exchange Service 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 Vanguard's Fund Express allows you to transfer money
Express 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.
Vanguard Dividend Vanguard's Dividend Express allows you to transfer
Express your dividends and/or capital gains distributions
automatically from your Fund account, one business
day after
24
<PAGE>
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 Vanguard's Tele-Account is a convenient, automated
Tele-Account service that provides share price, price change and
yield quotations on Vanguard Funds through any
TouchTone(TM) telephone. This service also lets you
obtain information about your account balance, your
last transaction, and your most recent dividend or
capital gains payment. In addition, you may perform
investment exchanges of Vanguard Fund shares and
redemptions by check using Tele-Account. 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).
Computer Access Vanguard Online allows you to obtain information via
Vanguard Online your personal computer on Fund share price, yield,
Keyword: vanguard and total return. Vanguard Online is offered through
America Online (AOL). To establish an AOL account,
call 1-800-238-6336.
Vanguard on the Vanguard sponsors an education-oriented website
World Wide Web offering news and information about Vanguard Funds
http://www.vanguard.com and services, as well as interactive, easy-to-use
investment planning tools.
25
<PAGE>
(This page intentionally left blank.)
26
<PAGE>
LOGO
P R O S P E C T U S
MARCH 7, 1997
LOGO
------
The Vanguard Group
Vanguard Financial Center
Valley Forge, PA 19482
Investor Information
Department:
1-800-662-7447
Client Services
Department:
1-800-662-2739
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 A member of
Valley Forge, PA 19482 The Vanguard Group(R)
P082
<PAGE>
PART B
VANGUARD CONVERTIBLE SECURITIES FUND, INC.
STATEMENT OF ADDITIONAL INFORMATION
MARCH 7, 1997
This Statement is not a prospectus but should be read in conjunction with
the Fund's current Prospectus dated March 7, 1997. To obtain the Prospectus
please call:
INVESTOR INFORMATION DEPARTMENT
1-800-662-7447
TABLE OF CONTENTS
Page
--------
Investment Limitations ......................................... B-1
Purchase of Shares ............................................. B-2
Redemption of Shares ........................................... B-3
Management of the Fund ......................................... B-3
Directors and Officers ......................................... B-5
Investment Advisory Services ................................... B-7
Portfolio Transactions ......................................... B-9
General Information ............................................ B-10
Yield and Total Return ......................................... B-10
Comparative Indexes ............................................ B-10
Financial Statements ........................................... B-13
Appendix--Description of Securities and Ratings ................ B-14
INVESTMENT LIMITATIONS
The following restrictions are fundamental policies and cannot be changed
without approval of the holders of a majority of the outstanding shares of
the Fund or, if less, 67% of the shares represented at a meeting of
shareholders at which the holders of 50% or more of the shares are
represented. The Fund may not under any circumstances:
1. Borrow money, except that the Fund may borrow from banks (or through
reverse repurchase agreements), for temporary or emergency (not
leveraging) purposes, including the meeting of redemption requests which
might otherwise require the untimely disposition of securities, in an
amount not exceeding 10% of the value of the Fund's total assets
(including the amount borrowed) at the time the borrowing is made.
Whenever borrowings exceed 5% of the value of the Fund's total assets, the
Fund will not make any additional investments;
2. With respect to 75% of the value of its total assets, purchase the
securities of any issuer (except obligations of the United States
government and its instrumentalities) if as a result the Fund would hold
more than 10% of the outstanding voting securities of the issuer, or more
than 5% of the value of the Fund's total assets would be invested in the
securities of such issuer;
3. Invest for the purpose of exercising control of management of any
company;
B-1
<PAGE>
4. Invest in securities of other investment companies, except as they
may be acquired as part of a merger, consolidation or acquisition of
assets or otherwise to the extent permitted by Section 12 of the
Investment Company Act of 1940 (the "1940 Act"). The Fund will invest only
in investment companies which have investment objectives and investment
policies consistent with those of the Fund;
5. Engage in the business of underwriting securities issued by other
persons, except to the extent that the Fund may technically be deemed to
be an underwriter under the Securities Act of 1933, as amended, in
disposing of investment securities;
6. Purchase or otherwise acquire any security if, as a result, more
than 15% of its net assets would be invested in securities that are
illiquid (including the Fund's investment in The Vanguard Group, Inc.);
7. Invest in commodities or real estate, although the Fund may purchase
and sell securities of companies which deal in real estate, or interests
therein, and the Fund may purchase covered call options as described in
the prospectus;
8. Purchase securities on margin or sell any securities short;
9. Invest more than 5% of the assets of the Fund, at the time of
investment, in the securities of any issuers which have (with
predecessors) a record of less than three years' continuous operation;
10. Purchase or retain any security if (i) one or more officers,
directors or partners of the Fund or its investment adviser individually
own or would own, directly or beneficially, more than 1/2 of 1 per cent of
the securities of such issuer, and (ii) in the aggregate such persons own
or would own more than 5% of such securities;
11. Make loans except (i) by purchasing bonds, debentures or similar
obligations (including repurchase agreements, subject to the limitation
described in (6) above), which are publicly distributed, and (ii) by
lending its securities to banks, brokers, dealers and other financial
institutions so long as such loans are not inconsistent with the
Investment Company Act or the Rules and Regulations or interpretations of
the Securities and Exchange Commission (the "Commission") thereunder;
12. Pledge, mortgage, or hypothecate any of its assets to an extent
greater than 5% of its total assets;
13. Invest directly in interests in oil, gas or other mineral
exploration or development programs; and
14. Invest more than 25% of the value of its total assets in any one
industry.
The above mentioned investment limitations are considered at the time
investment securities are purchased. Notwithstanding these limitations, the
Fund 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 wholly-owned by the Fund and one or more other investment companies
and is primarily engaged in the business of providing, at-cost, management,
administrative, distribution or related services to the Fund and other
investment companies. See "The Vanguard Group."
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 for certain fiduciary accounts or under
circumstances where certain economies can be achieved in sales of the Fund's
shares.
B-2
<PAGE>
REDEMPTION OF SHARES
The Fund may suspend redemption privileges or postpone the date of payment
for redeemed shares (i) during any period that the New York Stock Exchange is
closed, or trading on the Exchange is restricted, as determined by 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
determine the value of its assets; and (iii) for such other periods as the
Commission may permit.
No charge is made by the Fund for redemptions. Any redemption may be more
or less than the shareholder's cost, depending on the current market value of
the securities held by the Fund.
The Fund has made an election with the Commission to pay in cash all
redemptions requested by any shareholder of record limited in amount during
any 90-day period to the lesser of $250,000 or 1% of the net assets of the
Fund at the beginning of such period. Such commitment is irrevocable without
the prior approval of the Commission. Redemptions in excess of the above
limits may be paid in whole or in part in investment securities or in cash,
as the Directors may deem advisable; however, payment will be made wholly in
cash unless the Directors believe that economic or market conditions exist
which would make such a practice detrimental to the best interests of the
Fund. If redemptions are paid in investment securities, such securities will
be valued as set forth in the Prospectus under "The Fund's Share Price," and
a redeeming shareholder would normally incur brokerage expenses if he
converted these securities to cash.
MANAGEMENT OF THE FUND
THE VANGUARD GROUP
Vanguard Convertible Securities 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. 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 Directors (Trustees) of each Fund. In
addition, each Fund bears its own direct expenses such as legal, auditing and
custodian fees.
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.
Vanguard 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.
Vanguard was established and operates under a Funds' Service Agreement
which was approved by the shareholders of each of the Funds. The amounts
which each of the Funds has invested in Vanguard are
B-3
<PAGE>
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, 1996, the Fund had contributed capital of
$16,000 to Vanguard, representing .10% of Vanguard's capitalization. The
Funds' Service Agreement provides for the following arrangement: (1) each
Vanguard Fund may invest a maximum of 0.40% of its assets in Vanguard; and
(2) there is no restriction on the maximum aggregate cash investment that the
Vanguard Funds may make in Vanguard.
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, 1996, the Fund's share of actual net costs
of operation relating to management and administrative services provided by
Vanguard totaled approximately $457,000.
Distribution. Vanguard provides all distribution and marketing activities
for the Funds in the Group. Vanguard Marketing Corporation, a wholly-owned
subsidiary of Vanguard, acts as Sales Agent for the 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 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 relative net assets. The
remaining one-half of those 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 average distribution expense rate for the Group,
and that no Fund shall incur annual distribution expenses in excess of .02 of
1% of its average month-end net assets. During the fiscal year ended November
30, 1996, the Fund paid approximately $30,000 of the group's distribution and
marketing expenses, or approximately .02 of 1% of its average month-end
assets.
Investment Advisory Services. Vanguard provides investment advisory
services to Vanguard Money Market Reserves, Vanguard Bond Index Fund,
Vanguard REIT Index Portfolio, Vanguard Index Trust, Vanguard Balanced Index
Fund, Vanguard International Equity Index Fund, Vanguard Municipal Bond Fund,
several portfolios of Vanguard Fixed Income Securities Fund, Vanguard Admiral
Funds, Vanguard Institutional Index Fund, several Portfolios of Vanguard
Variable Insurance Fund, Vanguard California Tax-Free Fund, Vanguard New York
Insured Tax-Free Fund, Vanguard Pennsylvania Tax-Free Fund, Vanguard Ohio
Tax-Free Fund, Vanguard Florida Insured Tax-Free Fund, Vanguard New Jersey
Tax-Free Fund, Vanguard Tax-Managed Fund, Aggressive Growth Portfolio of
Vanguard Horizon Fund, Total International Portfolio of Vanguard STAR Fund, a
portion of Vanguard/Windsor II and 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.
B-4
<PAGE>
DIRECTORS AND OFFICERS
The Officers of the Fund manage its day-to-day operations and are
responsible to the Fund's Board of Directors. The Directors set broad
policies for the Fund and choose its Officers. The following is a list of
Directors and Officers of the Fund and a statement of their present positions
and principal occupations during the past five years. The mailing address of
the Fund's Directors and Officers is Post Office Box 876, Valley Forge, PA
19482.
JOHN C. BOGLE, Chairman and Director*
Chairman and Director of The Vanguard Group, Inc., and each of the
investment companies in The Vanguard Group; Director of The Mead
Corporation, General Accident Insurance and Chris-Craft Industries, Inc.
JOHN J. BRENNAN, President, Chief Executive Officer & Director*
President, Chief Executive Officer and Director of The Vanguard Group, Inc.
and each of the investment companies in The Vanguard Group.
ROBERT E. CAWTHORN, Director
Chairman Emeritus and Director of Rhone-Poulenc Rorer, Inc.; Director of Sun
Company, Inc. and Westinghouse Electric Corporation.
BARBARA BARNES HAUPTFUHRER, Director
Director of The Great Atlantic and Pacific Tea Company, Raytheon Company,
Knight-Ridder, Inc., and Massachusetts Mutual Life Insurance Co. and Trustee
Emerita of Wellesley College.
BRUCE K. MACLAURY, Director
President Emeritus of The Brookings Institution; Director of American
Express Bank, Ltd., The St. Paul Companies, Inc., and National Steel
Corporation.
BURTON G. MALKIEL, Director
Chemical Bank Chairman's Professor of Economics, Princeton University;
Director of Prudential Insurance Co. of America, Amdahl Corporation, Baker
Fentress & Co., The Jeffrey Co. and Southern New England Communications
Company.
ALFRED M. RANKIN, JR., Director
Chairman, President, and Chief Executive Officer of NACCO Industries, Inc.;
Director of The BFGoodrich Company and The Standard Products Company.
JOHN C. SAWHILL, Director
President and Chief Executive Officer, The Nature Conservacy; formerly,
Director and Senior Partner, McKinsey & Co. and President, New York
University; Director, Pacific Gas and Electric Company, Procter & Gamble
Company and NACCO Industries.
JAMES O. WELCH, JR., Director
Retired Chairman of Nabisco Brands Inc. and retired Vice Chairman and
Director of RJR Nabisco; Director, TECO Energy, Inc. and Kmart Corporation.
J. LAWRENCE WILSON, Director
Chairman and Chief Executive Officer of Rohm & Haas Company; Director of
Cummins Energy 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.
------
* Mr. Bogle and the Officers of the Fund are "interested persons" as defined
in the Investment Company Act of 1940.
B-5
<PAGE>
REMUNERATION OF DIRECTORS AND OFFICERS
The Fund pays each Director who is not also an Officer an annual fee plus
travel and other expenses incurred in attending Board meetings. 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 fiscal
year ended November 30, 1996 the Fund paid approximately $1,000 in Directors
fees and expenses to its "non interested" directors. The Fund's proportionate
share of remuneration paid by Vanguard (and reimbursed by the Fund) during
the fiscal year was $5,192.
Directors who are not Officers are paid an annual fee upon retirement
equal to $1,000 for each year of service on the Board, up to a maximum of
$15,000. This fee is paid for a period of ten years or until the death of a
retired Director, and each Vanguard Fund contributes a proportionate amount
of this fee based on its relative net assets. Under its Retirement Plan,
Vanguard contributes annually an amount equal to 10% of each Officer's annual
compensation plus 5.7% of that part of the 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 equal to 4% of total compensation
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 eligible Officers of the Fund as a group during the
1996 fiscal year was approximately $1,500.
The following table provides detailed information with respect to the
amounts paid or accrued for the Directors for the fiscal year ended November
30, 1996.
VANGUARD CONVERTIBLE SECURITIES FUND
COMPENSATION TABLE
<TABLE>
<CAPTION>
Aggregate Pension or Retirement Estimated Total Compensation
Compensation Benefits Accrued As Annual Benefits From All Vanguard Funds
Names of Directors From Fund Part of Fund Expenses Upon Retirement Paid to Directors(2)
--------------------------- -------------- --------------------- --------------- -----------------------
<S> <C> <C> <C> <C>
John C. Bogle(1) .......... -- -- -- --
John J. Brennan(1) ........ -- -- -- --
Barbara Barnes Hauptfuhrer $65 $10 $15,000 $65,000
Robert E. Cawthorn ........ $65 $ 8 $13,000 $65,000
Bruce K. MacLaury ......... $70 $10 $12,000 $60,000
Burton G. Malkiel ......... $65 $ 7 $15,000 $65,000
Alfred M. Rankin, Jr. ..... $65 $ 5 $15,000 $65,000
John C. Sawhill ........... $65 $ 6 $15,000 $65,000
James O. Welch, Jr. ....... $65 $ 8 $15,000 $65,000
J. Lawrence Wilson ........ $65 $ 6 $15,000 $65,000
</TABLE>
(1) As "Interested Directors," Messrs. Bogle and Brennan receive no
compensation for their service as Directors.
(2) The amounts reported in this column reflect the total compensation paid
to each Director for their service as Director or Trustee of 34 Vanguard
Funds (33 in the case of Mr. Malkiel; 27 in the case of Mr. MacLaury).
B-6
<PAGE>
INVESTMENT ADVISORY SERVICES
The Fund employs Oaktree Capital Management, LLC (the "Adviser") under an
investment advisory agreement dated November 1, 1996 to manage the investment
and reinvestment of the assets of the Fund and to continuously review,
supervise and administer the Fund's investment program. The Adviser
discharges its responsibilities subject to the control of the Officers and
Directors of the Fund.
The Fund pays the Adviser an advisory fee at the end of each fiscal
quarter, calculated by applying a quarterly rate, based on the following
annual percentage rates, to the Fund's average month-end net assets for the
quarter (the "Basic Fee"):
Net Assets Rate
- ------------------ --------
First $100 million ................................................ 0.425%
Next $100 million ................................................. 0.400%
Next $100 million ................................................. 0.375%
Next $100 million ................................................. 0.350%
Over $400 million ................................................. 0.325%
It is not intended that the funding under this contract will exceed $500
million.
Beginning November 30, 1997, the Basic Fee payment to the Adviser may be
increased or decreased by a Performance Fee Adjustment (the "Adjustment").
The Adjustment shall be a percentage of the Basic Fee and shall change
proportionately with the investment performance of the Fund relative to the
investment performance of the First Boston Convertible Securities Index (the
"Index"). The following table sets forth the Adjustment of the Basic Fee
payable by the Fund to the Adviser under the investment advisory agreement.
Cumulative Performance of
the Fund vs. the Index Performance Fee Adjustment
for the Relevant Period as a Percentage of Basic Fee
--------------------------------------- --------------------------------
- -100% of Performance Factor or more -50%
- -1% to -99% of Performance Factor 0 to -50%
0 0
+1% to +99% Performance Factor 0 to +50%
+100% of Performance Factor or more +50%
The Adjustment will be calculated as follows, using data from the table
below:
To calculate the Adjustment for a given quarter, (1) for the Relevant
Period for that quarter as set forth in the table below (the "Relevant
Period"), the difference between the investment performance of the Fund and
the investment performance of the Index (the "Performance Differential") will
be calculated, (2) the Performance Differential will be compared to the
Performance Factor specified by the table for that period to determine the
extent to which an Adjustment is in order, and (3) the Adjustment will be the
appropriate percentage of the Basic Fee* for an average quarter in that
Relevant Period determined from the table above.
- ------
* For purposes of this calculation, the relevant Basic Fee is calculated by
applying the quarterly rate against average assets over which performance
is measured.
B-7
<PAGE>
Performance
Quarter Ending Relevant Period Factor (b.p.)
--------------- ---------------- -------------
Before 11/30/97 --no adjustment--
11/30/97 12/1/96-11/30/97 67
2/28/98 12/1/96-2/28/98 83
5/31/98 12/1/96-5/31/98 100
8/31/98 12/1/96-8/31/98 117
11/30/98 12/1/96-11/30/98 133
2/28/99 12/1/96-2/28/99 150
5/31/99 12/1/96-5/31/99 167
8/31/99 12/1/95-8/31/99 183
11/30/99 12/1/96-11/30/99 200
After 11/30/99 prior 36 months 200
The investment performance of the Fund for such period, expressed as a
percentage of the net asset value per share of the Fund at the beginning of
such period, shall be the sum of: (i) the change in the net asset value per
share of the Fund during such period; (ii) the value of the cash
distributions per share of the Fund accumulated to the end of such period;
and (iii) the value of capital gains taxes per share paid or payable by the
Fund on undistributed realized long-term capital gains accumulated to the end
of such period. For this purpose, the value of distributions per share of
realized capital gains, of dividends per share paid from investment income
and of capital gains taxes per share paid or payable on undistributed
realized long-term capital gains shall be treated as reinvested in shares of
the Fund at the net asset value per share in effect at the close of business
on the record date for the payment of such distributions and dividends and
the date on which provision is made for such taxes, after giving effect to
such distributions, dividends and taxes.
The "investment record" of the Index for the period, expressed as a
percentage of the Index level at the beginning of the period, shall be the
sum of (i) the change in the level of the Index during the period and (ii)
the value, computed consistently with the Index, of cash distributions having
an ex-dividend date occurring within the period made by companies whose
securities comprise the Index.
During the fiscal years ended November 30, 1994, 1995, and 1996, the Fund
paid investment advisory fees of approximately $749,000, $674,000, and
$578,000 respectively.
The agreement will continue until October 31, 1998 and will be renewable
thereafter for successive one- year periods, only if each renewal is
specifically approved by a vote of the Fund's Board of Directors, including
the affirmative votes of a majority of the Directors who are not parties to
the contract or "interested persons" (as defined in the Investment Company
Act of 1940) of any such party, cast in person at a meeting called for the
purpose of considering such approval. In addition, the question of
continuance of the agreement may be presented to the shareholders of the
Fund; in such event, continuation must be approved by the affirmative vote of
a majority of the outstanding voting securities of the Fund. The agreement is
automatically terminated if assigned, and may be terminated without penalty
at any time (1) either by vote of the Board of Directors of the Fund or by
vote of its outstanding voting securities on 60 days' written notice to the
Adviser, or (2) by the Adviser upon 60 days' written notice to the Fund.
The Fund's Board of Directors may, without the approval of shareholders,
provide for:
A. The employment of a new investment adviser pursuant to the terms of
a new advisory agreement, either as a replacement for an existing adviser
or as an additional adviser;
B-8
<PAGE>
B. A change in the terms of an advisory agreement; and
C. The continued employment of an existing adviser, on the same
advisory contract terms, where a contract has been assigned because of a
change in control of the adviser.
Any such change will only be made upon not less than 30 days' prior
written notice to shareholders, which shall include the information
concerning the adviser that would have normally been included in a proxy
statement.
Oaktree Capital Management, LLC specializes in selected niche investment
markets. The founders of Oaktree formed the company in April of 1995 after
having managed funds in the convertible securities, distressed debt, and high
yield bond areas of Trust Company of the West (TCW) since 1985.
Larry W. Keele, Principal and one of the five founders of Oaktree, serves
as Portfolio Manager of the Fund. Mr. Keele is supported by research and
other investment services provided by the professional staff of Oaktree. As
of November 30, 1996, Oaktree managed approximately $7.3 billion.
PORTFOLIO TRANSACTIONS
The investment advisory agreement authorizes the Adviser (with the
approval of the Fund's Board of Directors) to select the brokers or dealers
that will execute the purchases and sales of portfolio securities for the
Fund and directs the Adviser to use its best efforts to obtain the best
available price and most favorable execution as to all transactions for the
Fund. The Adviser has undertaken to execute each investment transaction at a
price and commission which provides the most favorable total cost or proceeds
reasonably obtainable under the circumstances.
In placing portfolio transactions, the Adviser will use its best judgment
to choose the broker most capable of providing the brokerage services
necessary to obtain best available price and most favorable execution. The
full range and quality of brokerage services available will be considered in
making these determinations. In those instances where it is reasonably
determined that more than one broker can offer the brokerage services needed
to obtain the best available price and most favorable execution,
consideration may be given to those brokers which supply investment research
and statistical information and provide other services in addition to
execution services to the Fund and/or the Adviser. The Adviser considers such
information useful in the performance of its obligations under the agreement,
but is unable to determine the amount by which such services may reduce its
expenses.
The investment advisory agreement also incorporates the concepts of
Section 28(e) of the Securities Exchange Act of 1934 by providing that,
subject to the approval of the Fund's Board of Directors, the Adviser may
cause the Fund to pay a broker-dealer which furnishes brokerage and research
services a higher commission than that which might be charged by another
broker-dealer for effecting the same transaction; provided that such
commission is deemed reasonable in terms of either that particular
transaction or the overall responsibilities of the Adviser to the Fund.
Currently, it is the Fund's policy that the Adviser may at times pay
higher commissions in recognition of brokerage services felt necessary for
the achievement of better execution of certain securities transactions that
otherwise might not be available. The Adviser will only pay such higher
commissions if it believes this to be in the best interest of the Fund. Some
brokers or dealers who may receive such higher commissions in recognition of
brokerage services related to execution of securities transactions are also
providers of research information to the Adviser and/or the Fund. However,
the Adviser has informed the Fund that it will not pay higher commission
rates specifically for the purpose of obtaining research services.
B-9
<PAGE>
Since the Fund does not market its shares through intermediary brokers or
dealers, it is not the Fund's practice to allocate brokerage or principal
business on the basis of sales of its shares which may be through such firms.
However, the Fund may place portfolio orders with qualified broker-dealers
who recommend the Fund to other clients, or who act as agent in the purchase
of the Fund's shares for their clients, and may, when a number of brokers and
dealers can provide comparable best price and execution on a particular
transaction, consider the sale of the Fund shares by a broker or dealer in
selecting among qualified broker-dealers.
Some securities considered for investment by the Fund may also be
appropriate for other clients served by the Adviser. If purchase or sale of
securities consistent with the investment policies of the Fund and one or
more of these other clients serviced by the Adviser are considered at or
about the same time, transactions in such securities will be allocated among
the Fund and such other clients in a manner deemed equitable by the Adviser.
During the fiscal years ended November 30, 1994, 1995 and 1996 the Fund paid
$58,489, $38,822, and $111,718 in brokerage commissions.
GENERAL INFORMATION
DESCRIPTION OF SHARES AND VOTING RIGHTS
The Fund is a diversified open-ended investment company established under
Maryland law. The Fund's Amended and Restated Articles of Incorporation dated
April 8, 1986 permit the Directors to issue 1,000,000,000 shares of common
stock, with a $.001 par value. The Board of Directors has the power to
designate one or more classes ("Portfolios") of shares of common stock and to
classify or reclassify any unissued shares with respect to such Portfolios.
Currently the Fund is offering shares of one portfolio.
The shares of the Fund are fully paid and non-assessable, and have no
preference as to conversion, exchange, dividends, retirement or other
features. The shares have no pre-emptive rights. The shares have
non-cumulative voting rights, which means that the holders of more than 50%
of the shares voting for the election of Directors can elect 100% of the
Directors 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.
YIELD AND TOTAL RETURN
The yield of the Fund for the 30-day period ended November 30, 1996 was
+2.85%.
The average annual total return of the Fund for the one-, five-, and
ten-year periods ended November 30, 1996 was +14.88%, +13.05% and +9.73%,
respectively. The average annual total return of the Fund for the period
since its inception on June 17, 1986 was +9.27%.
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.
B-10
<PAGE>
Each of the investment company members of the Vanguard Group, including
Vanguard Convertible Securities Fund, may, from time to time, use one or more
of the following unmanaged indices 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 Index--consists of more than 7,000 common equity
securities, covering all stocks in the U.S. for which daily pricing is
available.
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.
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, Australasia 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.
The Lehman Aggregate Bond Index is composed of the Lehman Brothers
Government/Corporate Bond Index and the Lehman Brothers Mortgage-Backed
Securities Index and includes treasury issues, agency issues, corporate bond
issues and mortgage-backed securities. All securities are rated investment
grade or higher by Moody's Investors Service, Standard & Poor's Corporation,
or Fitch Investor's Service, in that order. All issues have at least one year
to maturity and an outstanding par value of at least $100 million.
Lehman Long-Term Treasury Bond Index--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 Index--consist 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 issues rated at least Baa, with at least $50 million
principal outstanding and maturity greater than 10 years.
Bond Buyer Municipal Bond Index--is a yield index on current-coupon high
grade general-obligation municipal bonds.
B-11
<PAGE>
Standard & Poor's Preferred Index--is a yield index based upon the average
yield of four high grade, noncallable 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--65% Standard & Poor's 500 Index and 35% Lehman Long-Term
Corporate AA or Better Bond Index.
Composite Index--65% Lehman Long-Term Corporate AA or Better Bond Index and a
35% weighting in a blended equity composite (75% Standard & Poor's/BARRA
Value Index and 25% Standard & Poor's Utilities Index).
Lehman Long-Term Corporate AA or Better Bond Index--consists of all publicly
issued, fixed rate, nonconvertible investment grade, dollar-denominated, SEC
registered corporate debt rated AA or AAA.
Lehman Brothers Aggregate Bond Index--is a market weighted index that
contains over 4,000 individually priced U.S. Treasury, agency, corporate, and
mortgage pass-through securities corporate rated Baa--or better. The Index
has a market value of approximately $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
approximately $1.4 trillion.
Lehman Brothers Mutual Fund Intermediate (5-10) Government/Corporate
Index--is a market weighted index that contains individually priced U.S.
Treasury, agency, and corporate securities rated BBB--or better with
maturities between 5 and 10 years. The index has a market value of
approximately $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 of ten
or more years. The index has a market value of approximately $800 billion.
Lehman Brothers Mutual Fund Short (1-5) Investment Grade Debt Index--is a
market weighted index that contains all investment grade corporate debt
securities with maturities of one to five years. The index has a market value
of approximately $175 billion.
Lehman Brothers Mutual Fund Short (1-5) U.S. Treasury Index--is a market
weighted index that contains all U.S. Treasury securities with maturities of
one to five years. The index has a market value of approximately $1.1
trillion.
Lehman Brothers Mutual Fund Short (1-5) U.S. Government Index--is a market
weighted index that contains all U.S. Government agency and Treasury
securities with maturities of one to five years. The index has a market value
of approximately $1.3 trillion.
Lehman Brothers Mutual Fund Intermediate (5-10) U.S. Treasury Index--is a
market weighted index that contains all U.S. Treasury securities with
maturities of five to ten years. The index has a market value of
approximately $300 billion.
B-12
<PAGE>
Lehman Brothers Mutual Fund Intermediate (5-10) Investment Grade Debt
Index--is a market weighted index that contains all investment grade debt
securities with maturities of five to ten years. The index has a market value
of approximately $225 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 or 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. (This 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 General Equity Fund Average--an industry benchmark of average general
equity funds with similar investment objectives and policies, as measured by
Lipper Analytical Services, Inc.
Lipper Fixed Income Fund Average--an industry benchmark of average fixed
income funds with similar investment objectives and policies, as measured by
Lipper Analytical Services, Inc.
Russell 3000 Index--consists of approximately the 3,000 largest stocks of
U.S.-domiciled companies commonly traded on the New York and American Stock
Exchanges or the NASDAQ over-the-counter market, accounting for over 90% of
the market value of publicly traded stocks in the U.S.
Russell 2000 Stock Index--consists of the smallest 2,000 stocks within the
Russell 3000; a widely used benchmark for small capitalization common stocks.
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.
First Boston Convertible Securities Index--Established as a performance
benchmark in 1982, the Index is valued monthly and generally includes 250 to
300 issues of convertible securities rated B- or better by Standard & Poor's,
and a predominant proportion of the market capitalization of the total value
of all convertible securities.
FINANCIAL STATEMENTS
The Fund's Financial Statements for the year ended November 30, 1996,
including the financial highlights for each of the five fiscal years in the
period ended November 30, 1996, appearing in the Fund's 1996 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 1996 Annual Report to
Shareholders is enclosed with this Statement of Additional Information.
B-13
<PAGE>
APPENDIX--DESCRIPTION OF SECURITIES AND RATINGS
I. DESCRIPTION OF BOND RATINGS
Excerpts from Moody's Investors Service, Inc., ("Moody's") description of
its four highest bond ratings: AAA--judged to be the best quality. They carry
the smallest degree of investment risk; AA--judged to be of high quality by
all standards. Together with the Aaa group they comprise what are generally
known as high grade bonds; A--possess many favorable investment attributes
and are to be considered as "upper medium grade obligations"; 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--judged to
have speculative elements; their future cannot be considered as well assured;
B--generally lack characteristics of the desirable investment; CAA--are of
poor standing. Such issues may be in default or there may be present elements
of danger with respect to principal or interest; CA--speculative in a high
degree; often in default; C--lowest rated class of bonds; regarded as having
extremely poor prospects.
Moody's also supplies numerical indicators 1, 2 and 3 to rating
categories. The modifier 1 indicates that the security is in the higher end
of its rating category; the modifier 2 indicates a mid-range ranking; and 3
indicates a ranking toward the lower end of the category.
Excerpts from Standard & Poor's Corporation ("S&P") description of its
five highest bond ratings: AAA-- highest grade obligations. Capacity to pay
interest and repay principal is extremely strong; AA--also qualify as high
grade obligations. A very strong capacity to pay interest and repay principal
and differs from AAA issues only in small degree; A--regarded as upper medium
grade. They have a strong capacity to pay interest and repay principal
although they are somewhat susceptible to the adverse effects of changes in
circumstances and economic conditions than debt in higher rated categories;
BBB--regarded as having an adequate capacity to pay interest and repay
principal. Whereas it normally exhibits adequate protection parameters,
adverse economic conditions or changing circumstances are more likely to lead
to a weakened capacity to pay interest and repay principal for debt in this
category than in higher rated categories. This group is the lowest which
qualifies for commercial bank investment. BB, B, CCC, CC--predominately
speculative with respect to capacity to pay interest and repay principal in
accordance with terms of the obligation; BB indicates the lowest degree of
speculation and CC the highest.
S&P applies indicators "+," no character, and "-" to its rating
categories. The indicators show relative standing within the major rating
categories.
B-14
