<PAGE>
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PROSPECTUS FEBRUARY 27, 1995
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KEYSTONE INTERNATIONAL FUND INC.
200 BERKELEY STREET, BOSTON, MASSACHUSETTS 02116-5034
CALL TOLL FREE 1-800-343-2898
Keystone International Fund Inc. (the "Fund") is a mutual fund whose primary
investment objective is long-term growth of capital. As a secondary objective,
the Fund seeks modest income.
The Fund's investments are internationally varied among common stocks, debt
obligations and other securities of United States ("U.S.") and foreign companies
and governments. Excluding repurchase agreements, the Fund currently follows a
policy of investing solely in securities of non-U.S. issuers.
Your purchase payment is fully invested. There is no sales charge when you
buy the Fund's shares. The Fund may, however, impose a deferred sales charge,
which declines from 4% to 1%, if you redeem your shares within four years of
purchase.
The Fund has adopted a Distribution Plan (the "Distribution Plan") pursuant
to Rule 12b-1 under the Investment Company Act of 1940 (the "1940 Act") under
which it bears some of the costs of selling its shares to the public.
This prospectus sets forth concisely the information about the Fund that you
should know before investing. Please read it and retain it for future reference.
Additional information about the Fund is contained in a statement of
additional information dated February 27, 1995 which has been filed with the
Securities and Exchange Commission and is incorporated by reference into this
prospectus. For a free copy, or for other information about the Fund, write to
the address or call the telephone number listed above.
SHARES OF THE FUND ARE NOT DEPOSITS OR OBLIGATIONS OF, OR GUARANTEED OR
ENDORSED BY, ANY BANK, AND SHARES ARE NOT FEDERALLY INSURED BY THE FEDERAL
DEPOSIT INSURANCE CORPORATION, THE FEDERAL RESERVE BOARD, OR ANY OTHER AGENCY.
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TABLE OF CONTENTS
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<TABLE>
<CAPTION>
Page Page
<S> <C>
Fee Table .......................................... 2 How to Buy Shares .............................. 12
Financial Highlights ............................... 3 Distribution Plan .............................. 13
Fund Description ................................... 4 How to Redeem Shares ........................... 15
Fund Objectives and Policies ....................... 4 Shareholder Services ........................... 17
Risk Factors ....................................... 5 Performance Data ............................... 18
Investment Restrictions ............................ 8 Fund Shares .................................... 18
Pricing Shares ..................................... 9 Additional Information ......................... 18
Dividends and Taxes ................................ 9 Additional Investment Information ............. (i)
Fund Management and Expenses ....................... 10
</TABLE>
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THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
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<PAGE>
FEE TABLE
KEYSTONE INTERNATIONAL FUND INC.
The purpose of the fee table is to assist investors in understanding the
costs and expenses that an investor in the Fund will bear directly or
indirectly. For more complete descriptions of the various costs and expenses,
see the following sections of this prospectus: "Fund Management and Expenses";
"Distribution Plan"; and "Shareholder Services."
SHAREHOLDER TRANSACTION XPENSES
Contingent Deferred Sales Charge\1/ ................................. 4.00%
(as a percentage of the lesser of total cost or net asset value of shares
redeemed)
Exchange Fee\2/ (per exchange) .......................................... $10.00
ANNUAL FUND OPERATING EXPENSES\3/ (as a percentage of average net assets)
Management Fee ........................................................ 0.75%
12b-1 Fees\4/ ........................................................ 1.00%
Other Expenses ....................................................... 0.77%
Total Fund Operating Expenses ........................................ 2.52%
EXAMPLE\5/ 1 YEAR 3 YEARS 5 YEARS 10 YEARS
------ ------- ------- --------
You would pay the following expenses
on a $1,000 investment,
assuming (1) 5% annual return
and (2) redemption at the end
of each period ................... $66.00 $98.00 $134.00 $286.00
You would pay the following expenses
on the same investment, assuming
no redemption .................... $26.00 $78.00 $134.00 $286.00
AMOUNTS SHOWN IN THE EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF PAST
OR FUTURE EXPENSES; ACTUAL EXPENSES MAY BE GREATER OR LESS THAN THOSE SHOWN.
- ---------
\1/ The deferred sales charge declines from 4% to 1% of amounts redeemed within
four calendar years after purchase. No deferred sales charge is imposed
thereafter.
\2/ There is no fee for exchange orders received by the Fund directly from a
shareholder over the Keystone Automated Response Line ("KARL"). (For a
description of KARL, see "Shareholder Services.")
\3/ Expense ratios represent estimated ratios for the Fund's fiscal year ending
October 31, 1995.
\4/ Long-term shareholders may pay more than the economic equivalent of the
maximum front end sales charges permitted by rules adopted by the National
Association of Securities Dealers, Inc. ("NASD").
\5/ The Securities and Exchange Commission requires use of a 5% annual return
figure for purposes of the example. Actual return for the Fund may be
greater or less than 5%.
<PAGE>
FINANCIAL HIGHLIGHTS
KEYSTONE INTERNATIONAL FUND INC.
(For a share outstanding throughout the period)
The following table contains significant financial information with respect
to the Fund and has been audited by KPMG Peat Marwick LLP, the Fund's
independent auditors. The table appears in the Fund's Annual Report and should
be read in conjunction with the Fund's financial statements and related notes,
which also appear, together with the auditors' report, in the Fund's Annual
Report. The Fund's financial statements, related notes, and auditors' report are
included in the statement of additional information. Additional information
about the Fund's performance is contained in its Annual Report, which will be
made available upon request and without charge.
<TABLE>
<CAPTION>
ONE MONTH YEAR ENDED SEPTEMBER 30,
ENDED ------------------------------------------------------------------------------------------
10/31/94<F6><F7> 1994<F6><F7> 1993<F6> 1992<F6> 1991 1990 1989 1988 1987 1986 1985
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<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
NET ASSET VALUE,
BEGINNING OF PERIOD . $ 7.67 $ 7.08 $ 6.01 $ 5.91 $ 5.35 $ 7.51 $ 6.66 $ 9.53 $ 8.05 $ 5.35 $ 4.94
----- ----- ----- ----- ----- ----- ----- ----- ----- ----- -----
Income from investment
operations
Investment income --
net ................. 0 0 (0.03) (0.01) (0.01) (0.07) (0.14) 0.03 0 0.11 0.12
Net gains (losses) on
investments and
foreign currency
related transactions 0.10 0.62 1.14 0.34 0.83 (1.74) 1.06 (1.60) 2.65 3.25 0.63
Commissions paid on
fund share sales --
net<F1> ............. 0 0 0 0 0 0 0 0 0 (0.07) (0.03)
----- ----- ----- ----- ----- ----- ----- ----- ----- ----- -----
Total from investment
operations .......... 0.10 0.62 1.11 0.33 0.82 (1.81) 0.92 (1.57) 2.65 3.29 0.72
----- ----- ----- ----- ----- ----- ----- ----- ----- ----- -----
Less distributions
Dividends from
investment income --
net ............... 0 (0.02) 0 0 0 0 (0.07) (0.08) (0.06) (0.13) (0.11)
Distributions in
excess of investment
income -- net<F2> ... 0 (0.01) (0.04) (0.23) (0.03) 0 0 0 0 0 0
Distributions from
realized gains on
investments and
foreign currency
related transactions 0 0 0 0 (0.23) (0.35) 0 (1.22) (1.11) (0.46) (0.20)
----- ----- ----- ----- ----- ----- ----- ----- ----- ----- -----
Total distributions .. 0 (0.03) (0.04) (0.23) (0.26) (0.35) (0.07) (1.30) (1.17) (0.59) (0.31)
----- ----- ----- ----- ----- ----- ----- ----- ----- ----- -----
NET ASSET VALUE, END
OF PERIOD ........... $ 7.77 $ 7.67 $ 7.08 $ 6.01 $ 5.91 $ 5.35 $ 7.51 $ 6.66 $ 9.53 $ 8.05 $ 5.35
----- ----- ----- ----- ----- ----- ----- ----- ----- ----- -----
----- ----- ----- ----- ----- ----- ----- ----- ----- ----- -----
TOTAL RETURN<F3> ..... 1.30%<F5> 8.75% 18.59% 5.78% 15.59% (25.12%) 13.55% (15.55%) 39.96% 67.76% 15.58%
RATIOS/SUPPLEMENTAL DATA
Ratios to average net assets:
Operating and
management expenses 2.52%<F4> 2.54% 2.94% 3.41% 3.14% 2.92% 2.65% 2.04% 2.17% 1.49% 1.70%
Investment income --
net ............... (0.20%)<F4> 0.01% (0.46%) (0.09%) (0.07%) (0.51%) (0.79%) 0.33% (0.04%) 1.53% 2.42%
Portfolio turnover
rate ................ 2% 121% 68% 74% 85% 42% 42% 60% 61% 97% 73%
Net assets, end of
period (thousands) .. $157,929 $154,529 $111,752 $64,135 $72,923 $73,768 $121,047 $115,712 $173,319 $89,895 $31,396
<FN>
<F1>Prior to June 30, 1987, net commissions paid on new sales of shares under the Fund's Rule 12b-1 Distribution Plan had been
treated for both financial statement and tax purposes as capital charges. On June 11, 1987, the Securities and Exchange
Commission adopted a rule that required for financal statements for periods ended on or after June 30, 1987 that net
commissions paid under Rule 12b-1 Distribution Plans be treated as operating expenses rather than capital charges. Accordingly,
beginning with the fiscal year ended September 30, 1987, the Fund's financial statements reflect 12b-1 Distribution Plan
expenses (i.e., shareholder service fees plus commissions paid net of deferred sales charges received by the Fund) as a
component of net investment income.
<F2>Effective October 1, 1993 the Fund adopted Statement of Position 93-2: Determination, Disclosure and Financial Statement
Presentation of Income, Capital Gain and Return of Capital Distributions by Investment Companies. As a result, distribution
amounts exceeding book basis net investment income (or tax basis net income on a temporary basis) are presented as
"Distributions in excess of investment income -- net." Similarly, capital gain distributions in excess of book basis capital
gains (or tax basis capital gains on a temporary basis) are presented as "Distributions in excess of realized capital gains."
Prior to the adoption of this Statement of Position, distribution amounts exceeding book basis investment income -- net were
presented as "distributions from paid-in capital."
<F3>Excluding contingent deferred sales charges (CDSC).
<F4>Annualized.
<F5>Total return indicated is not annualized.
<F6>Calculation based on average shares outstanding.
<F7>On July 27, 1994, the Fund changed its fiscal year end from September 30 to October 31. Accordingly, the table above contains
financial data for the twelve month period ended September 30, 1994 and the one month period ended October 31, 1994.
</TABLE>
<PAGE>
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FUND DESCRIPTION
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The Fund is an open-end, diversified management investment company,
commonly known as a mutual fund. The Fund was incorporated in 1963 under the
laws of Massachusetts. It is the successor to Keystone International Fund Ltd.,
which was incorporated in 1954 under the Companies Act of Canada. From 1968 to
1979, the Fund was named the Polaris Fund Inc. The Fund is one of twenty funds
managed by Keystone Management, Inc. ("Keystone Management"), the Fund's
investment manager, and is one of twenty-nine funds managed or advised by
Keystone Custodian Funds, Inc. ("Keystone"), the Fund's investment adviser.
Keystone and Keystone Management are, from time to time, collectively referred
to as "Keystone."
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FUND OBJECTIVES AND POLICIES
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The Fund's primary investment objective is long-term growth of capital. As a
secondary objective, the Fund seeks modest income from its investments.
Investments are internationally varied in order to take advantage of domestic
and international changes in technology, the economy and market conditions. In
pursuing its objectives, the Fund may invest in the securities of U.S. companies
and companies of any foreign nation, including issuers located in certain
countries with developed markets as well as those with emerging markets and the
formerly communist countries of Eastern Europe. Countries with emerging markets
are generally those where the per capita income is in the low to middle ranges,
as determined by the International Bank for Reconstruction and Development
("World Bank").
The Fund may invest in preferred stocks, common stocks and securities
convertible into common stocks or having common stock characteristics
(consisting of rights, warrants and options); debt obligations, zero coupon
bonds and payment-in-kind ("PIK") securities of the U.S. and debt obligations of
any foreign governments, including their political subdivisions; securities and
debt obligations of any international agency; and time deposits with U.S. and
foreign banks. The Fund may hold cash and cash equivalents, as described below,
in U.S. currency or currencies of any nation. The Fund also may engage in the
various investment techniques described herein. The Fund invests at least 65% of
its assets in the securities of at least three countries other than the U.S.
Excluding repurchase agreements, the Fund currently follows a policy of
investing solely in securities of non-U.S. issuers.
There are no limitations on the types, sizes, operating histories or
dividend paying records of companies or industries in which the Fund may invest,
and there is no requirement that the Fund's foreign securities be listed on a
foreign exchange. Except as described below, the primary investment criterion
used by the Fund in the selection of portfolio securities is that the securities
provide opportunities for capital growth. For example, because the market value
of debt obligations can be expected to vary inversely with changes in prevailing
interest rates, investing in debt securities may provide an opportunity for
capital appreciation when interest rates are expected to decline.
The Fund may invest in debt securities and will invest predominantly in
foreign debt securities. Foreign debt securities generally are not rated, and
thus a portion of the Fund's assets will be invested in unrated securities.
Keystone will utilize the various evaluation methods described below to
determine the quality of the debt securities in which the Fund will invest.
A portion of the debt securities in which the Fund will invest will be rated
BBB or higher by Standard & Poor's Corporation ("S&P") or BAA or higher by
Moody's Investors Service, Inc. ("Moody's"). If unrated, the securities will be
deemed by Keystone to be of comparable quality to securities rated BBB or higher
by S&P or BAA or higher by Moody's. Debt rated BBB is regarded as having
adequate capacity to pay interest and repay principal; however, adverse economic
conditions or changing circumstances are more likely to lead to weakened
capacity to pay interest and repay principal for debt in this category than in
higher rated categories. Debt rated BAA is considered a medium grade obligation
and is neither highly protected nor poorly secured. Bonds in this category lack
outstanding investment characteristics and have speculative characteristics as
well. In addition, investments may be held on a short-term basis when the Fund
considers it desirable.
The Fund also has the authority to invest up to 10% of its assets in foreign
and domestic debt securities rated BB or lower by S&P or BA or lower by Moody's
or, if unrated, deemed by Keystone to be of comparable quality. Securities rated
BB or lower or BA or lower, or unrated securities of comparable quality, are
considered below investment grade and are generally referred to as high yield,
high risk securities.
In evaluating debt securities, Keystone will utilize its internal credit
analysis resources as well as financial and economic information obtained from
other sources. With respect to foreign corporate issuers, Keystone will consider
the financial condition of the issuer and market and economic conditions
relevant to its operations. In terms of foreign governmental obligations,
Keystone will review the financial position of the issuer and political and
economic conditions in the country. Investments in securities of supranational
entities are subject to the additional risk, to be considered by Keystone, that
member governments will fail to make required capital contributions, thereby
possibly preventing a supranational entity from meeting its obligations.
When Keystone determines that market conditions warrant, the Fund may invest
up to 100% of its assets for temporary defensive purposes in the following types
of money market instruments: (1) commercial paper, including master demand
notes, that at the date of investment is rated A-1 (the highest grade given by
S&P), PRIME-1 (the highest grade by Moody's) or, if not rated by such services,
is issued by a company that at the date of investment has an outstanding issue
rated A or better by S&P or Moody's; (2) obligations, including certificates of
deposit and bankers' acceptances, of banks or savings and loan associations with
at least $1 billion in assets as of the date of their most recently published
financial statements that are members of the Federal Deposit Insurance
Corporation, including U.S. branches of foreign banks and foreign branches of
U.S. banks; (3) corporate obligations that, at the date of investment, are rated
A or better by S&P or Moody's; (4) obligations issued or guaranteed by the U.S.
government or by any agency or instrumentality of the U.S.; and (5) repurchase
agreements and reverse repurchase agreements for such instruments.
The Fund may engage in options transactions. It may write covered call
options on securities that it owns, write covered call options traded in the
over-the-counter market and purchase put and call options, including put and
call options to close out existing positions. In addition, the Fund may use
subsequently developed investment techniques involving such options.
The Fund intends to follow policies of the Securities and Exchange
Commission as they are adopted from time to time with respect to illiquid
securities, including, at this time, (1) treating as illiquid, securities that
may not be sold or disposed of in the ordinary course of business within seven
days at approximately the value at which the Fund has valued such securities on
its books, and (2) limiting its holdings of such securities to 15% of net
assets.
The Fund may enter into firm commitment agreements for securities and
currencies and forward currency exchange contracts. In addition, the Fund may
enter into currency and other financial futures contracts and engage in related
options transactions for hedging purposes and not for speculation. The Fund may
also employ new investment techniques with respect to such futures contracts and
related options.
For further information about the types of investments and investment
techniques available to the Fund, including the risks associated with such
investments and investment techniques, see the section of this prospectus
entitled "Additional Investment Information" and the statement of additional
information.
<PAGE>
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RISK FACTORS
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Investing in the Fund involves the risk common to investing in any security,
i.e., net asset value will fluctuate in response to changes in economic
conditions, interest rates and the market's perception of the underlying
securities of the Fund.
By itself, the Fund does not constitute a balanced investment plan. Although
the Fund seeks to reduce risk by investing in a diversified portfolio, such
diversification does not eliminate all risks. Accordingly, the Fund makes most
sense for those investors who can afford to ride out changes in the markets. The
yield of the Fund's portfolio securities will fluctuate with changing market
conditions.
FOREIGN RISK -- GENERAL
Investing in the Fund, with its internationally varied portfolio, may
involve more risk than investing in a fund with a portfolio consisting solely of
securities of domestic issuers. An internationally diversified investment
portfolio presents certain risks, including the following:
(1) there may be less public information available about foreign companies than
is available about U.S. companies;
(2) foreign companies are not generally subject to the uniform accounting,
auditing and financial reporting standards and practices applicable to U.S.
companies;
(3) foreign stock markets have less volume than the U.S. market, and the
securities of some foreign companies are less liquid and more volatile than
the securities of comparable U.S. companies;
(4) there may be less government regulation of stock exchanges, brokers, listed
companies and banks in foreign countries than in the U.S.;
(5) the Fund may incur fees on currency exchanges when it changes investments
from one country to another;
(6) the Fund's foreign investments could be affected by expropriation,
confiscatory taxation, nationalization of bank deposits, establishment of
exchange controls, political or social instability or diplomatic
developments;
(7) fluctuations in foreign exchange rates will affect the value of the Fund's
portfolio securities, the value of dividends and interest earned, gains and
losses realized on the sale of securities, net investment income and
unrealized appreciation or depreciation of investments;
(8) possible imposition of dividend or interest withholding at the source may
occur; and
(9) to the extent the Fund invests in securities of issuers located in the
formerly communist countries of Eastern Europe, there is the risk that those
countries could convert back to a single economic structure.
EMERGING MARKETS
Investing in securities of issuers in emerging markets countries involves
exposure to economic systems that are generally less mature and political
systems that are generally less stable than those of developed countries. In
addition, investing in companies in emerging markets countries may also involve
exposure to national policies that may restrict investment by foreigners and
undeveloped legal systems governing private and foreign investments and private
property. The typically small size of the markets for securities issued by
companies in emerging markets countries and the possibility of a low or
nonexistent volume of trading in those securities may also result in a lack of
liquidity and in price volatility of those securities. Furthermore, investing in
securities of companies in the formerly communist countries of Eastern Europe
involves additional risks to those associated with investments in companies in
non-formerly communist emerging markets countries. Specifically, those countries
could convert back to a single economic system, and the claims of property
owners prior to the expropriation by the communist regime could be settled in
favor of the former property owners, in which case the Fund could lose its
entire investment in those countries.
NON-INVESTMENT GRADE BONDS
The Fund currently has the authority to invest up to 10% of its assets in
foreign and domestic high yield, high risk bonds and similar securities. The
degree to which the Fund will hold such securities will, among other things,
depend upon Keystone's economic forecast and its judgment as to the comparative
values offered by high yield, high risk securities and higher quality issues.
The Fund intends to invest a portion of its assets aggressively and seeks to
maximize return on such assets over time from a combination of many factors,
including high current income and capital appreciation from high yield, high
risk securities. Such aggressive investing involves risks that are greater than
the risks of investing in higher quality debt securities. These risks are
discussed in greater detail below and include risks from (1) interest rate
fluctuation; (2) changes in credit status, including weaker overall credit
conditions of issuers and risks of default; (3) industry, market and economic
risk; (4) volatility of price resulting from broad and rapid changes in the
value of underlying securities; and (5) greater price variability and credit
risks of certain high yield, high risk securities, such as zero coupon bonds and
PIK securities.
While these risks provide the opportunity for the Fund to maximize return
over time on a portion of its assets, they may result in greater upward and
downward movement of the net asset value per share of the Fund. As a result,
they should be carefully considered by investors.
The high yield, high risk securities in which the Fund may invest generally
will be rated BB or lower by S&P or Ba or lower by Moody's. If unrated, such
securities will be deemed by Keystone to be of comparable quality. The Fund may
invest in securities that are rated (or unrated but of comparable quality to
securities rated) as low as D by S&P and C- by Moody's. The descriptions at the
back of this prospectus describe the S&P and Moody's rating categories.
The Fund intends to invest in D rated debt (or unrated securities deemed to
be of comparable quality to D rated debt) only in cases where, in Keystone's
judgment, there is a distinct prospect of improvement in the issuer's financial
position as a result of the completion of reorganization or otherwise.
Investment in higher yielding, higher risk securities involves certain
risks, including the following:
(1) securities rated BB or lower by S&P or Ba or lower by Moody's (or comparable
unrated securities) are considered predominantly speculative with respect to
the ability of the issuer to meet principal and interest payments;
(2) the value of high yield, high risk securities may be more susceptible to
real or perceived adverse economic, company or industry conditions than is
the case for higher quality securities;
(3) adverse market, credit or economic conditions could make it difficult at
certain times to sell certain high yield, high risk securities held by the
Fund;
(4) the secondary market for high yield, high risk securities may be less liquid
than the secondary market for higher quality securities, which may affect
the value of certain high yield, high risk securities held by the Fund at
certain times; and
(5) zero coupon and PIK high yield, high risk securities may be subject to
greater changes in value due to market conditions, the absence of a cash
interest payment and the tendency of issuers of such securities to have
weaker overall credit conditions than issuers of other high yield, high risk
securities.
These characteristics of high yield, high risk securities make them
generally more appropriate for long term investment.
If and when the Fund invests in zero coupon bonds, the Fund does not expect
to have enough zero coupon bonds to have a material effect on dividends. The
Fund has undertaken to a state securities authority to disclose that zero coupon
securities pay no interest to holders prior to maturity, and the interest on
these securities is reported as income to the Fund and distributed to its
shareholders. These distributions must be made from the Fund's cash assets or,
if necessary, from the proceeds of sales of portfolio securities. The Fund will
not be able to purchase additional income producing securities with cash used to
make such distributions and its current income ultimately may be reduced as a
result.
The table below shows the weighted average percentages of the Fund's assets
invested at the end of each month during the last fiscal year in (1) debt
securities assigned to the various rating categories by S&P and (2) unrated debt
securities determined by Keystone to be of comparable quality. Since the
percentages in this table are based on month-end averages throughout the Fund's
fiscal year, they do not reflect the Fund's holdings at any one point in time.
The percentages in each category may be higher or lower on any day than those
shown in the table. In the future, a portion of the Fund's assets may be
invested in high yield, high risk securities that are rated BB or lower by S&P
or unrated securities of comparable quality.
*UNRATED
SECURITIES
OF COMPARABLE
RATED SECURITIES QUALITY AS
AS PERCENTAGE OF PERCENTAGE OF
RATING FUND'S ASSETS FUND'S ASSETS
- ------ ---------------- -------------
AAA 0.00% 0.00%
AA- 0.00% 0.00%
A 0.00% 0.79%
BBB 0.00% 1.14%
BB+ 0.00% 0.00%
BB and below 1.78% 0.96%
CCC 0.00% 0.00%
CC and below 0.00% 0.00%
Unrated* 2.89%
Cash, equities and
others 95.33%
-----
TOTAL 100.00%
-----
-----
Since the Fund intends to take an aggressive approach to investing a portion
of its assets, Keystone will attempt to maximize the return by controlling risk
through diversification, credit analysis, review of sector and industry trends,
interest rate forecasts and economic analysis. Keystone's analysis of securities
focuses on factors such as interest or dividend coverage, asset values, earnings
prospects and the quality of management of the issuer. In making investment
recommendations, Keystone also considers current income, potential for capital
appreciation, maturity structure, quality guidelines, coupon structure, average
yield, percentage of zeros and PIKs, percentage of non-accruing items and yield
to maturity.
Keystone may consider the ratings of Moody's and S&P assigned to various
securities, but will not rely on ratings assigned by Moody's and S&P for the
following reasons: (1) Moody's and S&P assigned ratings are based largely on
historical financial data and may not accurately reflect the current financial
outlook of companies; (2) there can be large differences among the current
financial conditions of issuers within the same rating category; and (3) a large
portion of the high yield, high risk securities in which the Fund will invest
will be unrated.
Income and yields on high yield, high risk securities, as on all securities,
will fluctuate over time.
RULE 144A SECURITIES
The Fund may invest in restricted securities, including securities eligible
for resale pursuant to Rule 144A under the Securities Act of 1933 (the "1933
Act"). Generally, Rule 144A establishes a safe harbor from the registration
requirements of the 1933 Act for resales by large institutional investors of
securities not publicly traded in the U.S. The Fund may purchase Rule 144A
securities when such securities present an attractive investment opportunity and
otherwise meet the Fund's selection criteria. The Board of Directors has adopted
guidelines and procedures pursuant to which the liquidity of the Fund's Rule
144A securities is determined by Keystone and the Board of Directors monitors
Keystone's implementation of such guidelines and procedures.
At the present time, the Fund cannot accurately predict exactly how the
market for Rule 144A securities will develop. A Rule 144A security that was
readily marketable upon purchase may subsequently become illiquid. In such an
event, the Board of Directors will consider what action, if any, is appropriate.
Of course, there can be no assurance that the Fund will achieve its
investment objectives since there is uncertainty in every investment.
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INVESTMENT RESTRICTIONS
- --------------------------------------------------------------------------------
The Fund has adopted the fundamental restrictions summarized below, which
may not be changed without the approval of a majority of the Fund's outstanding
shares. These restrictions and certain other fundamental and nonfundamental
restrictions are set forth in the statement of additional information.
Generally, the Fund may not do the following: (1) invest more than 5% of its
total assets, computed at market value at the time of purchase, in the
securities of any one issuer; (2) borrow money, except that the Fund may borrow
money from banks and/or enter into reverse repurchase agreements for emergency
or extraordinary purposes in aggregate amounts up to 10% of the value of the
Fund's gross assets computed at the lower of cost or current value, provided
that no additional investments shall be made at any time when outstanding
borrowings (including amounts payable under reverse repurchase agreements)
exceed 5% of the Fund's gross assets; and (3) invest more than 25% of its total
assets in securities of issuers in the same industry.
In addition, the Fund may, notwithstanding any other investment policy or
restriction, invest all of its assets in the securities of a single open-end
management investment company with substantially the same fundamental investment
objectives, policies and restrictions as the Fund. The Fund does not currently
intend to implement this policy and would do so only if the Directors were to
determine such action to be in the best interest of the Fund and its
shareholders. In the event of such implementation, the Fund will comply with
such requirements as to written notice to shareholders as are then in effect.
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PRICING SHARES
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The net asset value of a Fund share is computed each day on which the New
York Stock Exchange (the "Exchange") is open as of the close of trading on the
Exchange (currently 4:00 p.m. eastern time for the purpose of pricing Fund
shares) except on days when changes in the value of the Fund's securities do not
affect the current net asset value of its shares. The Exchange is currently
closed on weekends, New Year's Day, Presidents' Day, Good Friday, Memorial Day,
Independence Day, Labor Day, Thanksgiving Day and Christmas Day. The net asset
value per share is arrived at by determining the value of all of the Fund's
assets, subtracting all liabilities and dividing the result by the number of
shares outstanding.
The Fund values its money market investments as follows: short-term money
market investments purchased with maturities of sixty days or less are valued at
amortized cost (original purchase cost as adjusted for amortization of premium
or accretion of discount), which, when combined with accrued interest,
approximates market; money market investments with maturities of more than sixty
days for which market quotations are readily available are valued at market
value; and money market investments maturing in more than sixty days when
purchased that are held on the sixtieth day prior to maturity are valued at
amortized cost (market value on the sixtieth day adjusted for amortization of
premium or accretion of discount), which, when combined with accrued interest,
approximates market; and which in any case reflects fair value as determined by
the Board of Directors. All other investments are valued at market value or,
where market quotations are not readily available, at fair value as determined
in good faith by the Board of Directors.
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DIVIDENDS AND TAXES
- ------------------------------------------------------------------------------
The Fund has qualified and intends to qualify in the future as a regulated
investment company under the Internal Revenue Code (the "Code"). The Fund
qualifies if, among other things, it distributes to its shareholders at least
90% of its net investment income for its fiscal year. The Fund also intends to
make timely distributions, if necessary, sufficient in amount to avoid the
nondeductible 4% excise tax imposed on a regulated investment company to the
extent that it fails to distribute, with respect to each calendar year, at least
98% of its ordinary income for such calendar year and 98% of its net capital
gains for the one-year period ending on October 31 of such calendar year. Any
taxable distribution would be (1) declared in October, November, or December to
shareholders of record in such a month, (2) paid by the following January 31,
and (3) includable in the taxable income of shareholders for the year in which
such distributions were declared. If the Fund qualifies and if it distributes
substantially all of its net investment income and net capital gains, if any, to
shareholders, it will be relieved of any federal income tax liability. The Fund
will make distributions from its net investment income and distributions of net
capital gains, if any, at least annually.
Currently, commissions paid by the Fund on new sales of shares under the
Fund's Distribution Plan (see "Distribution Plan") and deferred sales charge
receipts are treated as capital charges and capital credits, respectively, in
determining net investment income for tax purposes. For financial statement
purposes, however, these expenses and receipts are treated as operating expenses
and expense offsets. As a result, the amount of dividend distributions required
to satisfy the requirements of the Code might exceed net investment income for
financial statement purposes, resulting in a portion of such dividends being a
return of capital for financial statement purposes, but not for tax purposes.
Total investment return is equally affected by both treatments.
Recently, the Internal Revenue Service ("IRS") issued a ruling that will
require the Fund effective April 1, 1995 to treat its 12b-1 fees as operating
expenses, instead of capital charges. The Fund intends to comply with the IRS
ruling by that date. As a result, after April 1, 1995, dividend distributions
are no longer expected to exceed net investment income for financial statement
purposes. Total investment return will not be affected.
The Fund makes distributions in additional shares of the Fund or, at the
shareholder's election (which must be made before the record date for the
distribution), in cash. Income dividends and net short-term gains distributions
are taxable as ordinary income. Net long-term gains are taxable as capital gains
regardless of how long the shareholder has held the Fund's shares. If Fund
shares are held for less than six months, however, and are sold at a loss, such
loss will be treated for tax purposes as a long-term capital loss to the extent
of any long-term capital gains dividends received.
In addition, if more than 50% of the value of the Fund's total assets at the
end of a fiscal year is represented by securities of foreign corporations and
the Fund elects to make foreign tax credits available to its shareholders, a
shareholder will be required to include in his gross income both dividends paid
by the Fund and the amount the Fund advises him is his pro rata portion of taxes
withheld by foreign governments from interest and dividends paid on the Fund's
foreign investments. A shareholder will be entitled to take, however, his share
of the amount of any foreign taxes withheld as a credit against his U.S. income
tax or to treat his share of the foreign tax withheld as an itemized deduction
from his gross income.
Dividends and distributions may also be subject to state and local taxes.
The Fund advises its shareholders annually as to the federal tax status of all
distributions made during the year.
<PAGE>
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FUND MANAGEMENT AND EXPENSES
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FUND MANAGEMENT
Subject to the general supervision of the Fund's Board of Directors,
Keystone Management, located at 200 Berkeley Street, Boston, Massachusetts
02116-5034, serves as investment manager to the Fund and is responsible for the
overall management of the Fund's business and affairs.
INVESTMENT MANAGER
Keystone Management, organized in 1989, is a wholly-owned subsidiary of
Keystone and its directors and principal executive officers have been affiliated
with Keystone, a seasoned investment adviser, for a number of years.
The Fund pays Keystone Management a fee for its services at the following
annual rate:
AGGREGATE NET ASSET VALUE
MANAGEMENT OF THE SHARES
FEE OF THE FUND
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0.75% of the first $200,000,000, plus
0.65% of the next $200,000,000, plus
0.55% of the next $200,000,000, plus
0.45% of amounts over $600,000,000.
Pursuant to its Investment Management Agreement with the Fund, Keystone
Management has delegated its investment management functions, except for certain
administrative and management services, to Keystone and has entered into an
Investment Advisory Agreement with Keystone under which Keystone provides
investment advisory and management services to the Fund. Services performed by
Keystone Management include (1) performing research and planning with respect to
(a) the Fund's qualification as a regulated investment company under Subchapter
M of the Internal Revenue Code, (b) tax treatment of the Fund's portfolio
investments, (c) tax treatment of special corporate actions (such as
reorganizations), (d) state tax matters affecting the Fund, and (e) the Fund's
distributions of income and capital gains; (2) preparing the Fund's federal and
state tax returns; (3) providing services to the Fund's shareholders in
connection with federal and state taxation and distributions of income and
capital gains; and (4) storing documents relating to the Fund's activities.
INVESTMENT ADVISER
Keystone, the Fund's investment adviser, located at 200 Berkeley Street,
Boston, Massachusetts 02116-5034, has provided investment advisory and
management services to investment companies and private accounts since it was
organized in 1932. Keystone is a wholly-owned subsidiary of Keystone Group, Inc.
("Keystone Group"), 200 Berkeley Street, Boston, Massachusetts 02116-5034.
Keystone Group is a corporation predominantly owned by former and current
members of management of Keystone and its affiliates. The shares of Keystone
Group common stock beneficially owned by management are held in a number of
voting trusts, the trustees of which are George S. Bissell, Albert H. Elfner,
III, Roger T. Wickers, Edward F. Godfrey and Ralph J. Spuehler, Jr. Keystone
Group provides accounting, bookkeeping, legal, personnel and general corporate
services to Keystone Management, Keystone, their affiliates and the Keystone
Group of Mutual Funds.
Pursuant to the Investment Advisory Agreement, Keystone receives for its
services an annual fee representing 85% of the management fee received by
Keystone Management under its Investment Management Agreement with the Fund.
During the twelve month period ended September 30, 1994 and the one month
period ended October 31, 1994, the Fund paid or accrued to Keystone Management
investment management and administrative services fees of $1,094,303 and $98,556
for the respective periods, which represented 0.75% and 0.75% (annualized),
respectively, of the Fund's average net assets. Of such amounts paid to Keystone
Management, $930,158 and $83,773 were paid to Keystone for its investment
advisory services. The fee charged to the Fund is higher than that charged to
most investment companies. The fee is comparable, however, to fees charged to
other global and international funds, which, like the Fund, are subject to the
higher costs involved in managing a portfolio of predominantly international
securities.
FUND EXPENSES
The Fund will pay all of its expenses. In addition to the investment
advisory and management fees discussed above, the principal expenses that the
Fund is expected to pay include, but are not limited to, expenses of its
transfer agent, its custodian and its independent auditors; expenses under its
Distribution Plan; fees of its Independent Directors ("Independent Directors");
expenses of shareholders' and Directors' meetings; fees payable to government
agencies, including registration and qualification fees of the Fund and its
shares under federal and state securities laws; expenses of preparing, printing
and mailing Fund prospectuses, notices, reports and proxy material; and certain
extraordinary expenses. In addition to such expenses, the Fund pays its
brokerage commissions, interest charges and taxes. For the twelve month period
ended September 30, 1994 and the one month period ended October 31, 1994, the
Fund paid 2.54% and 2.52% (annualized), respectively, of its average net assets
in expenses.
During the twelve month period ended September 30, 1994 and the one month
period ended October 31, 1994, the Fund paid or accrued to Keystone Investor
Resource Center, Inc. ("KIRC"), the Fund's transfer and dividend disbursing
agent, and to Keystone Group $24,705 and $2,108 for the respective periods for
certain accounting and printing services and $667,589 and $57,040 to KIRC for
the respective periods for shareholder services. KIRC is a wholly-owned
subsidiary of Keystone.
PORTFOLIO MANAGER
Gilman C. Gunn is the Fund's portfolio manager. Mr. Gunn is a Keystone
Senior Vice President and Senior Portfolio Manager. An investment professional
with 22 years of experience, he has spent over ten years in London, Kuwait and
Thailand.
SECURITIES TRANSACTIONS
Keystone selects broker-dealers to execute transactions subject to the
receipt of best execution. When selecting broker-dealers to execute portfolio
transactions for the Fund, Keystone may follow a policy of considering as a
factor the number of shares of the Fund sold by such broker-dealers. In
addition, broker-dealers may, from time to time, be affiliated with the Fund,
Keystone, Keystone Management, the Fund's principal underwriter ("Principal
Underwriter") or their affiliates.
PORTFOLIO TURNOVER
The Fund's portfolio turnover rates for the one month period ended October
31, 1994 and the twelve month period ended September 30, 1994 and the fiscal
year ended 1993 were 2%, 121% and 68%, respectively.
FISCAL YEAR
The Fund's fiscal year ends October 31.
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HOW TO BUY SHARES
- ------------------------------------------------------------------------------
Shares of the Fund may be purchased from any broker-dealer that has a
selling agreement with Keystone Distributors, Inc. ("KDI"), the Fund's Principal
Underwriter. KDI, a wholly-owned subsidiary of Keystone, is located at 200
Berkeley Street, Boston, Massachusetts 02116-5034.
In addition, you may open an account for the purchase of shares of the Fund
by mailing to the Fund, c/o KIRC, P.O. Box 2121, Boston, Massachusetts 02106-
2121, a completed account application and a check payable to the Fund. Or you
may telephone 1-800-343-2898 to obtain the number of an account to which you can
wire or electronically transfer funds and then send in a completed account
application. Subsequent investments in Fund shares in any amount may be made by
check, by wiring Federal funds or by an electronic funds transfer ("EFT").
The Fund's shares are sold at an offering price equal to the net asset value
per share next computed after the Fund receives the purchase order. The initial
purchase must be at least $1,000 except for purchases by participants in certain
retirement plans for which the minimum is waived. There is no minimum for
subsequent purchases. Purchase payments are fully invested at net asset value.
There are no sales charges on purchases of Fund shares at the time of purchase.
CONTINGENT DEFERRED SALES CHARGE
With certain exceptions, when shares are redeemed within four calendar years
after their purchase, a deferred sales charge may be imposed at rates ranging
from a maximum of 4% of amounts redeemed during the same calendar year of
purchase to 1% of amounts redeemed during the third calendar year after the year
of purchase. No contingent deferred sales charge is imposed on amounts redeemed
thereafter or on shares purchased through reinvestment of dividends and
distributions. If imposed, the contingent deferred sales charge is deducted from
the redemption proceeds otherwise payable to the shareholder. Prior to July 8,
1992, the Fund retained the deferred sales charge. Since July 8, 1992, the
deferred sales charge attributable to shares purchased prior to January 1, 1992
has been retained by the Fund, and the deferred sales charge attributable to
shares purchased after January 1, 1992 is, to the extent permitted by NASD
rules, paid to KDI. For the one month period ended October 31, 1994 and the
twelve month period ended September 30, 1994, the Fund recovered $801 and
$7,861, respectively, in contingent deferred sales charges.
The contingent deferred sales charge is a declining percentage of the lesser
of (1) the net asset value of the shares redeemed or (2) the total cost of such
shares. No contingent deferred sales charge is imposed when a shareholder
redeems amounts derived from (1) increases in the value of his account above the
total cost of such shares due to increases in the net asset value per share of
the Fund; (2) certain shares with respect to which the Fund did not pay a
commission on issuance, including shares acquired through reinvestment of
dividend income and capital gains distributions; or (3) shares held in all or
part of more than four consecutive calendar years.
In determining whether a contingent deferred sales charge is payable and, if
so, the percentage charge applicable, it is assumed that shares held the longest
are the first to be redeemed. There is no deferred sales charge on permitted
exchanges of shares between Keystone funds that have adopted distribution plans
pursuant to Rule 12b-1 under the 1940 Act. Moreover, when shares of one such
fund have been exchanged for shares of another such fund, for purposes of any
future contingent deferred sales charge, the calendar year of the purchase of
the shares of the fund exchanged into, is assumed to be the year shares tendered
for exchange were originally purchased.
In addition, no contingent deferred sales charge is imposed on a redemption
of shares of the Fund in the event of (1) death or disability of the
shareholder; (2) a lump-sum distribution from a 401(k) plan or other benefit
plan qualified under the Employee Retirement Income Security Act of 1974
("ERISA"); (3) automatic withdrawals from ERISA plans if the shareholder is at
least 59 1/2 years old; (4) involuntary redemptions of accounts having an
aggregate net asset value of less than $1,000; or (5) automatic withdrawals
under an automatic withdrawal plan of up to 1% per month of the shareholder's
initial account balance.
WAIVER OF DEFERRED SALES CHARGE
Shares may also be sold, to the extent permitted by applicable law, at net
asset value without the payment of commissions or the imposition of an initial
sales charge or a deferred sales charge to (1) certain officers, Directors,
Trustees and employees of the Fund, Keystone Management, Keystone and certain of
their affiliates; (2) registered representatives of firms with dealer agreements
with KDI; and (3) a bank or trust company acting as trustee for a single
account.
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DISTRIBUTION PLAN
- --------------------------------------------------------------------------------
The Fund bears some of the costs of selling its shares under a Distribution
Plan adopted on June 1, 1983 pursuant to Rule 12b-1 under the 1940 Act. The
Fund's Distribution Plan provides that the Fund may expend up to 0.3125%
quarterly (approximately 1.25% annually) of the average daily net asset value of
its shares to pay distribution costs for sales of its shares and to pay
shareholder service fees. The NASD currently limits such annual expenditures to
1%, of which 0.75% may be used to pay such distribution costs and 0.25% may be
used to pay shareholder services fees. The aggregate amount that the Fund may
pay for such distribution costs is limited to 6.25% of gross share sales since
the inception of the Fund's Distribution Plan plus interest at the prime rate
plus 1% on unpaid amounts thereof (less any contingent deferred sales charges
paid by shareholders to KDI).
Payments under the Distribution Plan are currently made to KDI (which may
reallow all or part to others such as dealers) (1) as commissions for Fund
shares sold and (2) as shareholder service fees in respect of shares maintained
by the recipients outstanding on the Fund's books for specified periods. Amounts
paid or accrued to KDI under (1) and (2) in the aggregate may not exceed the
annual limitations referred to above. KDI generally reallows to brokers or
others a commission equal to 4% of the price paid for each Fund share sold as
well as a shareholder service fee at a rate of 0.25% per annum of the net asset
value of shares maintained by such recipients outstanding on the books of the
Fund for specified periods.
If the Fund is unable to pay KDI a commission on a new sale because the
annual maximum (0.75% of average daily net assets) has been reached, KDI
intends, but is not obligated, to continue to accept new orders for the purchase
of Fund shares and to pay or accrue commissions and service fees to dealers in
excess of the amount it currently receives from the Fund. While the Fund is
under no contractual obligation to pay KDI such amounts that exceed the
Distribution Plan limitation, KDI intends to seek full payment of such charges
from the Fund (together with interest at the rate of prime plus one percent) at
such time in the future as, and to the extent that, payment thereof by the Fund
would be within permitted limits. KDI currently intends to seek payment of
interest only on such charges paid or accrued by KDI subsequent to July 7, 1992.
If the Fund's Independent Directors authorize such payments, the effect would be
to extend the period of time during which the Fund incurs the maximum amount of
costs allowed by the Distribution Plan. If the Distribution Plan is terminated,
KDI will ask the Independent Directors to take whatever action they deem
appropriate under the circumstances with respect to payment of such amounts.
During the twelve month period ended September 30, 1994 and the one month
period ended October 31, 1994, the Fund recovered $7,861 and $801, respectively,
in deferred sales charges. During those same periods, the Fund paid KDI
$1,460,493 and $113,527, respectively. For those same periods, the amounts paid
by the Fund under its Distribution Plan, net of deferred sales charges, were
$1,452,632 and $112,726, respectively (1.00% and 0.07%, respectively, of the
Fund's average daily net asset value during the respective period). During those
same periods, KDI received $0 and $36,343 after payments of commissions on new
sales and service fees to dealers and others of $1,709,228 and $77,184,
respectively. During the same periods, KDI also received $183,020 and $22,063,
respectively, in contingent deferred sales charges. At October 31, 1994, KDI's
total unreimbursed 12b-1 expenses amounted to $2,213,911 (1.40% of net assets as
of October 31, 1994), of which $1,058,492 and $0 were incurred during the twelve
month period ended September 30, 1994 and the one month period ended October 31,
1994, respectively. The right to certain portions of this amount, if and when
receivable, was assigned by KDI in 1988 in connection with a financing
transaction. As of October 31, 1994, $51,270 of the amount assigned remained
outstanding.
Accordingly, KDI intends to seek total payments of $2,213,911 with respect
to sales of the Fund's shares from inception of the Distribution Plan to October
31, 1994 to the extent such payments together with payments for future sales
will not exceed the limitations discussed above. At each Director's meeting
(usually quarterly), the Independent Directors of the Fund consider whether to
authorize payments to such extent until the next quarterly Directors' meeting,
and pursuant to such authorizations, such payments are made. Except as described
above, the Fund has no obligation to pay any portion of this amount, and the
times, conditions and amounts, if any, to be paid by the Fund are solely within
the discretion of the Fund's Independent Directors.
The amounts and purposes of expenditures under the Distribution Plan must be
reported to the Independent Directors quarterly. The Independent Directors may
require or approve changes in the operation of the Distribution Plan and may
require that total expenditures by the Fund under the Distribution Plan be kept
within limits lower than the maximum amount permitted by the Distribution Plan
as stated above. If such costs are not limited by the Independent Directors,
such costs could, for some period of time, be higher than such costs permitted
by most other plans presently adopted by other investment companies.
The Distribution Plan may be terminated at any time by vote of the
Independent Directors or by vote of a majority of the outstanding voting shares
of the Fund. Any change in the Distribution Plan that would materially increase
the distribution expenses of the Fund provided for in the Distribution Plan
requires shareholder approval. Otherwise, the Distribution Plan may be amended
by votes of the majority of both (1) the Fund's Directors and (2) the
Independent Directors cast in person at a meeting called for the purpose of
voting on such amendment.
While the Distribution Plan is in effect, the Fund is required to commit the
selection and nomination of candidates for Independent Directors to the
discretion of the Independent Directors.
Whether any expenditure under the Distribution Plan is subject to a state
expense limit depends upon the nature of the expenditure and the terms of the
state law, regulation or order imposing the limit. A portion of the Fund's
Distribution Plan expenses may be includable in the Fund's total operating
expenses for purposes of determining compliance with state expense limits.
Upon written notice to dealers, KDI, at its own expense, may periodically
sponsor programs that offer additional compensation in connection with sales of
shares of the Fund. Participation in such programs may be available to all
dealers or to selected dealers who have sold or are expected to sell significant
amounts of shares. Additional compensation may also include financial assistance
to dealers in connection with preapproved seminars, conferences and advertising.
No such programs or additional compensation will be offered to the extent they
are prohibited by the laws of any state or any self-regulatory agency, such as
the NASD.
KDI may, at its own expense, pay concessions in addition to those described
above to dealers which satisfy certain criteria established from time to time by
KDI. These conditions relate to increasing sales of shares of the Keystone funds
over specified periods and certain other factors. Such payments may, depending
on the dealer's satisfaction of the required conditions, be up to 0.25% of the
value of shares sold by such dealer.
KDI may also pay a transaction fee (up to the level of payments allowed to
dealers for the sale of shares, as described above) to banks and other financial
services firms that facilitate transactions of shares of the Fund for their
clients.
The Glass-Steagall Act currently limits the ability of a depository
institution (such as a commercial bank or a savings and loan association) to
become an underwriter or distributor of securities. In the event the Glass-
Steagall Act is deemed to prohibit depository institutions from accepting
payments under the arrangement described above, or should Congress relax current
restrictions on depository institutions, the Board of Directors will consider
what action, if any, is appropriate.
In addition, state securities laws on this issue may differ from the
interpretations of federal law expressed herein, and banks and financial
institutions may be required to register as dealers pursuant to state law.
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HOW TO REDEEM SHARES
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Fund shares may be redeemed for cash at the redemption value upon written
order by the shareholder(s) to the Fund, c/o KIRC, Box 2121, Boston,
Massachusetts 02106-2121, and presentation to the Fund of a properly endorsed
share certificate if certificates have been issued. The signature(s) of the
shareholder(s) on the written order and certificates must be guaranteed. The
redemption value is the net asset value adjusted for fractions of a cent and may
be more or less than the shareholder's cost depending upon changes in the value
of the Fund's portfolio securities between purchase and redemption. A deferred
sales charge may be imposed by the Fund at the time of redemption of certain
shares as explained under "How to Buy Shares." If imposed, the deferred sales
charge is deducted from the redemption proceeds otherwise payable to the
shareholder.
At various times, the Fund may be requested to redeem shares for which it
has not yet received good payment. In such a case, the Fund will mail the
redemption proceeds upon clearance of the purchase check, which may take up to
15 days or more. Any delay may be avoided by purchasing shares either with a
certified check drawn on a U.S. bank or by bank wire of funds. Although the
mailing of a redemption check may be delayed, the redemption value will be
determined and the redemption processed in the ordinary course of business upon
receipt of proper documentation. In such a case, after redemption and prior to
the release of the proceeds, no appreciation or depreciation will occur in the
value of the redeemed shares, and no interest will be paid on the redemption
proceeds. If the mailing of a redemption check has been delayed, the check will
be mailed or the proceeds wired or sent by electronic funds transfer promptly
after good payment has been collected.
The Fund computes the redemption value at the close of the Exchange at the
end of the day on which it has received all proper documentation from the
shareholder. Payment of the amount due on redemption, less any applicable
deferred sales charge, will be made within seven days thereafter.
Shareholders may also redeem their shares through their broker-dealers. KDI,
acting as agent for the Fund, stands ready to repurchase Fund shares upon orders
from dealers as follows: redemption requests received by broker-dealers prior to
that day's close of trading on the Exchange and transmitted to the Fund prior to
its close of business that day will receive the net asset value per share
computed at the close of trading on the Exchange on the same day. Redemption
requests received by broker-dealers after that day's close of trading on the
Exchange and transmitted to the Fund prior to the close of business on the next
business day will receive the next business day's net asset value price. KDI
will pay the redemption proceeds, less any applicable deferred sales charge, to
the dealer placing the order within seven days thereafter, assuming it has
received proper documentation. KDI charges no fees for this service, but the
shareholder's broker-dealer may do so.
For the protection of shareholders, SIGNATURES ON CERTIFICATES, STOCK POWERS
AND ALL WRITTEN ORDERS OR AUTHORIZATIONS MUST BE GUARANTEED BY A U.S. STOCK
EXCHANGE MEMBER, A BANK OR OTHER PERSONS ELIGIBLE TO GUARANTEE SIGNATURES UNDER
THE SECURITIES EXCHANGE ACT OF 1934 AND KIRC'S POLICIES. The Fund and KIRC may
waive this requirement, but may also require additional documents in certain
cases. Currently, the requirement for a signature guarantee has been waived on
redemptions of $50,000 or less where the account address of record has been the
same for a minimum period of 30 days. The Fund and KIRC reserve the right to
withdraw this waiver at any time.
If the Fund receives a redemption or repurchase order, but the shareholder
has not clearly indicated the amount of money or number of shares involved, the
Fund cannot execute the order. In such cases, the Fund will request the missing
information from the shareholder and process the order the day it receives such
information.
TELEPHONE
Under ordinary circumstances, you may redeem up to $50,000 from your account
by telephone by calling toll free 1-800-343-2898. To engage in telephone
transactions generally, you must complete the appropriate sections of the Fund's
application.
In order to insure that instructions received by KIRC are genuine when you
initiate a telephone transaction, you will be asked to verify certain criteria
specific to your account. At the conclusion of the transaction, you will be
given a transaction number confirming your request, and written confirmation of
your transaction will be mailed the next business day. Your telephone
instructions will be recorded. Redemptions by telephone are allowed only if the
address and bank account of record have been the same for a minimum period of 30
days.
If the redemption proceeds are less than $2,500, they will be mailed by
check. If they are $2,500 or more, they will be mailed, wired or sent by EFT to
your previously designated bank account as you direct. If you do not specify how
you wish your redemption proceeds to be sent, they will be mailed by check.
If you cannot reach the Fund by telephone, you should follow the procedures
for redeeming by mail or through a broker as set forth above.
SMALL ACCOUNTS
Because of the high cost of maintaining small accounts, the Fund reserves
the right to redeem your account if its value falls below $1,000, the current
minimum investment level, as a result of your redemptions (but not as a result
of market action). You will be notified in writing and allowed 60 days to
increase the value of your account to the minimum investment level. No
contingent deferred sales charges are applied to such redemptions.
GENERAL
The Fund reserves the right at any time to terminate, suspend or change the
terms of any redemption method described in this prospectus, except redemption
by mail, and to impose fees.
Except as otherwise noted, neither the Fund, KIRC nor KDI assumes
responsibility for the authenticity of any instructions received by any of them
from a shareholder in writing, over the Keystone Automated Response Line
("KARL") or by telephone. KIRC will employ reasonable procedures to confirm that
instructions received over KARL or by telephone are genuine. Neither the Fund,
KIRC nor KDI will be liable when following instructions received over KARL or by
telephone that KIRC reasonably believes to be genuine.
The Fund may temporarily suspend the right to redeem its shares when (1) the
Exchange is closed, other than customary weekend and holiday closings; (2)
trading on the Exchange is restricted; (3) the Fund cannot dispose of its
investments or fairly determine their value; or (4) the Securities and Exchange
Commission, for the protection of shareholders, so orders.
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SHAREHOLDER SERVICES
- ------------------------------------------------------------------------------
Details on all shareholder services may be obtained from KIRC by calling
toll free 1-800-343-2898.
KEYSTONE AUTOMATED RESPONSE LINE
KARL offers shareholders specific fund account information and price and
yield quotations as well as the ability to effect account transactions,
including investments, exchanges and redemptions. Shareholders may access KARL
by dialing toll free 1-800-346-3858 on any touch-tone telephone, 24 hours a day,
seven days a week.
EXCHANGES
A shareholder who has obtained the appropriate prospectus may exchange
shares of the Fund for shares of any of the Keystone Custodian Funds, Keystone
Precious Metals Holdings, Inc. ("KPMH"), Keystone Tax Exempt Trust ("KTET"),
Keystone Tax Free Fund ("KTFF") or Keystone Liquid Trust ("KLT") on the basis of
their respective net asset values by calling toll free 1-800-343-2898 or by
writing KIRC at Box 2121, Boston, Massachusetts 02106-2121. Fund shares
purchased by check may be exchanged for shares of the named funds, other than
KPMH, KTET or KTFF, after 15 days provided good payment for the purchase of Fund
shares has been collected. In order to exchange Fund shares for shares of KPMH,
KTET or KTFF, a shareholder must have held Fund shares for a period of six
months. There is a $10.00 service fee for each exchange, except that the fee is
waived for individual investors who make an exchange using KARL. If the shares
being tendered for exchange have been held for less than four years and are
still subject to a deferred sales charge, such charge will carry over to the
shares being acquired in the exchange transaction. The Fund reserves the right
to terminate this exchange offer or to change its terms, including the right to
change the service charge for any exchange.
Orders to exchange shares of the Fund for shares of KLT will be executed by
redeeming the shares of the Fund and purchasing shares of KLT at the net asset
value of KLT shares determined after the proceeds from such redemption become
available, which may be up to seven days after such redemption. In all other
cases, orders for exchanges received by the Fund prior to 4:00 p.m. eastern time
on any day the funds are open for business will be executed at the respective
net asset values determined as of the close of business that day. Orders for
exchanges received after 4:00 p.m. eastern time on any business day will be
executed at the respective net asset values determined at the close of the next
business day.
An excessive number of exchanges may be disadvantageous to the Fund.
Therefore, the Fund, in addition to its right to reject any exchange, reserves
the right to terminate the exchange privilege of any shareholder who makes more
than five exchanges in a year or three in a calendar quarter.
An exchange order must comply with the requirements for a redemption or
repurchase order and must specify the dollar value or number of shares to be
exchanged. Exchanges are subject to the minimum initial purchase requirements of
the fund being acquired. An exchange constitutes a sale for federal income tax
purposes.
The exchange privilege is available only in states where shares of the fund
being acquired may legally be sold.
RETIREMENT PLANS
The Fund has various pension and profit-sharing plans available to
investors, including Individual Retirement Accounts ("IRAs"); Rollover IRAs;
Simplified Employee Pension Plans ("SEPs"); Tax Sheltered Annuity Plans
("TSAs"); 401(k) Plans; Keogh Plans; Corporate Profit-Sharing Plans; Money
Purchase Pension Plans and Salary-Reduction Plans. For details, including fees
and application forms, call KIRC toll free at 1-800-247-4075 or write to KIRC at
P.O. Box 2121, Boston, Massachusetts 02106-2121.
AUTOMATIC INVESTMENT PLAN
Shareholders may take advantage of investing on an automatic basis by
establishing an Automatic Investment Plan. Funds are drawn on a shareholder's
checking account monthly and used to purchase Fund shares.
AUTOMATIC WITHDRAWAL PLAN
Under an Automatic Withdrawal Plan, shareholders may arrange for regular
monthly or quarterly fixed withdrawal payments. Each payment must be at least
$100 and may be as much as 1% per month or 3% per quarter of the total net asset
value of the Fund shares in the shareholder's account when the Automatic
Withdrawal Plan is opened. Fixed withdrawal payments are not subject to a
deferred sales charge. Excessive withdrawals may decrease or deplete the value
of a shareholder's account.
OTHER SERVICES
Under certain circumstances, shareholders may, within 30 days after a
redemption, reinstate their accounts at current net asset value.
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PERFORMANCE DATA
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From time to time, the Fund may advertise "total return" and "current
yield." BOTH FIGURES ARE BASED ON HISTORICAL EARNINGS AND ARE NOT INTENDED TO
INDICATE FUTURE PERFORMANCE. Total return refers to the Fund's average annual
compounded rates of return over specified periods determined by comparing the
initial amount invested to the ending redeemable value of that amount. The
resulting equation assumes reinvestment of all dividends and distributions and
deduction of all recurring charges, if any, applicable to all shareholder
accounts. The deduction of the contingent deferred sales charge is reflected in
the applicable years. The exchange fee is not included in the calculation.
Current yield quotations represent the yield on an investment for a stated
30-day period computed by dividing net investment income earned per share during
the base period by the maximum offering price per share on the last day of the
base period. The Fund presently does not intend to advertise current yield.
The Fund may include comparative performance information in advertising or
marketing the Fund's shares, such as data from Lipper Analytical Services, Inc.,
Morningstar, Inc., Ibbotson Associations, or other industry publications.
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FUND SHARES
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The Fund currently issues one class of shares, which participate in
dividends and distributions and have equal voting, liquidation and other rights.
When issued and paid for, the shares will be fully paid and nonassessable by the
Fund. Shares may be exchanged as explained under "Shareholder Services," but
will have no other preference, conversion, exchange or preemptive rights.
Shareholders are entitled to one vote for each full share owned and fractional
votes for fractional shares. Shares are redeemable, transferable and freely
assignable as collateral. There are no sinking fund provisions. The Fund may
establish additional classes or series of shares. The Fund is required to hold
annual meetings of shareholders.
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ADDITIONAL INFORMATION
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KIRC, located at 101 Main Street, Cambridge, Massachusetts 02142-1519, is a
wholly-owned subsidiary of Keystone and serves as the Fund's transfer agent and
dividend disbursing agent.
When the Fund determines from its records that more than one account in the
Fund is registered in the name of a shareholder or shareholders having the same
address, upon written notice to those shareholders, the Fund intends, when an
annual report or semi-annual report of the Fund is required to be furnished, to
mail one copy of such report to that address.
Except as otherwise stated in this prospectus or required by law, the Fund
reserves the right to change the terms of the offer stated in this prospectus
without shareholder approval, including the right to impose or change fees for
services provided.
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ADDITIONAL INVESTMENT INFORMATION
- ------------------------------------------------------------------------------
The Fund may engage in the following investment practices to the extent
described in the prospectus and statement of additional information.
CORPORATE BOND RATINGS
Higher yields are usually available on securities that are lower rated or
that are unrated. Bonds rated Baa by Moody's are considered as medium grade
obligations, which are neither highly protected nor poorly secured. Debt rated
BBB by S&P is regarded as having an adequate capacity to pay interest and repay
principal, although adverse economic conditions 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. Lower rated securities are usually defined as
Baa or lower by Moody's or BBB or lower by S&P. The Fund may purchase unrated
securities, which are not necessarily of lower quality than rated securities,
but may not be attractive to as many buyers. Debt rated BB, B, CCC, CC and C by
S&P is regarded, on balance, as predominantly speculative with respect to
capacity to pay interest and repay principal in accordance with the terms of the
obligation. BB indicates the lowest degree of speculation and C the highest
degree of speculation. While such debt will likely have some quality and
protective characteristics, these are outweighed by large uncertainties or major
risk exposures to adverse conditions. Debt rated CI by S&P is debt (income
bonds) on which no interest is being paid. Debt rated D by S&P is in default and
payment of interest and/or repayment of principal is in arrears. The Fund
intends to invest in D-rated debt only in cases where in Keystone's judgment
there is a distinct prospect of improvement in the issuer's financial position
as a result of the completion of reorganization or otherwise. Bonds that are
rated Caa by Moody's are of poor standing. Such issues may be in default or
there may be present elements of danger with respect to principal or interest.
Bonds that are rated Ca by Moody's represent obligations that are speculative in
a high degree. Such issues are often in default or have other market
shortcomings. Bonds that are rated C by Moody's are the lowest rated class of
bonds, and issues so rated can be regarded as having extremely poor prospects of
ever attaining any real investment standing.
REPURCHASE AGREEMENTS
The Fund may enter into repurchase agreements with member banks of the
Federal Reserve System having at least $1 billion in assets, primary dealers in
U.S. government securities or other financial institutions believed by Keystone
to be creditworthy. Such persons must be registered as U.S. government
securities dealers with an appropriate regulatory organization. Under such
agreements, the bank, primary dealer or other financial institution agrees, upon
entering into the contract, to repurchase the security at a mutually agreed upon
date and price, thereby determining the yield during the term of the agreement.
This results in a fixed rate of return insulated from market fluctuations during
such period. Under a repurchase agreement, the seller must maintain the value of
the securities subject to the agreement at not less than the repurchase price,
and such value will be determined on a daily basis by marking the underlying
securities to their market value. Although the securities subject to the
repurchase agreement might bear maturities exceeding a year, the Fund only
intends to enter into repurchase agreements that provide for settlement within a
year and usually within seven days. Securities subject to repurchase agreements
will be held by the Fund's custodian or in the Federal Reserve book entry
system. The Fund does not bear the risk of a decline in the value of the
underlying security unless the seller defaults under its repurchase obligation.
In the event of a bankruptcy or other default of a seller of a repurchase
agreement, the Fund could experience both delays in liquidating the underlying
securities and losses, including (1) possible declines in the value of the
underlying securities during the period while the Fund seeks to enforce its
rights thereto; (2) possible subnormal levels of income and lack of access to
income during this period; and (3) expenses of enforcing its rights. The Board
of Directors of the Fund has established procedures to evaluate the
creditworthiness of each party with whom the Fund enters into repurchase
agreements by setting guidelines and standards of review for Keystone and
monitoring Keystone's actions with regard to repurchase agreements. As a general
matter, the Fund anticipates that not more than 10% of its assets will be
invested in repurchase agreements. However, during temporary defensive periods,
up to 50% of the Fund's net assets may be so invested.
REVERSE REPURCHASE AGREEMENTS
Under a reverse repurchase agreement, the Fund would sell securities and
agree to repurchase them at a mutually agreed upon date and price. The Fund
intends to enter into reverse repurchase agreements to avoid otherwise having to
sell securities during unfavorable market conditions in order to meet
redemptions. At the time the Fund enters into a reverse repurchase agreement, it
will establish a segregated account with the Fund's custodian containing liquid
assets such as U.S. government securities or other high grade debt securities
having a value not less than the repurchase price (including accrued interest)
and will subsequently monitor the account to ensure such value is maintained.
Reverse repurchase agreements involve the risk that the market value of the
securities that the Fund is obligated to repurchase may decline below the
repurchase price. Borrowing and reverse repurchase agreements magnify the
potential for gain or loss on the portfolio securities of the Fund and,
therefore, increase the possibility of fluctuation in the Fund's net asset
value. Such practices may constitute leveraging. In the event the buyer of
securities under a reverse repurchase agreement files for bankruptcy or becomes
insolvent, such buyer or its trustee or receiver may receive an extension of
time to determine whether to enforce the Fund's obligation to repurchase the
securities and the Fund's use of the proceeds of the reverse repurchase
agreement may effectively be restricted pending such determination. The staff of
the Securities and Exchange Commission ("SEC") has taken the position that
reverse repurchase agreements are subject to the percentage limit on borrowings
imposed on the Fund under the 1940 Act.
FOREIGN SECURITIES
The Fund may invest its assets in securities principally traded in
securities markets outside the U.S. While investment in foreign securities is
intended to reduce risk by providing further diversification, such investments
involve sovereign risk in addition to the credit and market risks normally
associated with domestic securities. Foreign investments may be affected
favorably or unfavorably by changes in currency rates and exchange control
regulations. There may be less publicly available information about a foreign
company, particularly emerging market countries companies, than about a U.S.
company, and foreign companies may not be subject to accounting, auditing and
financial reporting standards and requirements comparable to those applicable to
U.S. companies. Securities of some foreign companies are less liquid or more
volatile than securities of U.S. companies, and foreign brokerage commissions
and custodian fees are generally higher than in the United States. Investments
in foreign securities may also be subject to other risks different from those
affecting U.S. investments, including local political or economic developments,
particularly with respect to companies in the formerly communist countries of
Eastern Europe, expropriation or nationalization of assets, imposition of
withholding taxes on dividend or interest payments and currency blockage (which
would prevent cash from being brought back to the U.S.). These risks are
carefully considered by Keystone prior to the purchase of these securities.
"WHEN-ISSUED" AND "FORWARD COMMITMENT" TRANSACTIONS
The Fund may also purchase securities on a when issued and delayed delivery
basis and may purchase or sell securities on a forward commitment basis. When
issued or delayed delivery transactions arise when securities are purchased or
sold by the Fund with payment and delivery taking place in the future in order
to secure what is considered to be an advantageous price and yield to the Fund
at the time of purchase. A forward commitment transaction is an agreement by the
Fund to purchase or sell securities at a specified future date. The Fund may
also enter into foreign currency forward contracts which are described in more
detail in the section entitled "Foreign Currency Transactions." When the Fund
engages in these transactions, the Fund relies on the buyer or seller, as the
case may be, to consummate the sale. Failure to do so may result in the Fund
missing the opportunity to obtain a price or yield considered to be
advantageous. When issued, delayed delivery and forward commitment transactions
may be expected to occur a month or more before delivery is due. No payment or
delivery is made by the Fund, however, until it receives payment or delivery
from the other party to the transaction. The SEC has established certain
requirements to assure that the Fund is able to meet its obligations under these
contracts, for example a separate account of liquid assets equal to the value of
such purchase commitments may be maintained until payment is made. When issued,
delayed delivery and forward commitment transactions are subject to risks from
changes in value based upon changes in the level of interest rates, currency
rates and other market factors, both before and after delivery. The Fund does
not accrue any income on such securities or currencies prior to their delivery.
To the extent the Fund engages in any of these transactions, it will do so for
the purpose of acquiring portfolio securities or currencies consistent with its
investment objective and policies and not for the purpose of investment
leverage. The Fund currently does not intend to invest more than 5% of its
assets in when issued or delayed delivery transactions.
OPTIONS TRANSACTIONS
WRITING COVERED OPTIONS. The Fund may write (i.e., sell) covered call
options. By writing a call option, the Fund becomes obligated during the term of
the option to deliver the securities underlying the option upon payment of the
exercise price.
The Fund may only write "covered" options. This means that so long as the
Fund is obligated as the writer of a call option, it will own the underlying
securities subject to the option or, in the case of call options on U.S.
Treasury bills, the Fund might own substantially similar U.S. Treasury bills. If
the Fund has written options against all of its securities that are available
for writing options, the Fund may be unable to write additional options unless
it sells a portion of its portfolio holdings to obtain new securities against
which it can write options. If this were to occur, higher portfolio turnover and
correspondingly greater brokerage commissions and other transaction costs may
result. However, the Fund does not expect that this will occur.
The principal reason for writing call options is to obtain, through a
receipt of premiums, a greater current return than would be realized on the
underlying securities alone. The Fund receives a premium from writing a call
option which it retains whether or not the option is exercised. By writing a
call option, the Fund might lose the potential for gain on the underlying
security while the option is open.
PURCHASING OPTIONS. The Fund may purchase call options for the purpose of
offsetting previously written call options of the same series.
An option position may be closed out only in a secondary market for an
option of the same series. Although the Fund generally will write only those
options for which there appears to be an active secondary market, there is no
assurance that a liquid secondary market will exist for any particular option at
any particular time, and, for some options, no secondary market may exist. In
such event it might not be possible to effect a closing transaction in a
particular option. If the Fund as a covered call option writer is unable to
effect a closing purchase transaction, it will not be able to sell the
underlying securities until the option expires or it delivers the underlying
securities upon exercise.
Options on some securities are relatively new and it is impossible to
predict the amount of trading interest that will exist in such options. There
can be no assurance that viable markets will develop or continue. The failure of
such markets to develop or continue could significantly impair the Fund's
ability to use such options to achieve its investment objectives.
OPTIONS TRADING MARKETS. Options in which the Fund will trade are generally
listed on national securities exchanges. Exchanges on which such options are
currently traded include the Chicago Board Options Exchange and the New York,
American, Pacific and Philadelphia Stock Exchanges. Options on some securities
may not be listed on any exchange, but traded in the over-the-counter market.
Options traded in the over-the-counter market involve the additional risk that
securities dealers participating in such transactions could fail to meet their
obligations to the Fund. The use of options traded in the over-the-counter
market may be subject to limitations imposed by certain state securities
authorities. In addition to the limits on its use of options discussed herein,
the Fund is subject to the investment restrictions described in this prospectus
and in the statement of additional information.
The staff of the SEC is of the view that the premiums the Fund pays for the
purchase of unlisted options and the value of securities used to cover unlisted
options written by the Fund are considered to be invested in illiquid securities
or assets for the purpose of calculating whether the Fund is in compliance with
its policies pertaining to illiquid investments.
PAYMENT-IN-KIND SECURITIES
Payment-in-kind securities pay interest in either cash or additional
securities, at the issuer's option, for a specified period. The issuer's option
to pay in additional securities typically ranges from one to six years, compared
to an average maturity for all PIK securities of eleven years. Call protection
and sinking fund features are comparable to those offered on traditional debt
issues.
PIKs, like zero coupon bonds, are designed to give an issuer flexibility in
managing cash flow. Several PIKs are senior debt. In other cases, where PIKs are
subordinated, most senior lenders view them as equity equivalents.
An advantage of PIKs for the issuer -- as with zero coupon securities -- is
that interest payments are automatically compounded (reinvested) at the stated
coupon rate, which is not the case with cash-paying securities. However, PIKs
are gaining popularity over zeros since interest payments in additional
securities can be monetized and are more tangible than accretion of a discount.
As a group, PIK bonds trade flat (i.e., without accrued interest). Their
price is expected to reflect an amount representing accreted interest since the
last payment. PIKs generally trade at higher yields than comparable cash- paying
securities of the same issuer. Their premium yield is the result of the lesser
desirability of non-cash interest, the more limited audience for non-cash paying
securities, and the fact that many PIKs have been issued to equity investors who
do not normally own or hold such securities.
Calculating the true yield on a PIK security requires a discounted cash flow
analysis if the security (ex interest) is trading at a premium or a discount
because the realizable value of additional payments is equal to the current
market value of the underlying security, not par.
Regardless of whether PIK securities are senior or deeply subordinated,
issuers are highly motivated to retire them because they are usually their most
costly form of capital. Sixty-eight percent of the PIK debentures issued prior
to 1987 have already been redeemed, and approximately 35% of the over $10
billion PIK debentures issued through year-end 1988 have been retired.
ZERO COUPON "STRIPPED" BONDS
A zero coupon "stripped" bond represents ownership in serially maturing
interest payments or principal payments on specific underlying notes and bonds,
including coupons relating to such notes and bonds. The interest and principal
payments are direct obligations of the issuer. Coupon zero coupon bonds of any
series mature periodically from the date of issue of such series through the
maturity date of the securities related to such series. Principal zero coupon
bonds mature on the date specified therein, which is the final maturity date of
the related securities. Each zero coupon bond entitles the holder to receive a
single payment at maturity. There are no periodic interest payments on a zero
coupon bond. Zero coupon bonds are offered at discounts from their face amounts.
In general, owners of zero coupon bonds have substantially all the rights
and privileges of owners of the underlying coupon obligations or principal
obligations. Owners of zero coupon bonds have the right upon default on the
underlying coupon obligations or principal obligations to proceed directly and
individually against the issuer and are not required to act in concert with
other holders of zero coupon bonds.
For federal income tax purposes, a purchaser of principal zero coupon bonds
or coupon zero coupon bonds (either initially or in the secondary market) is
treated as if the buyer had purchased a corporate obligation issued on the
purchase date with an original issue discount equal to the excess of the amount
payable at maturity over the purchase price. The purchaser is required to take
into income each year as ordinary income an allocable portion of such discounts
determined on a "constant yield" method. Any such income increases the holder's
tax basis for the zero coupon bond, and any gain or loss on a sale of the zero
coupon bonds relative to the holder's basis, as so adjusted, is a capital gain
or loss. If the holder owns both principal zero coupon bonds and coupon zero
coupon bonds representing interest in the same underlying issue of securities, a
special basis allocation rule (requiring the aggregate basis to be allocated
among the items sold and retained based on their relative fair market value at
the time of sale) may apply to determine the gain or loss on a sale of any such
zero coupon bonds.
FUTURES TRANSACTIONS
The Fund may enter into currency and other financial futures contracts and
write options on such contracts. The Fund intends to enter into such contracts
and related options for hedging purposes. The Fund will enter into securities,
currency or index-based futures contracts in order to hedge against changes in
interest or exchange rates or securities prices. A futures contract on
securities or currencies is an agreement to buy or sell securities or currencies
at a specified price during a designated month. A futures contract on a
securities index does not involve the actual delivery of securities but merely
requires the payment of a cash settlement based on changes in the securities
index. The Fund does not make payment or deliver securities upon entering into a
futures contract. Instead, it puts down a margin deposit, which is adjusted to
reflect changes in the value of the contract and which continues until the
contract is terminated.
The Fund may sell or purchase futures contracts. When a futures contract is
sold by the Fund, the value of the contract will tend to rise when the value of
the underlying securities or currencies declines and to fall when the value of
such securities or currencies increases. Thus, the Fund sells futures contracts
in order to offset a possible decline in the value of its securities or
currencies. If a futures contract is purchased by the Fund, the value of the
contract will tend to rise when the value of the underlying securities or
currencies increases and to fall when the value of such securities or currencies
declines. The Fund intends to purchase futures contracts in order to fix what is
believed by Keystone to be a favorable price and rate of return for securities
or favorable exchange rate for currencies the Fund intends to purchase.
The Fund also intends to purchase put and call options on futures contracts
for hedging purposes. A put option purchased by the Fund would give it the right
to assume a position as the seller of a futures contract. A call option
purchased by the Fund would give it the right to assume a position as the
purchaser of a futures contract. The purchase of an option on a futures contract
requires the Fund to pay a premium. In exchange for the premium, the Fund
becomes entitled to exercise the benefits, if any, provided by the futures
contract, but is not required to take any action under the contract. If the
option cannot be exercised profitably before it expires, the Fund's loss will be
limited to the amount of the premium and any transaction costs.
The Fund may enter into closing purchase and sale transactions in order to
terminate a futures contract and may sell put and call options for the purpose
of closing out its options positions. The Fund's ability to enter into closing
transactions depends on the development and maintenance of a liquid secondary
market. There is no assurance that a liquid secondary market will exist for any
particular contract or at any particular time. As a result, there can be no
assurance that the Fund will be able to enter into an offsetting transaction
with respect to a particular contract at a particular time. If the Fund is not
able to enter into an offsetting transaction, the Fund will continue to be
required to maintain the margin deposits on the contract and to complete the
contract according to its terms, in which case it would continue to bear market
risk on the transaction.
Although futures and options transactions are intended to enable the Fund to
manage market, interest rate or exchange rate risk, unanticipated changes in
interest rates, exchange rates or market prices could result in poorer
performance than if it had not entered into these transactions. Even if Keystone
correctly predicts interest or exchange rate movements, a hedge could be
unsuccessful if changes in the value of the Fund's futures position did not
correspond to changes in the value of its investments. This lack of correlation
between the Fund's futures and securities or currencies positions may be caused
by differences between the futures and securities or currencies markets or by
differences between the securities or currencies underlying the Fund's futures
position and the securities or currencies held by or to be purchased for the
Fund. Keystone will attempt to minimize these risks through careful selection
and monitoring of the Fund's futures and options positions.
The Fund does not intend to use futures transactions for speculation or
leverage. The Fund has the ability to write options on futures, but intends to
write such options only to close out options purchased by the Fund. The Fund
will not change these policies without supplementing the information in its
prospectus and statement of additional information.
FOREIGN CURRENCY TRANSACTIONS
As discussed above, the Fund may invest in securities of foreign issuers.
When the Fund invests in foreign securities they usually will be denominated in
foreign currencies, and the Fund temporarily may hold funds in foreign
currencies. Thus, the value of Fund shares will be affected by changes in
exchange rates.
As one way of managing exchange rate risk, in addition to entering into
currency futures contracts, the Fund may enter into forward currency exchange
contracts (agreements to purchase or sell currencies at a specified price and
date). The exchange rate for the transaction (the amount of currency the Fund
will deliver or receive when the contract is completed) is fixed when the Fund
enters into the contract. The Fund usually will enter into these contracts to
stabilize the U.S. dollar value of a security it has agreed to buy or sell. The
Fund intends to use these contracts to hedge the U.S. dollar value of a security
it already owns, particularly if the Fund expects a decrease in the value of the
currency in which the foreign security is denominated. Although the Fund will
attempt to benefit from using forward contracts, the success of its hedging
strategy will depend on Keystone's ability to predict accurately the future
exchange rates between foreign currencies and the U.S. dollar. The value of the
Fund's investments denominated in foreign currencies will depend on the relative
strength of those currencies and the U.S. dollar, and the Fund may be affected
favorably or unfavorably by changes in the exchange rates or exchange control
regulations between foreign currencies and the dollar. Changes in foreign
currency exchange rates also may affect the value of dividends and interest
earned, gains and losses realized on the sale of securities and net investment
income and gains, if any, to be distributed to shareholders by the Fund.
Although the Fund does not currently intend to do so, the Fund may also purchase
and sell options related to foreign currencies. The Fund does not intend to
enter into foreign currency transactions for speculation or leverage.
LOANS OF SECURITIES TO BROKER-DEALERS
The Fund may lend securities to brokers or dealers pursuant to agreements
requiring that the loans be continuously secured by cash or securities of the
U.S. government, its agencies or instrumentalities, or any combination of cash
and such securities, as collateral equal at all times in value to at least the
market value of the securities loaned. Such securities loans will not be made
with respect to the Fund if, as a result, the aggregate of all outstanding
securities loans exceeds 15% of the value of the Fund's total assets taken at
their current value. The Fund continues to receive interest or dividends on the
securities loaned and simultaneously earns interest on the investment of the
cash loan collateral in U.S. Treasury notes, certificates of deposit, other
high-grade, short-term obligations or interest bearing cash equivalents.
Although voting rights attendant to securities loaned pass to the borrower, such
loans may be called at any time and will be called so that the securities may be
voted by the Fund if, in the opinion of the Fund, a material event affecting the
investment is to occur. There may be risks of delay in receiving additional
collateral or in recovering the securities loaned or even loss of rights in the
collateral should the borrower of the securities fail financially. Loans may
only be made, however, to borrowers deemed to be of good standing, under
standards approved by Keystone, when the income to be earned from the loan
justifies the attendant risks.
Read carefully before filling out application.
APPLICATION INFORMATION
Keystone offers a wide variety of options to help you manage your
investments quickly and effortlessly. Please be sure to indicate only the
services you desire.
Automatic investments and redemptions are normally processed through
Electronic Funds Transfer if your bank participates in the Automated Clearing
House. If your bank does not have Electronic Funds Transfer, your investments or
redemptions can be handled by check. Electronic Funds Transfer is generally
faster than issuing checks which may result in delays. For you own protection,
you may wish to inquire about your bank's standard procedures.
For the protection of shareholders, regardless of the number of shares or
amounts of money involved in a redemption or repurchase, signatures on
certificates, stock powers and all written orders or authorizations must be
guaranteed by a U.S. stock exchange member, a bank or other persons eligible to
guarantee signatures under the Securities Exchange Act of 1934 and KIRCOs
policies. KIRC may waive this requirement but may also require additional
documents in certain cases.
APPLICATION Keystone Custodian Funds
_______________________________________________________________________________
Mail application and check(s) to Keystone Investor Resource Center, Inc.
P.O. Box 2121, Boston, MA 02106-9970
_______________________________________________________________________________
INTERNAL USE ONLY
_______________________________________________________________________________
Account Number
_______________________ _______________________ _______________________
DN AT SC
A. FUND SELECTION
Initial Minimum $1,000 Except: Keystone Tax Exempt Trust $10,000.
Make checks payable to fund(s) selected.
(44) Series B-1 $______________ (49) Series S-1 $______________
(45) Series B-2 $______________ (50) Series S-3 $______________
(46) Series B-4 $______________ (51) Series S-4 $______________
(47) Series K-1 $______________ (52) Keystone
(48) Series K-2 $______________ International $______________
(54) Keystone (30) Keystone Tax
Precious Metals Exempt Trust $______________
Holdings $______________ ( ) Keystone Tax
Free Fund $______________
Other $______________
_______________________________________________________________________________
B. YOUR INVESTMENT DEALER
_______________________________________________________________________________
Broker/Dealer Firm Name
_______________________________________________________________________________
Branch Location and Number
_______________________________________________________________________________
Last Name First Name Rep #
(____________)_________________________________________________________________
Area Code Telephone
_______________________________________________________________________________
Investor's account # (if any) with dealer's firm
<PAGE>
_______________________________________________________________________________
C. SHAREHOLDER REGISTRATION (please print)
Individual_____________________________________________________________________
First Name Middle Initial Last Name Social Security #
Joint Tenant___________________________________________________________________
First Name Middle Initial Last Name Social Security #
Other__________________________________________________________________________
Name of Corporation, Organization, Fiduciary Taxpayer I.D. #
If trust give date of trust agreement:____________________
Uniform Gifts to Minors Act____________________________________________________
Custodian's Name
Uniform Transfers to Minors Act________________________________________________
Custodian's Name
As Custodian for__________________________________ Under the_______________ Act
Minor's Name Social Security # State
_______________________________________________________________________________
Street Address City State 9-digit Zip Code
Daytime Telephone ( )_________________________________________________
Area Code
NOTE: See reverse side for important tax information.
( ) Check here if any owner is a citizen or resident of the U.S.
( ) Check here if any owner is a foreign person not subject to U.S. tax
reporting requirements. Indicate Country_____________________________
_______________________________________________________________________________
D. DISTRIBUTIONS
Check appropriate box. If no choice indicated, all distributions will be
reinvested.
( ) Reinvest all income dividends and capital gains distributions in
additional shares.
( ) Pay all income dividends in cash; reinvest capital gains distributions.
( ) Pay all income dividends and capital gains distributions in cash.
( ) Invest all distributions in another Keystone Fund.
_______________________________________________________________________________
Designate Fund Name
_______________________________________________________________________________
E. OPTIONAL SERVICES
Check appropriate box(es). Please read "Application Information" on front.
1. TELEPHONE EXCHANGES 1-800-343-2898
( ) Subject to Prospectus provisions, I authorize Keystone to accept my
telephone instructions to exchange my shares in any fund in the Keystone
Custodian Family of Funds for shares of another fund in the Keystone
Custodian Family of Funds. There is a $10.00 fee for each exchange;
however, if the exchange is made through KARL by an individual investor
there is no fee.
( ) Subject to Prospectus provisions, I authorize Keystone to accept
telephone instructions from my financial adviser of record to exchange my
shares in any fund in the Keystone Custodian Family of Funds for shares
of another fund in the Keystone Custodian Family of Funds. There is a
$10.00 fee for each exchange.
Please refer to the Prospectus for a more complete description of
telephone privileges.
2. ( ) TELEPHONE REDEMPTIONS 1-800-343-2898
Subject to Prospectus provisions, I authorize Keystone to accept my
telephone instructions to redeem up to $50,000 (minimum $1,000) from my
account. Only shares on deposit with Keystone can be redeemed by
telephone. Redemptions by telephone are allowed only if the address and
bank account of record have been the same for a minimum period of 30
days. Please provide bank information in Section F at left.
Please refer to the Prospectus for a more complete description of
telephone privileges.
<PAGE>
3. ( ) AUTOMATIC INVESTMENT PLAN
I authorize $_____________ ($100 minimum) to be automatically invested
amount
in_______________________ on the ( ) 5th or ( )20th day of each month.
name of fund
Please allow up to 30 days after application is received to begin this
service. Provide bank information in Section F at left.
4. ( ) AUTOMATIC WITHDRAWAL PLAN ( ) MONTHLY OR ( ) QUARTERLY I authorize
Keystone to withdraw $_____________________ (min. $100 to max. 1% per
month or 3% per quarter of account assets) from my account on the first
day of each period, beginning ___________________________ 1st, 19___, and
month
and to send the amount as follows:
(check one)
( ) Deposit directly to my bank account shown in Section F at left.
( ) Mail a check to the registered shareholder's address.
( ) Mail check to other payee:__________________________________________
Payee Name
________________________________________________________________________
Street Address City State 9-Digit Zip Code
Please allow up to 30 days after application is received to begin this service.
Please provide bank information in Section F, at left.
________________________________________________________________________________
F. BANK INFORMATION
For Optional Services 2, 3 and 4.
If you elected to have funds deposited to or withdrawn from your bank, please
attach a voided check or preprinted deposit slip for your bank account. Your
Keystone account and your bank account must have one name in common.
________________________________________________________________________________
Name of Bank
________________________________________________________________________________
Bank Address
________________________________________________________________________________
Name on Bank Account
________________________________________________________________________________
Bank Account Number
IMPORTANT: KEYSTONE PRESENTLY DOES NOT CHARGE FOR ELECTRONIC BANKING TRANSFERS.
SOME BANKS, HOWEVER, MAY CHARGE FOR THESE SERVICES.
________________________________________________________________________________
G. SIGNATURES AND AUTHORIZATIONS
Under penalties of perjury, you, the undersigned, certify that the number shown
above is your correct taxpayer identification number and that you are not
subject to backup withholding unless you have checked a box below.
( ) Check here if you are subject to backup withholding under the provisions
of the Internal Revenue Code Section 3406(a)(1)(C).
( ) Check here if you do not have a Social Security or Taxpayer I.D. number
but have applied for one. Your signature on this application serves to
certify this, and that you understand that if you do not provide a number
within 60 days, Keystone is required by law to withhold 31% of all your
dividends, capital gains, redemptions, exchanges, and certain other
payments. If by setting up your account without a properly certified Social
Security or Taxpayer Identification Number Keystone incurs a penalty fine,
we reserve the right to deduct such an amount from your account.
<PAGE>
APPLICANT(S) SIGNATURE
I (we) am (are) of legal age and have read the prospectus(es) and agree to the
terms. I/we authorize Keystone to provide information over the telephone to any
person identifying him/herself as the registered shareholder or the
shareholder's representative and understand that all telephone conversations may
be recorded. IMPORTANT: If I (we) have elected any of the optional exchange,
redemption, automatic investment or automatic withdrawal services described
above: (i) I (we) hereby ratify any instructions received by Keystone in writing
and I (we) agree that neither the Fund, KIRC nor KDI will be held responsible
for the authenticity of such instructions; (ii) I (we) agree that neither the
Fund, KIRC nor KDI will be held liable when following instructions received over
KARL or by telephone which are reasonably believed to be genuine; and (iii) I
(we) understand, that if such reasonable procedures are not followed, the Fund,
KIRC or KDI may be liable for any losses due to unauthorized or fraudulent
instructions.
________________________________________________________________________________
Signature Date
________________________________________________________________________________
Signature Date
IMPORTANT TAX NOTICE
BACKUP WITHHOLDING INFORMATION
________________________________________________________________________________
Federal tax law requires us to obtain your certification that:
1. The taxpayer identification number you provide is correct, and
2. That you are not subject to backup withholding. (For most individuals, the
taxpayer identification number is the Social Security Number.)
Nonresident aliens must certify that they qualify as foreign persons, exempt
from U.S. tax reporting requirements. On joint accounts where an owner is a U.S.
citizen or resident, that owner must certify that the taxpayer identification
number provided is correct and is not subject to backup withholding.
Certification of foreign status must be filed every three years.
If you do not provide us with the above information on the application, we are
required by law to withhold 31% of all your dividends, capital gains,
redemptions, exchanges and certain other payments.
The following are the other conditions under which you will be subject to backup
withholding:
1. If you have received a notice from the Internal Revenue Service that you
provided an incorrect taxpayer identification number.
2. If you have received a notice from the Internal Revenue Service that you
underreported interest or dividend payments or did not file a return
reporting such payments.
DO NOT CHECK THE BOX INDICATING THAT YOU ARE SUBJECT TO BACKUP WITHHOLDING
UNLESS YOU HAVE RECEIVED A NOTICE FROM THE INTERNAL REVENUE SERVICE.
If you fall within one of the following categories, you are exempt from backup
withholding on ALL payments and should NOT check the box:
* CORPORATION * FINANCIAL INSTITUTION * REGISTERED SECURITIES DEALER * COMMON
TRUST FUND * COLLEGE, CHURCH OR CHARITABLE ORGANIZATION * RETIREMENT PLAN *
OTHER ENTITY LISTED IN INTERNAL REVENUE CODE SEC. 3452.
For further details, refer to Internal Revenue Service Form W-9.
<PAGE>
- 1 -
STATEMENT OF ADDITIONAL INFORMATION
KEYSTONE INTERNATIONAL FUND INC.
February 27, 1995
This statement of additional information is not a prospectus, but relates
to, and should be read in conjunction with, the prospectus of Keystone
International Fund Inc. (the "Fund") dated February 27, 1995. A copy of the
prospectus may be obtained from Keystone Distributors, Inc. ("KDI"), the Fund's
principal underwriter ("Principal Underwriter"), 200 Berkeley Street, Boston,
Massachusetts 02116-5034 or your broker-dealer.
- --------------------------------------------------------------------------------
TABLE OF CONTENTS
- --------------------------------------------------------------------------------
Page
The Fund's Objectives and Policies 2
Investment Restrictions 2
Valuation of Securities 4
Distributions and Taxes 5
Sales Charges 6
Shareholder Services 8
Distribution Plan 10
Redemptions in Kind 12
Investment Manager 13
Investment Adviser 15
Directors and Officers 16
Principal Underwriter 20
Brokerage 22
Standardized Total Return
and Yield Quotations 23
Additional Information 24
Appendix A-1
Financial Statements F-1
Independent Auditors' Report F-21
<PAGE>
- 2 -
- --------------------------------------------------------------------------------
THE FUND'S OBJECTIVES AND POLICIES
- --------------------------------------------------------------------------------
The Fund is an open-end, diversified management investment company
commonly known as a mutual fund. The Fund's primary investment objective is
long-term growth of capital. As a secondary objective, the Fund seeks modest
income on its investments. Investments are internationally diversified in order
to take advantage of domestic and international changes in technology, the
economy and market conditions. In pursuing its objectives, the Fund may invest
in securities of both United States ("U.S.") companies and companies of any
foreign nation. The Fund may invest in preferred stocks, debt obligations,
common stocks and securities convertible into common stocks or having common
stock characteristics (including rights, warrants and options). The Fund may
also invest in debt obligations of the U.S. and any foreign governments,
including their political subdivisions, and in securities and debt obligations
of any international agency, in time deposits with U.S. and foreign banks. The
Fund may hold cash and cash equivalents in U.S. currency or currencies of any
nation. At this time, the Fund follows a policy of investing solely in
securities of non-U.S. issuers. Investments may be held on a short-term basis
when the Fund considers it desirable.
- --------------------------------------------------------------------------------
INVESTMENT RESTRICTIONS
- --------------------------------------------------------------------------------
None of the restrictions enumerated in this paragraph may be changed
without a vote of the holders of a majority, as defined in the Investment
Company Act of 1940 (the "1940 Act"), of the Fund's outstanding shares. The Fund
shall not do the following:
(1) invest more than 5% of its total assets, computed at market value, in
the securities of any one issuer;
(2) invest in more than 10% of the outstanding voting securities of any
one issuer;
(3) invest more than 5% of the value of its total assets in companies that
have been in operation for less than three years;
(4) borrow money, except that the Fund may borrow money from banks and/or
enter into reverse repurchase agreements for emergency or extraordinary purposes
in aggregate amounts up to 10% of its gross assets, computed at the lower of
cost or current value, provided that no additional investments shall be made at
any time that outstanding borrowings (including amounts payable under
<PAGE>
- 3 -
reverse repurchase agreements) exceed 5% of the Fund's gross assets;
(5) underwrite securities, except that the Fund may purchase securities
from issuers thereof or others and dispose of such securities in a manner
consistent with its other investment policies; in the disposition of restricted
securities the Fund may be deemed to be an underwriter, as defined in the
Securities Act of 1933 (the "1933 Act");
(6) purchase real estate or commodities or commodity contracts, except
that the Fund may enter into currency or other financial futures contracts and
engage in related options transactions;
(7) invest in a company for the purpose of exercising control over or
management of any issuer;
(8) make margin purchases or short sales of securities;
(9) lend any of its assets, except through the purchase of debt securities
of a type commonly distributed or sold publicly or privately to financial
institutions and except that the Fund may lend limited amounts of its portfolio
securities to broker dealers;
(10) invest more than 25% of its assets in the securities of issuers in
any single industry; and
(11) purchase the securities of any other investment company except in the
open market and at customary brokerage rates and in no event more than 3% of the
voting securities of any investment company.
The Fund has no current intention of purchasing the securities of other
investment companies. Purchasing such securities would result in Fund investors
indirectly bearing a proportionate share of the expenses of such investment
companies, including their operating costs and investment advisory and
administrative fees. If the Fund were to purchase such securities, such purchase
would not result in the Fund owning immediately after the purchase securities of
such investment company having a value in excess of 5% of the Fund's total
assets, nor in the Fund owning securities of more than one investment company
with an aggregate value in excess of 10% of the Fund's total assets.
The Fund is subject to restrictions in the sale of portfolio securities
to, and in its purchase or retention of securities of, companies in which the
management personnel of the Fund or of its investment adviser own individually
more than 1/2 of 1% and together own more than 5% of such securities.
<PAGE>
- 4 -
The Fund intends to follow policies of the Securities and Exchange
Commission as they are adopted from time to time with respect to illiquid
securities, including, at this time, (1) treating as illiquid, securities that
may not be sold or disposed of in the ordinary course of business within seven
days at approximately the value at which the Fund has valued such securities on
its books, and (2) limiting its holdings of such securities to 15% of net
assets.
As a condition of its continuing registration in a state, the Fund has
undertaken not to invest more than 5% of its total assets in securities of
unseasoned issuers, including their predecessors, that have been in operation
for less than three years, and in equity securities of issuers that are not
readily marketable. The Fund similarly has undertaken not to invest in interests
in oil, gas, or other mineral exploration or development programs. The Fund has
also undertaken that its investment in warrants, valued at the lower of cost or
market, will not exceed 5% of the value of its net assets. Included within that
amount, but not to exceed 2% of the value of the Fund's net assets, may be
warrants not listed on the New York or American Stock Exchanges. Warrants
acquired by the Fund in units or attached to securities will be deemed to be
without value with regard to this restriction.
- --------------------------------------------------------------------------------
VALUATION OF SECURITIES
- --------------------------------------------------------------------------------
Current value for the Fund's portfolio securities is determined in the
following manner: Securities traded on an established exchange are valued on the
basis of the last sales price on the exchange where primarily traded prior to
the time of valuation. (Currently, values of Fund investments quoted in other
than U.S. dollars are converted into U.S. dollar equivalents at the midday
foreign exchange rate as reported by the Dow Jones News Service.) Securities
traded in the over-the-counter market, for which complete quotations are readily
available, are valued at the mean of the bid and asked prices at the time of
valuation. When the Board in good faith determines that amortized cost reflects
fair value, short-term money market instruments that are purchased with
maturities of sixty days or less are valued at amortized cost (original purchase
cost as adjusted for amortization of premium or accretion of discount), which,
when combined with accrued interest, approximates market; money market
instruments maturing in more than sixty days for which market quotations are
readily available are valued at market value; and money market instruments
maturing in more than sixty days when purchased that are held on the sixtieth
day prior to maturity are valued at amortized cost (market value on the sixtieth
day adjusted for amortization of premium or accretion of discount), which, when
combined with accrued interest, approximates market; and in any case reflects
fair value as
<PAGE>
- 5 -
determined by the Board of Directors. The Board of Directors of the Fund values
the following securities at prices it deems in good faith to be fair: (1)
securities, including restricted securities, for which complete quotations are
not readily available; (2) listed securities, if in the opinion of the Board of
Directors the last sales price does not reflect a current market value or if no
sale occurred; and (3) other assets.
The Fund believes that reliable market quotations are generally not
readily available for purposes of valuing fixed income securities. As a result,
depending on the particular securities owned by the Fund, it is likely that most
of the valuations for such securities will be based upon their fair value
determined under procedures approved by the Directors. The Board of Directors
has authorized the use of a pricing service to determine the fair value of its
fixed income securities and certain other securities. Securities for which
market quotations are readily available are valued on a consistent basis at the
price quoted that, in the opinion of the Board of Directors or the person
designated by the Board of Directors to make the determination, most nearly
represents the market value of the particular security. Any securities for which
market quotations are not readily available or other assets are valued on a
consistent basis at fair value as determined in good faith using methods
prescribed by the Board of Directors.
- --------------------------------------------------------------------------------
DISTRIBUTIONS AND TAXES
- --------------------------------------------------------------------------------
Distributed net investment income and net short-term capital gains are
taxable as ordinary income to the shareholder whether received in cash or
additional shares of the Fund. Distributed long-term gains are taxable as such
to the shareholder regardless of how long the shareholder has held his Fund
shares.
The Fund ordinarily distributes its net capital gains in shares of the
Fund or, at the option of the shareholder, in cash. All shareholders may
reinvest dividends without being subject to a deferred sales charge when shares
so purchased are redeemed. Shareholders who have opted prior to the record date
to receive shares with regard to capital gains and/or income distributions will
have the number of such shares determined on the basis of the share value
computed at the end of the day on the record date after adjustment for the
distribution. Net asset value is used in computing the appropriate number of
shares in both a capital gains distribution and an income distribution
reinvestment. Account statements and/or checks as appropriate will be mailed to
shareholders by the 15th of November each year. Unless the Fund receives
instructions to the contrary from a shareholder before the record date, it will
be assumed that the shareholder wishes to
<PAGE>
- 6 -
receive both capital gains distributions and income distributions in shares.
Instructions continue in effect until changed in writing.
If more than 50% of the value of the Fund's total assets at the end of a
fiscal year is represented by securities of foreign corporations and the Fund
elects to make foreign tax credits available to its shareholders, a shareholder
will be required to include in his gross income both cash dividends and the
amount the Fund advises him is his pro rata portion of income taxes withheld by
foreign governments from interest and dividends paid on the Fund's investments.
The shareholder will be entitled, however, to take the amount of such foreign
taxes withheld as a credit against his U.S. income tax, or to treat the foreign
tax withheld as an itemized deduction from his gross income, if that should be
to his advantage. In substance, this policy enables the shareholder to benefit
from the same foreign tax credit or deduction that he would have received if he
had been the individual owner of foreign securities and had paid foreign income
tax on the income therefrom. As in the case of individuals receiving income
directly from foreign sources, the above-described tax credit and deductions are
subject to certain limitations.
If the value of shares is reduced below a shareholder's cost by
distribution of capital gains realized on the sale of portfolio securities, such
distributions to the extent of the reduction would be a return of capital though
taxable as stated above. Since distributions of capital gains depend upon
securities profits actually realized, they may or may not occur. The foregoing
comments relating to the taxation of dividends and distributions paid on the
Fund's shares relate solely to federal income taxation. Such dividends and
distributions may also be subject to state and local taxes.
When the Fund makes a distribution, it intends to distribute only its net
capital gains and such income, if any, as has been predetermined to the best of
the Fund's ability to be taxable as ordinary income. Therefore, net investment
income distributions, if any, will not be made on the basis of distributable
income as computed on the books of the Fund, but will be made on a federal
taxation basis. Fund shareholders will continue to be advised of the tax status
of distributions.
- --------------------------------------------------------------------------------
SALES CHARGES
- --------------------------------------------------------------------------------
In order to reimburse the Fund for certain expenses relating to the sale
of its shares (see "Distribution Plan"), a contingent deferred sales charge may
be imposed at the time of redemption of certain Fund shares within four calendar
years after their
<PAGE>
- 7 -
purchase. If imposed, the deferred sales charge is deducted from the redemption
proceeds otherwise payable to the shareholder. Since July 8, 1992, the deferred
sales charge attributable to shares purchased prior to January 1, 1992 has been
retained by the Fund, and the deferred sales charge attributable to shares
purchased after January 1, 1992 is, to the extent permitted by the National
Association of Securities Dealers, Inc. ("NASD"), paid to KDI, the Fund's
Principal Underwriter. For the twelve month period ended September 30, 1994 and
the one month period ended October 31, 1994, the Fund recovered $7,861 and $801,
respectively, in deferred sales charges.
The contingent deferred sales charge is a declining percentage of the
lesser of (1) the net asset value of the shares redeemed, or (2) the total cost
of such shares. No deferred sales charge is imposed when the shareholder redeems
amounts derived from (1) increases in the value of his account above the total
cost of such shares due to increases in the net asset value per share of the
Fund; (2) certain shares with respect to which the Fund did not pay a commission
on issuance, including shares acquired through reinvestment of dividend income
and capital gains distributions; (3) shares held in all or part of more than
four consecutive calendar years.
Subject to the limitations stated above, the deferred sales charge is
imposed according to the following schedule: 4% of amounts redeemed during the
calendar year of purchase; 3% of amounts redeemed during the calendar year after
the year of purchase; 2% of amounts redeemed during the second calendar year
after the year of purchase; and 1% of amounts redeemed during the third calendar
year after the year of purchase. No deferred sales charge is imposed on amounts
redeemed thereafter.
The following example illustrates the operation of the contingent deferred
sales charge. Assume that an investor makes a purchase payment of $10,000 during
the calendar year 1994 and on a given date in 1995 the value of the investor's
account has grown through investment performance and reinvestment of
distributions to $12,000. On such date in 1995, the investor could redeem up to
$2,000 ($12,000 minus $10,000) without incurring a deferred sales charge. If, on
such date, the investor should redeem $3,000, a deferred sales charge would be
imposed on $1,000 of the redemption proceeds (the amount by which the investor's
account was reduced by the redemption below the amount of the initial purchase
payment). The charge would be imposed at the rate of 3% (because the redemption
is made during the calendar year after the calendar year of purchase) and would
total $30.
In determining whether a contingent deferred sales charge is payable and,
if so, the percentage charge applicable, it is assumed that shares held the
longest are the first to be redeemed. There is no deferred sales charge on
permitted exchanges of shares
<PAGE>
- 8 -
between Keystone Group Funds that have adopted substantially similar
distribution plans pursuant to Rule 12b-1 under the 1940 Act. Moreover, when
shares of one such fund have been exchanged for shares of another such fund, for
purposes of any future contingent deferred sales charge, the calendar year of
the purchase of the shares of the fund exchanged into is assumed to be the year
shares tendered for exchange were originally purchased.
Shares also may be sold, to the extent permitted by applicable law,
regulations, interpretations or exemptions, at net asset value without the
imposition of a deferred sales charge (or payment of commissions) to (1)
registered representatives of firms with dealer agreements with KDI; (2)
officers, Directors, full-time employees and sales representatives of the Fund,
Keystone Custodian Funds, Inc. ("Keystone"), Keystone Management, Inc.
("Keystone Management"), Keystone Group, Inc. ("Keystone Group"), Harbor Capital
Management Company, Inc., their subsidiaries and the Principal Underwriter who
have been such for not less than ninety days; and (3) the pension and
profit-sharing plans established by said companies, their subsidiaries and
affiliates, for the benefit of their officers, Directors, full-time employees
and sales representatives, provided all such sales are made upon the written
assurance of the purchaser that the purchase is made for investment purposes and
that the securities will not be resold except through redemption by the Fund.
In addition, no deferred sales charge is imposed on a redemption of shares
of the Fund purchased by a bank or trust company in a single account in the name
of such bank or trust company as trustee, if the initial investment in shares of
the Fund, any Keystone Custodian Fund (as hereinafter defined), Keystone
Precious Metals Holdings, Inc., Keystone Tax Exempt Trust, Keystone Tax Free
Fund, Keystone Liquid Trust and/or any Keystone America Fund (as hereinafter
defined) is at least $500,000 and any commission paid by the Fund and such other
funds invested at the time of such purchase is not more than 1% of the amount
invested.
- --------------------------------------------------------------------------------
SHAREHOLDER SERVICES
- --------------------------------------------------------------------------------
Reinvestment Privilege
A shareholder may elect to reinvest any part of the proceeds of a total or
partial redemption of Fund shares. Upon making such an election, the Fund will
recredit the deferred sales charge previously deducted. The calendar year of
such reinvestment purchase, for purposes of any future contingent deferred sales
charge, is assumed to be the year such shares were originally purchased. A
shareholder must make such an election within 30 days of the date of such
redemption and the purchase must be of Fund
<PAGE>
- 9 -
shares. The number of shares credited upon reinvesting the proceeds will be
based on the net asset value of Fund shares next computed following receipt of
the proceeds and request for reinvestment. This reinvestment privilege may be
used only once with respect to any shareholder. If a shareholder exercises this
reinvestment privilege, any tax loss realized upon the original sale of the Fund
shares will not be recognized for federal income tax purposes. Any capital
gains, however, would be recognized for federal income tax purposes. For tax
reporting purposes, the Fund treats a redemption and subsequent reinvestment
purchase as separate transactions.
Tax-Sheltered Plans
For an individual with earned income or wages not participating in a
qualified retirement plan who wishes to purchase Fund shares as a tax deductible
contribution prior to the year he or she attains age 70-1/2, there is available
a Custody Agreement for an Individual Retirement Account ("IRA") that has been
accepted by the Internal Revenue Service as a prototype under Section 408 of the
Internal Revenue Code (the "Code"). This Custody Agreement may also be used by
an individual wishing to establish a Rollover IRA or by an employer wishing to
establish a Simplified Employee Pension Plan.
For self-employed individuals, corporations and other organizations that
wish to purchase Fund shares in a qualified plan for the benefit of their
employees, there is available a Trust Agreement for a Defined Contribution Plan
that has been accepted by the Internal Revenue Service as a prototype under
Section 401 of the Code. The prototype contains a series of Adoption Agreements
classified as Profit Sharing, Money Purchase or Target Benefit.
For corporations and other organizations that wish to purchase Fund shares
in a qualified plan for the benefit of their employees, the following Corporate
Plans and Agreements that have been accepted by the Internal Revenue Service as
prototypes under the Employee Retirement Income Security Act of 1974 ("ERISA")
are available: Profit Sharing Plan and Trust Agreement, Pension Plan and Trust
Agreement and Target Benefit Plan and Trust Agreement.
For public educational institutions and certain tax-exempt organizations
that wish to purchase Fund shares on behalf of employees pursuant to a salary
reduction or waiver of increase agreement, there is available a Custody
Agreement that is intended to qualify as a tax-sheltered "annuity purchase"
plan.
Investors considering the funding of a plan are advised to consult with an
attorney or to obtain advice from a competent retirement plan consultant with
respect to the requirements of the plan and the tax aspects thereof. For
details, including fees, see the specific plan and agreement and supplementary
guide as provided
<PAGE>
- 10 -
by the Fund's Principal Underwriter. These plans may be restated in compliance
with changes mandated by applicable law.
Automatic Withdrawal Plan
Ordinarily, an investor must have made an initial purchase payment of at
least $10,000 or otherwise have accumulated shares having a net asset value of
$10,000 before being eligible for an Automatic Withdrawal Plan. If so eligible,
the investor may arrange for fixed withdrawal payments, of a minimum of $100 and
a maximum of 1% per month or 3% per quarter of the total net asset value of the
Fund shares in the shareholder's account at inception of the Plan. Payments will
be made at regular monthly or quarterly intervals to the investor or
beneficiaries designated by him. Fixed withdrawal payments are not subject to a
deferred sales charge. An investor may not make arrangements for fixed
withdrawal payments while he is making regular purchase payments since the Fund
will be paying distribution expenses in connection with shares purchased at the
same time shares are being redeemed at net asset value without a deferred sales
charge. Withdrawal payments may represent proceeds from the liquidation of
shares and, to the extent they exceed distributions by the Fund, will reduce or
possibly exhaust the shareholder's investment in the Fund. The latter effect
will be accentuated by a decline in the securities market. Capital gains
realized by such withdrawals will be subject to federal capital gains taxes.
Automatic Investment Plan
The investor may provide for continuous investing on an automatic basis by
establishing an automatic investment plan offered through Keystone Investor
Resource Center, Inc. ("KIRC"), the Fund's transfer and dividend disbursing
agent. On the fifth or twentieth day of each month, a minimum of at least $25
automatically drawn on the investor's checking account will be used to purchase
Fund shares, which will be held in his Fund account. The investor may increase
the amount of his investment at any time or stop his plan by written notice to
KIRC at least five business days before a purchase of Fund shares is to be made.
- --------------------------------------------------------------------------------
DISTRIBUTION PLAN
- --------------------------------------------------------------------------------
Rule 12b-1 under the 1940 Act permits investment companies, such as the
Fund, to use their assets to bear expenses of distributing their shares if they
comply with various conditions, including adoption of a distribution plan
containing certain provisions set forth in Rule 12b-1. The Fund bears some of
the costs of selling its shares under a Distribution Plan adopted on January 19,
1983 pursuant to Rule 12b-1 (the "Distribution Plan").
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The Fund's Distribution Plan provides that the Fund may expend up to
0.3125% quarterly (approximately 1.25% annually) of the average daily net asset
value of its shares to pay distribution costs for sales of its shares and to pay
shareholder service fees. The NASD limits such annual expenditures to 1%, of
which 0.75% may be used to pay such distribution costs and 0.25% may be used to
pay shareholder service fees. The aggregate amount that the Fund may pay for
such distribution costs is limited to 6.25% of gross share sales since the
inception of the Fund's Distribution Plan plus interest at the prime rate plus
1% on unpaid amounts thereof (less any contingent deferred sales charge paid by
shareholders to KDI).
In connection with the Distribution Plan, Fund shares are offered for sale
at net asset value without any initial sales charge, and the Fund pays the
Principal Underwriter a commission for each sale. Specifically, amounts paid or
accrued under the Distribution Plan are paid or accrued to the Fund's Principal
Underwriter, currently KDI, as commissions for Fund shares sold under the
Distribution Plan, all or any part of which commissions may be reallowed by KDI
to others (dealers). In addition, the Fund pays to the Principal Underwriter
amounts sufficient for the Principal Underwriter to pay to such others a service
fee at a rate of 0.25% per annum of the net asset value of the shares maintained
by such recipients outstanding on the books of the Fund for specified periods.
If the Fund is unable to pay KDI a commission on a new sale because the
annual maximum (0.75% of average daily net assets) has been reached, KDI
intends, but is not obligated, to continue to accept new orders for the purchase
of Fund shares and to pay or accrue commissions and service fees in excess of
the amount it currently receives from the Fund. While the Fund is under no
contractual obligation to pay KDI such amounts that exceed the Distribution Plan
limitation, KDI intends to seek full payment of such amounts from the Fund
(together with interest at the rate of prime plus one percent) at such time in
the future as, and to the extent that, payment thereof by the Fund would be
within permitted limits. KDI currently intends to seek payment of interest only
on such charges paid or accrued by KDI subsequent to July 7, 1992. If the Fund's
Independent Directors ("Independent Directors") authorize such payments, the
effect will be to extend the period of time during which the Fund incurs the
maximum amount of costs allowed by the Distribution Plan. If the Distribution
Plan is terminated, KDI will ask the Independent Directors to take whatever
action they deem appropriate under the circumstances with respect to payment of
such amounts.
The total amounts paid by the Fund under the foregoing arrangements may
not exceed the maximum Distribution Plan limit specified above, and the amounts
and purposes of expenditures under the Distribution Plan must be reported to the
Fund's Rule 12b-1 Directors ("Rule 12b-1 Directors") quarterly. The Fund's Rule
12b-1
<PAGE>
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Directors may require or approve changes in the implementation or operation of
the Distribution Plan, and may require that total expenditures by the Fund under
the Distribution Plan be kept within limits lower than the maximum amount
permitted by the Distribution Plan as stated above. If such costs are not
limited by the Independent Directors, such costs could, for some period of time,
be higher than such costs permitted by most other plans presently adopted by
other investment companies.
The Distribution Plan may be terminated, at any time, by vote of the Rule
12b-1 Directors, or by vote of a majority of the outstanding voting securities
of the Fund. Any change in the Distribution Plan that would materially increase
the distribution expenses of the Fund provided for in the Distribution Plan
requires shareholder approval. Otherwise, the Distribution Plan may be amended
by the Directors, including the Fund's Rule 12b-1 Directors.
While the Distribution Plan is in effect, the Fund will be required to
commit the selection and nomination of candidates for Independent Directors to
the discretion of the Independent Directors.
During the twelve month period ended September 30, 1994 and the one month
period ended October 31, 1994, the Fund paid KDI $1,460,493 and $113,527,
respectively, under the Distribution Plan. During those same periods, KDI
received $0 and $36,343, respectively, after payments of commissions on new
sales and service fees to dealers and others of $77,184 and $1,709,228,
respectively.
Whether any expenditure under the Distribution Plan is subject to a state
expense limit will depend upon the nature of the expenditure and the terms of
the state law, regulation or order imposing the limit. The Fund does not treat
Distribution Plan expenses as includable in the Fund's total operating expenses
for purposes of determining compliance with state expense limits.
For the twelve month period ended September 30, 1994 and the one month
period ended October 31, 1994, the Independent Directors have determined that
the sales of the Fund's shares resulting from payments under the Distribution
Plan have benefited the Fund.
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REDEMPTIONS IN KIND
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If conditions arise that would make it undesirable for the Fund to pay for
all redemptions in cash, the Fund may authorize payment to be made in portfolio
securities or other Fund property. The Fund has obligated itself, however, under
the 1940 Act to
<PAGE>
- 13 -
redeem for cash all shares presented for redemption by any one shareholder up to
the lesser of $250,000 or 1% of the Fund's net assets in any 90-day period.
Securities delivered in payment of redemptions would be valued at the same value
assigned to them in computing the net asset value per share. Shareholders
receiving such securities would incur brokerage costs when these securities are
sold.
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INVESTMENT MANAGER
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Subject to the general supervision of the Fund's Board of Directors,
Keystone Management, located at 200 Berkeley Street, Boston, Massachusetts
02116-5034, serves as investment manager to the Fund and is responsible for the
overall management of the Fund's business and affairs. Keystone Management,
organized in 1989, is a wholly-owned subsidiary of Keystone and its directors
and principal executive officers have been affiliated with Keystone, a seasoned
investment adviser, for a number of years. Keystone Management also serves as
investment manager to each of the other Keystone Custodian Funds and to certain
other funds in the Keystone Group of Mutual Funds.
The Investment Management Agreement (the "Management Agreement") between
the Fund and Keystone Management permits Keystone Management to enter into an
agreement with Keystone or another investment adviser under which Keystone or
such other investment adviser, as investment adviser, will provide substantially
all the services to be provided by Keystone Management under the Management
Agreement. The Management Agreement also permits Keystone Management to delegate
to Keystone or another investment adviser substantially all of the investment
manager's rights, duties and obligations under the Management Agreement.
Services performed by Keystone Management currently include (1) performing
research and planning with respect to (a) the Fund's qualification as a
regulated investment company under Subchapter M of the Internal Revenue Code,
(b) tax treatment of the Fund's portfolio investments, (c) tax treatment of
special corporate actions (such as reorganizations), (d) state tax matters
affecting the Fund, and (e) the Fund's distributions of income and capital
gains; (2) preparing the Fund's federal and state tax returns; (3) providing
services to the Fund's shareholders in connection with federal and state
taxation and distributions of income and capital gains; and (4) storing
documents relating to the Fund's activities.
The Fund pays Keystone Management a fee for its services at the annual
rate of:
<PAGE>
- 14 -
Aggregate Net Asset
Management Value of the Shares
Fee of the Fund
- --------------------------------------------------------------------------------
0.75% of the first $ 200,000,000, plus
0.65% of the next $ 200,000,000, plus
0.55% of the next $ 200,000,000, plus
0.45% of amounts over $ 600,000,000
The fee is higher than that charged to most investment companies. The fee
is comparable, however, to fees charged to other global and international funds,
which, together with the Fund, are subject to the higher costs involved in
managing a portfolio of predominantly international securities.
The Fund is subject to certain state annual expense limitations, the most
restrictive of which is as follows:
2.5% of the first $30 million of Fund average net assets;
2.0% of the next $70 million of Fund average net assets; and
1.5% of Fund average net assets over $100 million.
Capital charges and certain expenses, including a portion of the Fund's
Distribution Plan expenses, are not included in the calculation of the state
expense limitations. This limitation may be modified or eliminated in the
future.
In order to comply with these limitations, Keystone Management has agreed
to reimburse the Fund annually for any included expenses in excess of such
limitations. Keystone Management is not required, however, to make such
reimbursements to the extent it would result in the Fund's inability to qualify
as a regulated investment company under the provisions of the Internal Revenue
Code.
As a continuing condition of registration of shares in a state, Keystone
Management has agreed to reimburse the Fund annually for certain operating
expenses incurred by the Fund in excess of certain percentages of the Fund's
average daily net assets. Keystone Management is not required, however, to make
such reimbursements to an extent that would result in the Fund's inability to
qualify as a regulated investment company under provisions of the Internal
Revenue Code. This condition may be modified or eliminated in the future.
The Management Agreement will continue in effect only if approved at least
annually by the Board of Directors of the Fund or by a vote of a majority of the
outstanding shares, and such renewal has been approved by the vote of a majority
of the Independent Directors cast in person at a meeting called for the purpose
of voting on such approval. The Management Agreement may be terminated, without
penalty, on 60 days' written notice by the
<PAGE>
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Fund's Board of Directors or by a vote of a majority of outstanding shares. The
Management Agreement will terminate automatically upon its "assignment" as that
term is defined in the 1940 Act.
For additional discussion of fees paid to Keystone Management, see
"Investment Adviser" below.
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INVESTMENT ADVISER
- --------------------------------------------------------------------------------
Pursuant to the Management Agreement, Keystone Management has delegated
its investment management functions, except for certain administrative and
management services, to Keystone and has entered into an Investment Advisory
Agreement (the "Advisory Agreement") with Keystone under which Keystone provides
investment advisory and management services to the Fund.
Keystone, located at 200 Berkeley Street, Boston, Massachusetts
02116-5034, has provided investment advisory and management services to
investment companies and private accounts since it was organized in 1932.
Keystone is a wholly-owned subsidiary of Keystone Group, 200 Berkeley Street,
Boston, Massachusetts 02116-5034.
Keystone Group, is a corporation predominantly owned by former and current
members of management of Keystone and its affiliates. The shares of Keystone
Group common stock beneficially owned by management are held in a number of
voting trusts, the trustees of which are George S. Bissell, Albert H. Elfner,
III, Roger T. Wickers, Edward F. Godfrey, and Ralph J. Spuehler, Jr. Keystone
Group provides accounting, bookkeeping, legal, personnel and general corporate
services to Keystone Management, Keystone, their affiliates and the Keystone
Group of Mutual Funds.
Pursuant to the Advisory Agreement, Keystone receives for its services an
annual fee representing 85% of the management fee received by Keystone
Management under its Management Agreement with the Fund.
Pursuant to the Advisory Agreement, Keystone provides the Fund with
investment research, advice, and supervision and continuously furnishes an
investment program for the Fund's portfolio. Keystone recommends what securities
shall be purchased for the portfolio of the Fund, what portfolio securities
shall be sold by the Fund and what portion of the Fund's assets shall be held
uninvested. Keystone also advises and assists the officers of the Fund to take
such steps as are necessary or appropriate to carry out the decisions of the
Fund's Board of Directors and of the appropriate committees of such Board
regarding the foregoing and regarding the general conduct of the investment
business of the Fund.
<PAGE>
- 16 -
Under the Advisory Agreement, Keystone pays the ordinary office expenses
of the Fund, including its rent, and provides investment advisory, research, and
statistical facilities and all clerical services relating to research,
statistical and investment work. Keystone is not required to pay any expenses of
the Fund other than those enumerated in the Advisory Agreement and, in
particular, but without limiting the generality of the foregoing, is not
required to pay brokerage and Distribution Plan expenses; legal, auditing, and
registrar's fees and expenses; taxes and governmental fees; the cost of sale,
underwriting, distribution, redemption, transfer, or repurchase of shares of the
Fund; the expenses of registering or qualifying securities for sale; the cost of
preparing and distributing reports and notices to shareholders, or the fees and
disbursements of custodians of the Fund's assets, including expenses incurred in
the performance of any obligations enumerated in the Articles of Organization or
By-Laws of the Fund insofar as they govern agreement with any such custodian.
During the year ended September 30, 1992, the Fund paid or accrued to
Keystone Management investment management and administrative services fees of
$506,662, which represented 0.75% of the Fund's average net assets. Of such
amount paid to Keystone Management, $430,663 was paid to Keystone for its
services to the Fund.
During the year ended September 30, 1993, the Fund paid or accrued to
Keystone Management investment management and administrative services fees of
$573,317, which represented 0.75% of the Fund's average net assets. Of such
amount paid to Keystone Management, $487,319 was paid to Keystone for its
services to the Fund.
During the twelve month period ended September 30, 1994 and the one month
period ended October 31, 1994, the Fund paid or accrued to Keystone Management
investment management and administrative services fees of $1,094,303 and
$98,556, respectively, which represented 0.75% and 0.75% (annualized),
respectively, of the Fund's average net assets. Of such amounts paid to Keystone
Management, $930,158 and $83,773, respectively, were paid to Keystone for
investment advisory services under the Investment Advisory Agreement.
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DIRECTORS AND OFFICERS
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The Directors and officers of the Fund, their positions with the Fund and
their principal occupations during the past five years are as follows:
<PAGE>
- 17 -
*ALBERT H. ELFNER, III: President, Director and Chief Executive Officer of the
Fund; Chairman of the Board, President, Director and Chief Executive
Officer of Keystone Group, President and Trustee or Director of Keystone
America Capital Preservation and Income Fund, Keystone America
Intermediate Term Bond Fund, Keystone America Strategic Income Fund,
Keystone America World Bond Fund, Keystone Tax Free Income Fund, Keystone
America State Tax Free Fund, Keystone America State Tax Free Fund - Series
II, Keystone America Fund for Total Return, Keystone America Global
Opportunities Fund, Keystone America Hartwell Emerging Growth Fund, Inc.,
Keystone America Hartwell Growth Fund, Inc., Keystone America Omega Fund,
Inc., Keystone Fund of the Americas - Luxembourg and Keystone Fund of the
Americas - U.S., Keystone Strategic Development Fund (collectively,
"Keystone America Funds"); Keystone Custodian Funds, Series B-1, B-2, B-4,
K-1, K-2, S-1, S-3, and S-4; Keystone Precious Metals Holdings, Inc.,
Keystone Tax Free Fund, Keystone Tax Exempt Trust, Keystone Liquid Trust
(together with the Fund, collectively, "Keystone Custodian Funds");
Keystone Institutional Adjustable Rate Fund and Master Reserves Trust (all
such funds, collectively, "Keystone Group Funds"); Director and Chairman
of the Board, Chief Executive Officer and Vice Chairman of Keystone;
Chairman of the Board and Director of Keystone Investment Management
Corporation ("KIMCO") and Keystone Fixed Income Advisors ("KFIA");
Director, Chairman of the Board, Chief Executive Officer and President of
Keystone Management, Keystone Software Inc. ("Keystone Software");
Director and President of Hartwell Keystone Advisers, Inc. ("Hartwell
Keystone"), Keystone Asset Corporation, Keystone Capital Corporation, and
Keystone Trust Company; Director of KDI, Keystone Investor Resource
Center, Inc. ("KIRC"), and Fiduciary Investment Company, Inc. ("FICO");
Director and Vice President of Robert Van Partners, Inc.; Director of
Boston Children's Services Association; Trustee of Anatolia College,
Middlesex School, and Middlebury College; Member, Board of Governors, New
England Medical Center and former Trustee of Neworld Bank.
FREDERICK AMLING: Director of the Fund; Trustee or Director of all other
Keystone Group Funds; Professor, Finance Department, George Washington
University; President, Amling & Company (investment advice); Member, Board
of Advisers, Credito Emilano (banking); and former Economics and Financial
Consultant, Riggs National Bank.
CHARLES A. AUSTIN III: Director of the Fund; Trustee or Director of all other
Keystone Group Funds; Investment Counselor to Appleton Partners, Inc.;
former Managing Director, Seaward Management Corporation (investment
advice) and former Director, Executive Vice President and Treasurer, State
Street Research & Management Company (investment advice).
<PAGE>
- 18 -
*GEORGE S. BISSELL: Chairman of the Board and Director of the Fund; Director of
Keystone Group; Chairman of the Board and Trustee or Director of all other
Keystone Group Funds,; Director and Chairman of the Board of Hartwell
Keystone; Chairman of the Board and Trustee of Anatolia College; Trustee
of University Hospital (and Chairman of its Investment Committee); former
Chairman of the Board and Chief Executive Officer of Keystone Group; and
former Chief Executive Officer of the Fund.
EDWIN D. CAMPBELL: Director of the Fund; Trustee or Director of all other
Keystone Group Funds; Executive Director, Coalition of Essential Schools,
Brown University; Director and former Executive Vice President, National
Alliance of Business; former Vice President, Educational Testing Services;
and former Dean, School of Business, Adelphi University.
CHARLES F. CHAPIN: Director of the Fund; Trustee or Director of all other
Keystone Group Funds; former Group Vice President, Textron Corp.; and
former Director, Peoples Bank (Charlotte, N.C).
LEROY KEITH, JR.: Director of the Fund; Trustee or Director of all other
Keystone Group Funds; Director of Phoenix Total Return Fund and Equifax,
Inc.; Trustee of Phoenix Series Fund, Phoenix Multi-Portfolio Fund and The
Phoenix Big Edge Series Fund; and former President, Morehouse College.
K. DUN GIFFORD: Director of the Fund; Trustee or Director of all other
Keystone Group Funds; Chairman of the Board, Director and Executive Vice
President, The London Harness Company; Managing Partner, Roscommon Capital
Corp.; Trustee, Cambridge College; Chairman Emeritus and Director,
American Institute of Food and Wine; Chief Executive Officer, Gifford
Gifts of Fine Foods; Chairman, Gifford, Drescher & Associates
(environmental consulting); President, Oldways Preservation and Exchange
Trust (education); and former Director, Keystone Group and Keystone.
F. RAY KEYSER, JR.: Director of the Fund; Trustee or Director of all other
Keystone Group Funds; Of Counsel, Keyser, Crowley & Meub, P.C.; Member,
Governor's (VT) Council of Economic Advisers; Chairman of the Board and
Director, Central Vermont Public Service Corporation and Hitchcock Clinic;
Director, Vermont Yankee Nuclear Power Corporation, Vermont Electric Power
Company, Inc., Grand Trunk Corporation, Central Vermont Railway, Inc.,
S.K.I. Ltd., Sherburne Corporation, Union Mutual Fire Insurance Company,
New England Guaranty Insurance Company, Inc. and the Investment Company
Institute; former Governor of Vermont; former Director and President,
Associated Industries of Vermont; former Chairman and President, Vermont
<PAGE>
- 19 -
Marble Company; former Director of Keystone; and former Director and
Chairman of the Board, Green Mountain Bank.
DAVID M. RICHARDSON: Director of the Fund; Trustee or Director of all other
Keystone Group Funds; Executive Vice President, DHR International, Inc.
(executive recruitment); former Senior Vice President, Boyden
International Inc. (executive recruit- ment); and Director, Commerce and
Industry Association of New Jersey, 411 International, Inc. and J & M
Cumming Paper Co.
RICHARD J. SHIMA: Director of the Fund; Trustee or Director of all other
Keystone Group Funds; Chairman, Environmental Warranty, Inc., and
Consultant, Drake Beam Morin, Inc. (executive outplacement); Director of
Connecticut Natural Gas Corporation, Trust Company of Connecticut,
Hartford Hospital, Old State House Association and Enhanced Financial
Services, Inc.; Member, Georgetown College Board of Advisors; Chairman,
Board of Trustees, Hartford Graduate Center; Trustee, Kingswood-Oxford
School and Greater Hartford YMCA; former Director, Executive Vice
President and Vice Chairman of The Travelers Corporation; and former
Managing Director of Russell Miller, Inc.
ANDREW J. SIMONS: Director of the Fund; Trustee or Director of all other
Keystone Group Funds; Partner, Farrell, Fritz, Caemmerer, Cleary, Barnosky
& Armentano, P.C.; President, Nassau County Bar Association; former
Associate Dean and Professor of Law, St. John's University School of Law.
EDWARD F. GODFREY: Senior Vice President of the Fund; Senior Vice President of
all other Keystone Group Funds; Director, Senior Vice President, Chief
Financial Officer and Treasurer of Keystone Group, KDI, Keystone Asset
Corporation, Keystone Capital Corporation, Keystone Trust Company;
Treasurer of KIMCO, Robert Van Partners, Inc., and FICO; Treasurer and
Director of Keystone Management, Keystone Software, Inc., and Hartwell
Keystone; Vice President and Treasurer of KFIA; and Director of KIRC.
JAMES R. McCALL: Senior Vice President of the Fund; Senior Vice President of all
other Keystone Group Funds; and President of Keystone.
DONALD C. DATES: Vice President of the Fund.
GILMAN C. GUNN: Vice President of the Fund.
KEVIN J. MORRISSEY: Treasurer of the Fund; Treasurer of all other Keystone Group
Funds; Vice President of Keystone Group; Assistant Treasurer of FICO and
Keystone; and former Vice President and Treasurer of KIRC.
<PAGE>
- 20 -
ROSEMARY D. VAN ANTWERP: Senior Vice President and Secretary of the Fund; Senior
Vice President and Secretary of all other Keystone Group Funds; Senior
Vice President, General Counsel and Secretary of Keystone; Senior Vice
President, General Counsel, Secretary and Director of KDI, Keystone
Management and Keystone Software, Senior Vice President and General
Counsel of KIMCO; Senior Vice President, General Counsel and Director of
FICO and KIRC; Senior Vice President and Secretary of Hartwell Keystone
and Robert Van Partners, Inc.; Vice President and Secretary of KFIA;
Senior Vice President, General Counsel and Secretary of Keystone Group,
Keystone Asset Corporation, Keystone Capital Corporation and Keystone
Trust Company.
* This Director may be considered an "interested person" within the meaning of
the 1940 Act.
Mr. Elfner and Mr. Bissell are "interested persons" by virtue of their
positions as officers and/or Directors of Keystone Group and several of its
affiliates including Hartwell Keystone, KDI and KIRC. Mr. Elfner and Mr. Bissell
own shares of Keystone Group. Mr. Elfner is Chief Executive Officer, President
and a Director of Keystone Group. Mr. Bissell is a Director of Keystone Group.
On January 31, 1995, the Directors and officers beneficially owned 1.64% of
the Fund's outstanding shares. Directors who are not "interested persons" of the
Fund received no fees from the Fund during its twelve month period ended
September 30, 1994 and the one month period ended October 31, 1994,
respectively. For the twelve month period ending October 31, 1994, fees paid to
Independent Directors on a fund complex wide basis were approximately $585,960.
The address of the Fund's Directors and officers is 200 Berkeley Street,
Boston, Massachusetts 02116-5034.
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PRINCIPAL UNDERWRITER
- --------------------------------------------------------------------------------
Pursuant to a Principal Underwriting Agreement (the "Underwriting
Agreement"), KDI acts as the Fund's Principal Underwriter. KDI, located at 200
Berkeley Street, Boston, Massachusetts 02116-5034, is a Delaware corporation
wholly-owned by Keystone. KDI, as agent, has agreed to use its best efforts to
find purchasers for the shares. KDI may retain and employ representatives to
promote distribution of the shares and may obtain orders from brokers, dealers
and others, acting as principals, for sales of shares to them. The Underwriting
Agreement provides that KDI will bear the expense of preparing, printing and
distributing advertising and sales literature and prospectuses used by it. In
its capacity as Principal Underwriter, KDI may receive payments from the Fund
pursuant to the Fund's Distribution Plan.
<PAGE>
- 21 -
The Underwriting Agreement provides that it will remain in effect as long
as its terms and continuance are approved by a majority of the Fund's
Independent Directors at least annually at a meeting called for that purpose,
and if its continuance is approved annually by vote of a majority of Directors,
or by vote of a majority of the outstanding shares.
The Underwriting Agreement may be terminated, without penalty, on 60 days'
written notice by the Board of Directors or by a vote of a majority of
outstanding shares. The Underwriting Agreement will terminate automatically upon
its "assignment" as that term is defined in the 1940 Act.
From time to time, if in KDI's judgment it could benefit the sales of Fund
shares, KDI may use its discretion in providing to selected dealers promotional
materials and selling aids including, but not limited to, personal computers,
related software and Fund data files.
During the twelve month period ended September 30, 1994 and the one month
period ended October 31, 1994, the Fund recovered $7,861 and $801, respectively,
in deferred sales charges. During those same periods, the Fund paid KDI
$1,460,493 and $113,527, respectively. For those same periods, the amounts paid
by the Fund under its Distribution Plan, net of deferred sales charges, were
$1,452,632 and $112,726, respectively (1.00% and 0.07%, respectively, of the
Fund's average daily net asset value during the respective period. During those
same periods, KDI received $0 and $36,343 after payments of commissions on new
sales and service fees to dealers and others of $1,709,228 and $77,184,
respectively. During the same periods, KDI also received $183,020 and $22,063,
respectively, in contingent deferred sales charges. At October 31, 1994, KDI's
total unreimbursed 12b-1 expenses amounted to $2,213,911 (1.40% of net assets as
of October 31, 1994), of which $1,058,492 and $0 were incurred during the twelve
month period ended September 30, 1994 and the one month period ended October 31,
1994, respectively. The right to certain portions of this amount, if and when
receivable, was assigned by KDI in 1988 in connection with a financing
transaction. As of October 31, 1994, $51,270 of the amount assigned remained
outstanding.
KDI intends to seek payment of the remaining $2,213,911 to such extent
that such payment, together with payments for future sales, will not exceed the
limitations discussed above. The Independent Directors have agreed to reimburse
KDI prior to the next quarterly meeting of Directors, with respect to prior
sales of shares of the Fund, the maximum amount permissible within the cost
limitation of the Plan. Except as described above, the Fund has no obligation to
pay any portion of this amount, and the time, condition and amounts, if any, to
be paid by the Fund are solely within the discretion of the Independent
Directors.
<PAGE>
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BROKERAGE
- --------------------------------------------------------------------------------
It is the policy of the Fund, in effecting transactions in portfolio
securities, to seek best execution of orders at the most favorable prices. The
determination of what may constitute best execution and price in the execution
of a securities transaction by a broker involves a number of considerations,
including, without limitation, the overall direct net economic result to the
Fund, involving both price paid or received and any commissions and other costs
paid, the efficiency with which the transaction is effected, the ability to
effect the transaction at all where a large block is involved, the availability
of the broker to stand ready to execute potentially difficult transactions in
the future and the financial strength and stability of the broker. Such
considerations are judgmental and are weighed by management in determining the
overall reasonableness of brokerage commissions paid.
Subject to the foregoing, a factor in the selection of brokers is the
receipt of research services, such as analyses and reports concerning issuers,
industries, securities, economic factors and trends and other statistical and
factual information. Any such research and other statistical and factual
information provided by brokers to the Fund, Keystone and Keystone Management is
considered to be in addition to and not in lieu of services required to be
performed by Keystone and Keystone Management. The cost, value and specific
application of such information are indeterminable and cannot be practicably
allocated among the Fund and other clients of Keystone and Keystone Management
who may indirectly benefit from the availability of such information. Similarly,
the Fund may indirectly benefit from information made available as a result of
transactions effected for such other clients.
The Fund expects that purchases and sales of securities usually will be
effected through brokerage transactions for which commissions are payable.
Purchases from underwriters will include the underwriting commission or
concession and purchases from dealers serving as market makers will include the
spread between the bid and asked prices. Where transactions are made in the
over-the-counter market, the Fund will deal with primary market makers unless
more favorable prices are otherwise obtainable.
The Fund may participate, if and when practicable, in group bidding for
the purchase directly from an issuer of certain securities for the Fund's
portfolio in order to take advantage of the lower purchase price available to
members of such a group.
Neither Keystone Management, Keystone or the Fund intend to place
securities transactions with any particular broker-dealer or group thereof. The
Fund's Board of Directors, however, has
<PAGE>
- 23 -
determined that the Fund may follow a policy of considering sales of shares as a
factor in the selection of broker-dealers to execute portfolio transactions,
subject to the requirements of best execution, including best price, described
above.
The policy of the Fund with respect to brokerage is and will be reviewed
by the Board of Directors from time to time. Because of the possibility of
further regulatory developments affecting the securities exchanges and brokerage
practices generally, the foregoing practices may be changed, modified or
eliminated.
Investment decisions for the Fund are made independently from those of the
other funds and investment accounts managed by Keystone and Keystone Management.
It may frequently develop that the same investment decision is made for more
than one fund. Simultaneous transactions are inevitable when the same security
is suitable for the investment objective of more than one account. When two or
more funds or accounts are engaged in the purchase or sale of the same security,
the transactions are allocated as to amount in accordance with a formula that is
equitable to each fund or account. It is recognized that in some cases this
system could have a detrimental effect on the price or volume of the security as
far as the Fund is concerned. In other cases, however, it is believed that the
ability of the Fund to participate in volume transactions will produce better
executions for the Fund.
During the fiscal years ended September 30, 1992 and 1993, the twelve
month period ended September 30, 1994 and the one month period ended October 31,
1994, the Fund paid approximately $1,071,616, $14,827, $923,756 and $0,
respectively, in brokerage fees.
In no instance will portfolio securities be purchased from or sold to
Keystone, Keystone Management, KDI or any of their affiliated persons, as
defined in the 1940 Act.
- --------------------------------------------------------------------------------
STANDARDIZED TOTAL RETURN AND YIELD QUOTATIONS
- --------------------------------------------------------------------------------
Total return quotations for the Fund as they may appear from time to time
in advertisements are calculated by finding the average annual compounded rates
of return over one, five and ten year periods on a hypothetical $1,000
investment that would equate the initial amount invested to the ending
redeemable value. To the initial investment all dividends and distributions are
added, and all recurring fees charged to all shareholder accounts are deducted.
The ending redeemable value assumes a complete redemption at the end of the one,
five and ten year periods.
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- 24 -
The cumulative total return of the Fund for the one, five and ten year
periods ended October 31, 1994 was 3.71% (including contingent deferred sales
charges), 24.95% and 212.55%, respectively. The compounded average rate of
return for the five and ten year periods ended October 31, 1994 were 4.56% and
12.07%, respectively.
Current yield quotations as they may appear, from time to time, in
advertisements will consist of a quotation based on a 30- day period ended on
the date of the most recent balance sheet of the Fund, computed by dividing the
net investment income per share earned during the period by the maximum offering
price per share on the last day of the base period. The Fund does not currently
intend to advertise current yield.
- --------------------------------------------------------------------------------
ADDITIONAL INFORMATION
- --------------------------------------------------------------------------------
State Street Bank and Trust Company, 225 Franklin Street, Boston,
Massachusetts 02110, is custodian of all securities and cash of the Fund (the
"Custodian"). The Custodian may hold securities of some foreign issuers outside
the U.S. The Custodian performs no investment management functions for the Fund,
but, in addition to its custodial services, is responsible for accounting and
related recordkeeping on behalf of the Fund.
KPMG Peat Marwick LLP, One Boston Place, Boston, Massachusetts 02108,
Certified Public Accountants, are the independent auditors for the Fund.
KIRC, located at 101 Main Street, Cambridge, Massachusetts 02142-1519, is
a wholly-owned subsidiary of Keystone. KIRC acts as transfer agent and dividend
disbursing agent for the Fund.
Except as otherwise stated in its prospectus or required by law, the Fund
reserves the right to change the terms of the offer stated in its prospectus
without shareholder approval, including the right to impose or change fees for
services provided.
No dealer, salesman or other person is authorized to give any information
or to make any representation not contained in the Fund's prospectus, this
statement of additional information or in supplemental sales literature issued
by the Fund or the Principal Underwriter, and no person is entitled to rely on
any information or representation not contained therein.
The Fund's prospectus and this statement of additional information omit
certain information contained in the registration statement filed with the SEC,
which may be obtained from the SEC's
<PAGE>
- 25 -
principal office in Washington, D.C. upon payment of the fee prescribed by the
rules and regulations promulgated by the SEC.
To the best of the Fund's knowledge, as of January 31, 1995, there were no
beneficial owners of record who owned 5% or more of the outstanding shares of
the Fund.
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APPENDIX
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COMMON AND PREFERRED STOCK RATINGS
S&P's Earnings and Dividend Rankings for Common Stocks
Because the investment process involves assessment of various factors,
such as product and industry position, corporate resources and financial policy,
with results that make some common stocks more highly esteemed than others,
Standard & Poor's Corporation ("S&P") believes that earnings and dividend
performance is the end result of the interplay of these factors and that, over
the long run, the record of this performance has a considerable bearing on
relative quality. S&P rankings, however, do not reflect all of the factors,
tangible or intangible, that bear on stock quality.
Growth and stability of earnings and dividends are deemed key elements in
establishing S&P earnings and dividend rankings for common stocks, which
capsulize the nature of this record in a single symbol.
S&P has established a computerized scoring system based on per-share
earnings and dividend records of the most recent ten years, a period deemed long
enough to measure a company's performance under varying economic conditions. S&P
measures growth, stability within the trend line and cyclicality. The ranking
system also makes allowances for company size, since large companies have
certain inherent advantages over small ones. From these, scores for earnings and
dividends are determined.
The final score for each stock is measured against a scoring matrix
determined by analysis of the scores of a large and representative sample which
is reviewed and sometimes modified with the following ladder of rankings:
A+ Highest B+ Average C Lowest
A High B Below Average D In Reorganization
A- Above Average B- Lower
S&P believes its rankings are not a forecast of future market price
performance but are basically an appraisal of past performance of earnings and
dividends and relative current standing.
Moody's Common Stock Rankings
Moody's Investors Service, Inc. (Moody's) presents a concise statement of
the important characteristics of a company and an
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A-2
evaluation of the grade (quality) of its common stock. Data presented includes:
(a) capsule stock information which reveals short and long-term growth and yield
afforded by the indicated dividend, based on a recent price; (b) a long-term
price chart which shows patterns of monthly stock price movements and monthly
trading volumes; (c) a breakdown of a company's capital account which aids in
determining the degree of conservatism or financial leverage in a company's
balance sheet; (d) interim earnings for the current year to date, plus three
previous years; (e) dividend information; (f) company background; (g) recent
corporate developments; (h) prospects for a company in the immediate future and
the next few years; and (i) a ten year comparative statistical analysis.
This information provides investors with information on what a company
does, how it has performed in the past, how it is performing currently and what
its future performance prospects appear to be.
These characteristics are then evaluated and result in a grading, or
indication of quality. The grade is based on an analysis of each company's
financial strength, stability of earnings and record of dividend payments. Other
considerations include conservativeness of capitalization, depth and caliber of
management, accounting practices, technological capabilities and industry
position. Evaluation is represented by the following grades:
(1) High Grade
(2) Investment Grade
(3) Medium Grade
(4) Speculative Grade
Moody's Preferred Stock Ratings
Preferred stock ratings and their definitions are as follows:
1. aaa: An issue that is rated aaa is considered to be a top-quality
preferred stock. This rating indicates good asset protection and the least risk
of dividend impairment within the universe of preferred stocks.
2. aa: An issue that is rated aa is considered a high-grade preferred
stock. This rating indicates that there is a reasonable assurance that earnings
and asset protection will remain relatively well maintained in the foreseeable
future.
3. a: An issue that is rated a is considered to be an upper- medium grade
preferred stock. While risks are judged to be somewhat greater then in the aaa
and aa classification, earnings and asset protection are, nevertheless, expected
to be maintained at adequate levels.
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A-3
4. baa: An issue that is rated baa is considered to be a medium-grade
preferred stock, neither highly protected nor poorly secured. Earnings and asset
protection appear adequate at present but may be questionable over any great
length of time.
5. ba: An issue that is rated ba is considered to have speculative
elements and its future cannot be considered well assured. Earnings and asset
protection may be very moderate and not well-safeguarded during adverse periods.
Uncertainty of position characterizes preferred stocks in this class.
6. b: An issue that is rated b generally lacks the characteristics of a
desirable investment. Assurance of dividend payments and maintenance of other
terms of the issue over any long period of time may be small.
7. caa: An issue that is rated caa is likely to be in arrears on dividend
payments. This rating designation does not purport to indicate the future status
of payments.
8. ca: An issue which is rated ca is speculative in a high degree and is
likely to be in arrears on dividends with little likelihood of eventual
payments.
9. c: This is the lowest rated class of preferred or preference stock.
Issues so rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing.
Moody's applies numerical modifiers 1, 2 and 3 in each rating
classification: the modifier 1 indicates that the security ranks in the higher
end of its generic rating category; the modifier 2 indicates a mid-range
ranking; and the modifier 3 indicates that the issue ranks in the lower end of
its generic rating category.
CORPORATE BOND RATINGS
S&P Corporate Bond Ratings
An S&P corporate bond rating is a current assessment of the
creditworthiness of an obligor, including obligors outside the United States,
with respect to a specific obligation. This assessment may take into
consideration obligors such as guarantors, insurers, or lessees. Ratings of
foreign obligors do not take into account currency exchange and related
uncertainties. The ratings are based on current information furnished by the
issuer or obtained by S&P from other sources it considers reliable.
The ratings are based, in varying degrees, on the following
considerations:
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A-4
a. Likelihood of default - capacity and willingness of the obligor as to
the timely payment of interest and repayment of principal in accordance with the
terms of the obligation;
b. Nature of and provisions of the obligation; and
c. Protection afforded by and relative position of the obligation in the
event of bankruptcy, reorganization or other arrangement under the laws of
bankruptcy and other laws affecting creditors' rights.
PLUS (+) OR MINUS (-): To provide more detailed indications of credit
quality, ratings from AA to A may be modified by the addition of a plus or minus
sign to show relative standing within the major rating categories.
Bond ratings are as follows:
1. AAA - Debt rated AAA has the highest rating assigned by S&P. Capacity
to pay interest and repay principal is extremely strong.
2. AA - Debt rated AA has a very strong capacity to pay interest and repay
principal and differs from the higher rated issues only in small degree.
3. A - Debt rated A has a strong capacity to pay interest and repay
principal although it is somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than debt in higher rated
categories.
4. BBB - Debt rated BBB is regarded as having an adequate capacity to pay
interest and repay principal. Whereas it normally exhibits adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal for
debt in this category than in higher rated categories.
5. BB, B, CCC, CC and C - Debt rated BB, B, CCC, CC andC is regarded, on
balance, as predominantly speculative with respect to capacity to pay interest
and repay principal in accordance with the terms of the obligation. BB indicates
the lowest degree of speculation and C the highest degree of speculation. While
such debt will likely have some quality and protective characteristics, these
are outweighed by large uncertainties or major risk exposures to adverse
conditions.
6. CI - The rating CI is reserved for income bonds on which no interest is
being paid.
7. D - Debt rated D is in default, and payment of interest and/or
repayment of principal is in arrears.
<PAGE>
A-5
Moody's Corporate Bond Ratings
Moody's ratings are as follows:
1. Aaa - Bonds that are rated Aaa are judged to be of the best quality.
They carry the smallest degree of investment risk and are generally referred to
as "gilt-edge". Interest payments are protected by a large or by an
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be visualized are
most unlikely to impair the fundamentally strong position of such issues.
2. Aa - Bonds that are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally known as
high grade bonds. They are rated lower than the best bonds because margins of
protection may not be as large as in Aaa securities or fluctuation of protective
elements may be of greater amplitude or there may be other elements present that
make the long term risks appear somewhat larger than in Aaa securities.
3. A - Bonds that are rated A possess many favorable investment attributes
and are to be considered as upper medium grade obligations. Factors giving
security to principal and interest are considered adequate but elements may be
present that suggest a susceptibility to impairment sometime in the future.
4. Baa - Bonds that are rated Baa are considered as medium grade
obligations, i.e., they are neither highly protected nor poorly secured.
Interest payments and principal security appear adequate for the present but
certain protective elements may be lacking or may be characteristically
unreliable over any great length of time. Such bonds lack outstanding investment
characteristics and in fact have speculative characteristics as well.
5. Ba - Bonds that are rated Ba are judged to have speculative elements.
Their future cannot be considered as well assured. Often the protection of
interest and principal payments may be very moderate and thereby not well
safeguarded during both good and bad times over the future. Uncertainty of
position characterizes bonds in this class.
6. B - Bonds that are rated B generally lack characteristics of the
desirable investment. Assurance of interest and principal payments or of
maintenance of other terms of the contract over any long period of time may be
small.
7. Caa - Bonds that are rated Caa are of poor standing. Such issues may be
in default or there may be present elements of danger with respect to principal
or interest.
<PAGE>
A-6
8. Ca - Bonds that are rated Ca represent obligations that are speculative
in a high degree. Such issues are often in default or have other market
shortcomings.
9. C - Bonds that are rated as C are the lowest rated class of bonds and
issues so rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing.
Moody's applies numerical modifiers, 1, 2 and 3 in each generic rating
classification from Aa through B in its corporate bond rating system. The
modifier 1 indicates that the security ranks in the higher end of its generic
rating category; the modifier 2 indicates a mid-range ranking; and the modifier
3 indicates that the issue ranks in the lower end of its generic rating
category.
MONEY MARKET INSTRUMENTS
The Fund's investments in commercial paper are limited to those rated A-1
by Standard & Poor's Corporation, Prime-1 by Moody's Investors Service, Inc. or
F-1 by Fitch Investors Service, Inc. These ratings and other money market
instruments are described as follows:
Commercial Paper Ratings
Commercial paper rated A-1 by Standard & Poor's has the following
characteristics: Liquidity ratios are adequate to meet cash requirements. The
issuer's long-term senior debt is rated A or better, although in some cases BBB
credits may be allowed. The issuer has access to at least two additional
channels of borrowing. Basic earnings and cash flow have an upward trend with
allowance made for unusual circumstances. Typically, the issuer's industry is
well established and the issuer has a strong position within the industry.
The rating Prime-1 is the highest commercial paper rating assigned by
Moody's. Among the factors considered by Moody's in assigning ratings are the
following: (1) evaluation of the management of the issuer; (2) economic
evaluation of the issuer's industry or industries and an appraisal of
speculative-type risks which may be inherent in certain areas; (3) evaluation of
the issuer's products in relation to competition and customer acceptance; (4)
liquidity; (5) amount and quality of long-term debt; (6) trend of earnings over
a period of ten years; (7) financial strength of a parent company and the
relationships that exist with the issuer; and (8) recognition by the management
of obligations that may be present or may arise as a result of public
preparations to meet such obligations. Relative strength or weakness of the
above factors determines how the issuer's commercial paper is rated within
various categories.
<PAGE>
A-7
The rating F-1 is the highest rating assigned by Fitch. Among the factors
considered by Fitch in assigning this rating are: (1) the issuer's liquidity;
(2) its standing in the industry; (3) the size of its debt; (4) its ability to
service its debt; (5) its profitability; (6) its return on equity; (7) its
alternative sources of financing; and (8) its ability to access the capital
markets. Analysis of the relative strength or weakness of these factors and
others determines whether an issuer's commercial paper is rated F-1.
United States Government Securities
Securities issued or guaranteed by the United States Government include a
variety of Treasury securities that differ only in their interest rates,
maturities and dates of issuance. Treasury bills have maturities of one year or
less. Treasury notes have maturities of one to ten years and Treasury bonds
generally have maturities of greater than ten years at the date of issuance.
Securities issued or guaranteed by the United States Government or its
agencies or instrumentalities include direct obligations of the United States
Treasury and securities issued or guaranteed by the Federal Housing
Administration, Farmers Home Administration, Export-Import Bank of the United
States, Small Business Administration, Government National Mortgage Association,
General Services Administration, Central Bank for Cooperatives, Federal Home
Loan Banks, Federal Loan Mortgage Corporation, Federal Intermediate Credit
Banks, Federal Land Banks, Maritime Administration, The Tennessee Valley
Authority, District of Columbia Armory Board and Federal National Mortgage
Association.
Some obligations of United States Government agencies and
instrumentalities, such as Treasury bills and Government National Mortgage
Association pass-through certificates, are supported by the full faith and
credit of the United States; others, such as securities of Federal Home Loan
Banks, by the right of the issuer to borrow from the Treasury; still others,
such as bonds issued by the Federal National Mortgage Association, a private
corporation, are supported only by the credit of the instrumentality. Because
the United States Government is not obligated by law to provide support to an
instrumentality it sponsors, the Fund will invest in the securities issued by
such an instrumentality only when Keystone determines that the credit risk with
respect to the instrumentality does not make its securities unsuitable
investments. United States Government securities will not include international
agencies or instrumentalities in which the United States Government, its
agencies or instrumentalities participate, such as the World Bank, the Asian
Development Bank or the InterAmerican Development Bank, or issues insured by the
Federal Deposit Insurance Corporation.
<PAGE>
A-8
Certificates of Deposits
Certificates of deposit are receipts issued by a bank in exchange for the
deposit of funds. The issuer agrees to pay the amount deposited plus interest to
the bearer of the receipt on the date specified on the certificate. The
certificate usually can be traded in the secondary market prior to maturity.
Certificates of deposit will be limited to U.S. dollar-denominated
certificates of United States banks, including their branches abroad, and of
U.S. branches of foreign banks that are members of the Federal Reserve System or
the Federal Deposit Insurance Corporation and have at least $1 billion in
deposits as of the date of their most recently published financial statements.
The Fund will not acquire time deposits or obligations issued by the
International Bank for Reconstruction and Development, the Asian Development
Bank or the Inter-American Development Bank. Additionally, the Fund does not
currently intend to purchase such foreign securities (except to the extent that
certificates of deposit of foreign branches of U.S. banks may be deemed foreign
securities) or purchase certificates of deposit, bankers' acceptances or other
similar obligations issued by foreign banks.
Bankers' Acceptances
Bankers' acceptances typically arise from short-term credit arrangements
designed to enable businesses to obtain funds to finance commercial
transactions. Generally, an acceptance is a time draft drawn on a bank by an
exporter or an importer to obtain a stated amount of funds to pay for specific
merchandise. The draft is then "accepted" by the bank that, in effect,
unconditionally guarantees to pay the face value of the instrument on its
maturity date. The acceptance may then be held by the accepting bank as an
earning asset or it may be sold in the secondary market at the going rate of
discount for a specific maturity. Although maturities for acceptances can be as
long as 270 days, most acceptances have maturities of six months or less.
Bankers' acceptances acquired by the Fund must have been accepted by U.S.
commercial banks, including foreign branches of U.S. commercial banks, having
total deposits at the time of purchase in excess of $1 billion and must be
payable in U.S. dollars.
OPTIONS TRANSACTIONS
Writing Covered Options
The Fund writes only covered options. Options written by the Fund will
normally have expiration dates of not more than nine months from the date
written. The exercise price of the options may be below, equal to, or above the
current market values of the underlying securities at the times the options are
written.
<PAGE>
A-9
Unless the option has been exercised, the Fund may close out an option it
has written by effecting a closing purchase transaction, whereby it purchases an
option covering the same underlying security and having the same exercise price
and expiration date ("of the same series") as the one it has written. If the
Fund desires to sell a particular security on which it has written a call
option, it will effect a closing purchase transaction prior to or concurrently
with the sale of the security. If the Fund is able to enter into a closing
purchase transaction, the Fund will realize a profit (or loss) from such
transaction if the cost of such transaction is less (or more) than the premium
received from the writing of the option.
An option position may be closed out only in a secondary market for an
option of the same series. Although the Fund will generally write only those
options for which there appears to be an active secondary market, there is no
assurance that a liquid secondary market will exist for any particular option at
any particular time, and for some options no secondary market may exist. In such
event it might not be possible to effect a closing transaction in a particular
option. If the Fund as a covered call option writer is unable to effect a
closing purchase transaction, it will not be able to sell the underlying
securities until the option expires or it delivers the underlying securities
upon exercise.
Because the Fund intends to qualify as a regulated investment company
under the Internal Revenue Code, the extent to which the Fund may write covered
call options and enter into so-called "straddle" transactions involving put and
call options may be limited.
Many options are traded on registered securities exchanges. Options traded
on such exchanges are issued by the Options Clearing Corporation ("OCC"), a
clearing corporation which assumes responsibility for the completion of options
transactions.
Option Writing and Related Risks
The Fund may write covered call and put options. A call option gives the
purchaser of the option the right to buy, and the writer the obligation to sell
the underlying security at the exercise price during the option period.
Conversely, a put option gives the purchaser the right to sell, and the writer
the obligation to buy the underlying security at the exercise price during the
option period.
So long as the obligation of the writer continues, the writer may be
assigned an exercise notice by the broker-dealer through whom the option was
sold. The exercise notice would require the writer to deliver, in the case of a
call, or take delivery of, in the case of a put, the underlying security against
payment of the
<PAGE>
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exercise price. This obligation terminates upon expiration of the option, or at
such earlier time as the writer effects a closing purchase transaction by
purchasing an option of the same series as the one previously sold. Once an
option has been exercised, the writer may not execute a closing purchase
transaction. For options traded on national securities exchanges ("Exchanges"),
to secure the obligation to deliver the underlying security in the case of a
call option, the writer of the option is required to deposit in escrow the
underlying security or other assets in accordance with the rules of the OCC, an
institution created to interpose itself between buyers and sellers of options.
Technically, the OCC assumes the order side of every purchase and sale
transaction on an Exchange and by doing so, gives its guarantee to the
transaction.
The principal reason for writing options on a securities portfolio is to
attempt to realize, through the receipt of premiums, a greater return than would
be realized on the underlying securities alone. In return for the premium, the
covered call option writer has given up the opportunity for profit from a price
increase in the underlying security above the exercise price so long as the
option remains open, but retains the risk of loss should the price of the
security decline. Conversely, the put option writer gains a profit, in the form
of a premium, so long as the price of the underlying security remains above the
exercise price, but assumes an obligation to purchase the underlying security
from the buyer of the put option at the exercise price, even though the security
may fall below the exercise price, at any time during the option period. If an
option expires, the writer realizes a gain in the amount of the premium. Such a
gain may, in the case of a covered call option, be offset by a decline in the
market value of the underlying security during the option period. If a call
option is exercised, the writer realizes a gain or loss from the sale of the
underlying security. If a put option is exercised, the writer must fulfill his
obligation to purchase the underlying security at the exercise price, which will
usually exceed the then market value of the underlying security. In addition,
the premium paid for the put effectively increases the cost of the underlying
security, thus reducing the yield otherwise available from such securities.
Because the Fund can write only covered options, it may at times be unable
to write additional options unless it sells a portion of its portfolio holdings
to obtain new debt securities against which it can write options. This may
result in higher portfolio turnover and correspondingly greater brokerage
commissions and other transaction costs.
To the extent that a secondary market is available the covered option
writer may close out options it has written prior to the assignment of an
exercise notice by purchasing, in a closing purchase transaction, an option of
the same series as the option
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A-11
previously written. If the cost of such a closing purchase, plus transaction
costs, is greater than the premium received upon writing the original option,
the writer will incur a loss in the transaction.
Options Trading Markets
Options that the Fund will trade are generally listed on Exchanges.
Exchanges on which such options currently are traded are the Chicago Board
Options Exchange and the American, Pacific, and Philadelphia Stock Exchanges.
Options on some securities may not be listed on any Exchange but traded in the
over-the-counter market. Options traded in the over-the-counter market involve
the additional risk that securities dealers participating in such transactions
would fail to meet their obligations to the Fund. The use of options traded in
the over-the-counter market may be subject to limitations imposed by certain
state securities authorities. In addition to the limits on its use of options
discussed herein, the Fund is subject to the investment restrictions described
in the prospectus and the statement of additional information.
The staff of the Commission is of the view that the premiums that the Fund
pays for the purchase of unlisted options, and the value of securities used to
cover unlisted options written by the Fund, are considered to be invested in
illiquid securities or assets for the purpose of calculating whether the Fund is
in compliance with its fundamental investment restriction prohibiting it from
investing more than 10% of its net assets (taken at current value) in any
combination of illiquid assets and securities.
Special Considerations Applicable to Options
On Treasury Bonds and Notes. Because trading interest in U.S. Treasury
bonds and notes tends to center on the most recently auctioned issues, new
series of options with expirations to replace expiring options on particular
issues will not be introduced indefinitely. Instead, the expirations introduced
at the commencement of options trading on a particular issue will be allowed to
run their course, with the possible addition of a limited number of new
expirations as the original ones expire. Options trading on each series of bonds
or notes will thus be phased out as new options are listed on the more recent
issues, and a full range of expiration dates will not ordinarily be available
for every series on which options are traded.
On Treasury Bills. Because the deliverable U.S. Treasury bill changes from
week to week, writers of U.S. Treasury bill call options cannot provide in
advance for their potential exercise settlement obligations by acquiring and
holding the underlying security. However, if the Fund holds a long position in
U.S. Treasury bills with a principal amount corresponding to the option contract
size, the Fund may be hedged from a risk standpoint. In
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addition, the Fund will maintain in a segregated account with its Custodian
liquid assets maturing no later than those that would be deliverable in the
event of an assignment of an exercise notice to ensure that it can meet its open
option obligations.
On GNMA Certificates. Options on GNMA certificates are not currently
traded on any Exchange. However, the Fund may purchase and write such options in
the over the counter market or, should they commence trading, on any Exchange.
Since the remaining principal balance of GNMA certificates declines each
month as a result of mortgage payments, the Fund, as a writer of a covered GNMA
call holding GNMA certificates as "cover" to satisfy its delivery obligation in
the event of assignment of an exercise notice, may find that its GNMA
certificates no longer have a sufficient remaining principal balance for this
purpose. Should this occur, the Fund will enter into a closing purchase
transaction or will purchase additional GNMA certificates from the same pool (if
obtainable) or replacement GNMA certificates in the cash market in order to
remain covered.
A GNMA certificate held by the Fund to cover an option position in any but
the nearest expiration month may cease to present cover for the option in the
event of a decline in the GNMA coupon rate at which new pools are originated
under the FHA/VA loan ceiling in effect at any given time. Should this occur,
the Fund will no longer be covered, and the Fund will either enter into a
closing purchase transaction or replace the GNMA certificate with a certificate
which represents cover. When the Fund closes its position or replaces the GNMA
certificate, it may realize an unanticipated loss and incur transaction costs.
Risks Pertaining to the Secondary Market. An option position may be closed
out only in a secondary market for an option of the same series. Although the
Fund will generally purchase or write only those options for which there appears
to be an active secondary market, there is no assurance that a liquid secondary
market will exist for any particular option at any particular time, and for some
options no secondary market may exist. In such event, it might not be possible
to effect closing transactions in particular options, with the result that the
Fund would have to exercise its options in order to realize any profit and might
incur transaction costs in connection therewith. If the Fund as a covered call
option writer is unable to effect a closing purchase transaction in a secondary
market, it will not be able to sell the underlying security until the option
expires or it delivers the underlying security upon exercise.
Reasons for the absence of a liquid secondary market include the
following: (i) insufficient trading interest in certain options; (ii)
restrictions imposed on transactions; (iii) trading halts, suspensions or other
restrictions imposed with respect to
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particular classes or series of options or underlying securities; (iv)
interruption of the normal operations on an Exchange or by a broker; (v)
inadequacy of the facilities of an Exchange, the OCC or a broker to handle
current trading volume; or (vi) a decision by one or more Exchanges or a broker
to discontinue the trading of options (or a particular class or series of
options), in which event the secondary market in that class or series of options
would cease to exist, although outstanding options that had been issued as a
result of trades would generally continue to be exercisable in accordance with
their terms.
The hours of trading for options on U.S. government securities may not
conform to the hours during which the underlying securities are traded. To the
extent that the option markets close before the markets for the underlying
securities, significant price and rate movements can take place in the
underlying markets that cannot be reflected in the option markets.
FUTURES CONTRACTS AND RELATED OPTIONS TRANSACTIONS
The Fund intends to enter into currency and other financial futures
contracts as a hedge against changes in prevailing levels of interest or
currency exchange rates to seek relative stability of principal and to establish
more definitely the effective return on securities held or intended to be
acquired by the Fund or as a hedge against changes in the prices of securities
or currencies held by the Fund or to be acquired by the Fund. The Fund's hedging
may include sales of futures as an offset against the effect of expected
increases in interest or currency exchange rates or securities prices and
purchases of futures as an offset against the effect of expected declines in
interest or currency exchange rates.
For example, when the Fund anticipates a significant market or market
sector advance, it will purchase a stock index futures contract as a hedge
against not participating in such advance at a time when the Fund is not fully
invested. The purchase of a futures contract serves as a temporary substitute
for the purchase of individual securities which may then be purchased in an
orderly fashion. As such purchases are made, an equivalent amount of index based
futures contracts would be terminated by offsetting sales. In contrast, the Fund
would sell stock index futures contracts in anticipation of or in a general
market or market sector decline that may adversely affect the market value of
the Fund's portfolio. To the extent that the Fund's portfolio changes in value
in correlation with a given index, the sale of futures contracts on that index
would substantially reduce the risk to the portfolio of a market decline or
change in interest rates, and, by so doing, provide an alternative to the
liquidation of the Fund's securities positions and the resulting transaction
costs.
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The Fund intends to engage in options transactions that are related to
commodity futures contracts for hedging purposes and in connection with the
hedging strategies described above.
Although techniques other than sales and purchases of futures contracts
and related options transactions could be used to reduce the Fund's exposure to
interest rate and/or market fluctuations, the Fund may be able to hedge its
exposure more effectively and perhaps at a lower cost through using futures
contracts and related options transactions. While the Fund does not intend to
take delivery of the instruments underlying futures contracts it holds, the Fund
does not intend to engage in such futures contracts for speculation.
Futures Contracts
Futures contracts are transactions in the commodities markets rather than
in the securities markets. A futures contract creates an obligation by the
seller to deliver to the buyer the commodity specified in the contract at a
specified future time for a specified price. The futures contract creates an
obligation by the buyer to accept delivery from the seller of the commodity
specified at the specified future time for the specified price. In contrast, a
spot transaction creates an immediate obligation for the seller to deliver and
the buyer to accept delivery of and pay for an identified commodity. In general,
futures contracts involve transactions in fungible goods such as wheat, coffee
and soybeans. However, in the last decade an increasing number of futures
contracts have been developed that specify currencies, financial instruments or
financially based indexes as the underlying commodity.
U.S. futures contracts are traded only on national futures exchanges and
are standardized as to maturity date and underlying financial instrument. The
principal financial futures exchanges in the United States are The Board of
Trade of the City of Chicago, the Chicago Mercantile Exchange, the International
Monetary Market (a division of the Chicago Mercantile Exchange), the New York
Futures Exchange and the Kansas City Board of Trade. Each exchange guarantees
performance under contract provisions through a clearing corporation, a
nonprofit organization managed by the exchange membership, which is also
responsible for handling daily accounting of deposits or withdrawals of margin.
A futures commission merchant ("Broker") effects each transaction in connection
with futures contracts for a commission. Futures exchanges and trading are
regulated under the Commodity Exchange Act by the Commodity Futures Trading
Commission ("CFTC") and National Futures Association ("NFA").
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Interest Rate Futures Contracts
The sale of an interest rate futures contract creates an obligation by the
Fund, as seller, to deliver the type of financial instrument specified in the
contract at a specified future time for a specified price. The purchase of an
interest rate futures contract creates an obligation by the Fund, as purchaser,
to accept delivery of the type of financial instrument specified at a specified
future time for a specified price. The specific securities delivered or
accepted, respectively, at settlement date, are not determined until at or near
that date. The determination is in accordance with the rules of the exchange on
which the futures contract sale or purchase was made.
Currently interest rate futures contracts can be purchased or sold on
90-day U.S. Treasury bills, U.S. Treasury bonds, U.S. Treasury notes with
maturities between 6 1/2 and 10 years, Government National Mortgage Association
("GNMA") certificates, 90- day domestic bank certificates of deposit, 90-day
commercial paper, and 90-day Eurodollar certificates of deposit. It is expected
that futures contracts trading in additional financial instruments will be
authorized. The standard contract size is $100,000 for futures contracts in U.S.
Treasury bonds, U.S. Treasury notes and GNMA certificates, and $1,000,000 for
the other designated contracts. While U.S. Treasury bonds, U.S. Treasury bills
and U.S. Treasury notes are backed by the full faith and credit of the U.S.
government and GNMA certificates are guaranteed by a U.S. government agency, the
futures contracts in U.S. government securities are not obligations of the U.S.
Treasury.
Index Based Futures Contracts
Stock Index Futures Contracts
A stock index assigns relative values to the common stocks included in the
index. The index fluctuates with changes in the market values of the common
stocks so included. A stock index futures contract is a bilateral agreement by
which two parties agree to take or make delivery of an amount of cash equal to a
specified dollar amount times the difference between the closing value of the
stock index on the expiration date of the contract and the price at which the
futures contract is originally made. No physical delivery of the underlying
stocks in the index is made.
Currently stock index futures contracts can be purchased or sold on the
Standard and Poor's Corporation (S&P) Index of 500 Stocks, the S&P Index of 100
Stocks, the New York Stock Exchange Composite Index, the Value Line Index and
the Major Market Index. It is expected that futures contracts trading in
additional stock indices will be authorized. The standard contract size is $500
times the value of the index.
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A-16
The Fund does not believe that differences between existing stock indices
will create any differences in the price movements of the stock index futures
contracts in relation to the movements in such indices. However, such
differences in the indices may result in differences in correlation of the
futures with movements in the value of the securities being hedged.
Other Index Based Futures Contracts
It is expected that bond index and other financially based index futures
contracts will be developed in the future. It is anticipated that such index
based futures contracts will be structured in the same way as stock index
futures contracts but will be measured by changes in interest rates, related
indexes or other measures, such as the consumer price index. In the event that
such futures contracts are developed the Fund will sell interest rate index and
other index based futures to hedge against changes which are expected to affect
the Fund's portfolio.
The purchase or sale of a futures contract differs from the purchase or
sale of a security, in that no price or premium is paid or received. Instead, to
initiate trading an amount of cash, cash equivalents, money market instruments,
or U.S. Treasury bills equal to approximately 1 1/2% (up to 5%) of the contract
amount must be deposited by the Fund with the Broker. This amount is known as
initial margin. The nature of initial margin in futures transactions is
different from that of margin in security transactions. Futures contract margin
does not involve the borrowing of funds by the customer to finance the
transactions. Rather, the initial margin is in the nature of a performance bond
or good faith deposit on the contract which is returned to the Fund upon
termination of the futures contract assuming all contractual obligations have
been satisfied. The margin required for a particular futures contract is set by
the exchange on which the contract is traded, and may be significantly modified
from time to time by the exchange during the term of the contract.
Subsequent payments, called variation margin, to the Broker and from the
Broker, are made on a daily basis as the value of the underlying instrument or
index fluctuates making the long and short positions in the futures contract
more or less valuable, a process known as mark-to-market. For example, when the
Fund has purchased a futures contract and the price of the underlying financial
instrument or index has risen, that position will have increased in value and
the Fund will receive from the Broker a variation margin payment equal to that
increase in value. Conversely, where the Fund has purchased a futures contract
and the price of the underlying financial instrument or index has declined, the
position would be less valuable and the Fund would be required to make a
variation margin payment to the Broker. At any time prior to expiration of the
futures contract, the Fund may elect to close the position. A final
determination of variation margin is then made,
<PAGE>
A-17
additional cash is required to be paid to or released by the Broker, and the
Fund realizes a loss or gain.
The Fund intends to enter into arrangements with its custodian and with
Brokers to enable its initial margin and any variation margin to be held in a
segregated account by its custodian on behalf of the Broker.
Although interest rate futures contracts by their terms call for actual
delivery or acceptance of financial instruments, and index based futures
contracts call for the delivery of cash equal to the difference between the
closing value of the index on the expiration date of the contract and the price
at which the futures contract is originally made, in most cases such futures
contracts are closed out before the settlement date without the making or taking
of delivery. Closing out a futures contract sale is effected by an offsetting
transaction in which the Fund enters into a futures contract purchase for the
same aggregate amount of the specific type of financial instrument or index and
same delivery date. If the price in the sale exceeds the price in the offsetting
purchase, the Fund is paid the difference and thus realizes a gain. If the
offsetting purchase price exceeds the sale price, the Fund pays the difference
and realizes a loss. Similarly, the closing out of a futures contract purchase
is effected by an offsetting transaction in which the Fund enters into a futures
contract sale. If the offsetting sale price exceeds the purchase price, the Fund
realizes a gain. If the purchase price exceeds the offsetting sale price the
Fund realizes a loss. The amount of the Fund's gain or loss on any transaction
is reduced or increased, respectively, by the amount of any transaction costs
incurred by the Fund.
As an example of an offsetting transaction, the contractual obligations
arising from the sale of one contract of September U.S. Treasury bills on an
exchange may be fulfilled at any time before delivery of the contract is
required (i.e., on a specified date in September, the "delivery month") by the
purchase of one contract of September U.S. Treasury bills on the same exchange.
In such instance the difference between the price at which the futures contract
was sold and the price paid for the offsetting purchase after allowance for
transaction costs represents the profit or loss to the Fund.
There can be no assurance, however, that the Fund will be able to enter
into an offsetting transaction with respect to a particular contract at a
particular time. If the Fund is not able to enter into an offsetting
transaction, the Fund will continue to be required to maintain the margin
deposits on the contract and to complete the contract according to its terms.
<PAGE>
A-18
Options on Currency and Other Financial Futures
The Fund intends to purchase call and put options on currency and other
financial futures contracts and sell such options to terminate an existing
position. Options on currency and other financial futures contracts are similar
to options on stocks except that an option on a currency or other financial
futures contract gives the purchaser the right, in return for the premium paid,
to assume a position in a futures contract (a long position if the option is a
call and a short position if the option is a put) rather than to purchase or
sell stock, currency or other financial instruments at a specified exercise
price at any time during the period of the option. Upon exercise of the option,
the delivery of the futures position by the writer of the option to the holder
of the option will be accompanied by delivery of the accumulated balance in the
writer's futures margin account. This amount represents the amount by which the
market price of the futures contract at exercise exceeds, in the case of a call,
or is less than, in the case of a put, the exercise price of the option on the
futures contract. If an option is exercised the last trading day prior to the
expiration date of the option, the settlement will be made entirely in cash
equal to the difference between the exercise price of the option and value of
the futures contract.
The Fund intends to use options on currency and other financial futures
contracts in connection with hedging strategies. In the future the Fund may use
such options for other purposes.
Purchase of Put Options on Futures Contracts
The purchase of protective put options on commodity futures contracts is
analogous to the purchase of protective puts on individual stocks, where an
absolute level of protection is sought below which no additional economic loss
would be incurred by the Fund. Put options may be purchased to hedge a portfolio
of stocks or debt instruments or a position in the futures contract upon which
the put option is based.
Purchase of Call Options on Futures Contracts
The purchase of a call option on a commodity futures contract represents a
means of obtaining temporary exposure to market appreciation at limited risk. It
is analogous to the purchase of a call option on an individual stock which can
be used as a substitute for a position in the stock itself. Depending on the
pricing of the option compared to either the futures contract upon which it is
based, or upon the price of the underlying financial instrument or index itself,
the purchase of a call option may be less risky than the ownership of the
interest rate or index based futures contract or the underlying securities. Call
options on commodity futures contracts may be purchased to hedge against an
<PAGE>
A-19
interest rate increase or a market advance when the Fund is not fully invested.
Use of New Investment Techniques Involving Commodity Futures
Contracts or Related Options
The Fund may employ new investment techniques involving currency and other
financial futures contracts and related options. The Fund intends to take
advantage of new techniques in these areas which may be developed from time to
time and which are consistent with the Fund's investment objective. The Fund
believes that no additional techniques have been identified for employment by
the Fund in the foreseeable future other than those described above.
Limitations on Purchase and Sale of Futures Contracts and Related
Options on Such Futures Contracts
The Fund will not enter into a futures contract if, as a result thereof,
more than 5% of the Fund's total assets (taken at market value at the time of
entering into the contract) would be committed to margin deposits on such
futures contracts.
The Fund intends that its futures contracts and related options
transactions will be entered into for traditional hedging purposes. That is,
futures contracts will be sold to protect against a decline in the price of
securities that the Fund owns or futures contracts will be purchased to protect
the Fund against an increase in the price of securities it intends to purchase.
The Fund does not intend to enter into futures contracts for speculation.
In instances involving the purchase of futures contracts by the Fund, an
amount of cash and cash equivalents, equal to the market value of the futures
contracts will be deposited in a segregated account with the Fund's custodian
and/or in a margin account with a Broker to collateralize the position and
thereby insure that the use of such futures is unleveraged.
Federal Income Tax Treatment
For federal income tax purposes, the Fund is required to recognize as
income for each taxable year its net unrealized gains and losses on futures
contracts as of the end of the year as well as those actually realized during
the year. Any gain or loss recognized with respect to a futures contract is
considered to be 60% long-term and 40% short-term, without regard to the holding
period of the contract. In the case of a futures transaction classified as a
"mixed straddle," the recognition of losses may be deferred to a later taxable
year. The federal income tax treatment of gains or losses from transactions in
options on futures is unclear.
<PAGE>
A-20
In order for the Fund to continue to qualify for federal income tax
treatment as a regulated investment company, at least 90% of its gross income
for a taxable year must be derived from qualifying income. Any net gain realized
from the closing out of futures contracts, for purposes of the 90% requirement,
will be qualifying income. In addition, gains realized on the sale or other
disposition of securities held for less than three months must be limited to
less than 30% of the Fund's annual gross income. The 1986 Tax Act added a
provision that effectively treats both positions in certain hedging transactions
as a single transaction for the purpose of the 30% requirement. The provision
provides that, in the case of any "designated hedge," increases and decreases in
the value of positions of the hedge are to be netted for the purposes of the 30%
requirement. However, in certain situations, in order to avoid realizing a gain
within a three month period, the Fund may be required to defer the closing out
of a contract beyond the time when it would otherwise be advantageous to do so.
Risks of Futures Contracts
Currency and other financial futures contracts prices are volatile and are
influenced, among other things, by changes in stock prices, market conditions,
prevailing interest rates and anticipation of future stock prices, market
movements or interest rate changes, all of which in turn are affected by
economic conditions, such as government fiscal and monetary policies and
actions, and national and international political and economic events.
At best, the correlation between changes in prices of futures contracts
and of the securities being hedged can be only approximate. The degree of
imperfection of correlation depends upon circumstances, such as variations in
speculative market demand for futures contracts and for securities, including
technical influences in futures contracts trading; differences between the
securities being hedged and the financial instruments and indexes underlying the
standard futures contracts available for trading, in such respects as interest
rate levels, maturities and creditworthiness of issuers, or identities of
securities comprising the index and those in the Fund's portfolio. A decision of
whether, when and how to hedge involves the exercise of skill and judgment, and
even a well-conceived hedge may be unsuccessful to some degree because of market
behavior or unexpected interest rate trends.
Because of the low margin deposits required, futures trading involves an
extremely high degree of leverage. As a result, a relatively small price
movement in a futures contract may result in immediate and substantial loss, as
well as gain, to the investor. For example, if at the time of purchase, 10% of
the value of the futures contract is deposited as margin, a 10% decrease in the
<PAGE>
A-21
value of the futures contract would result in a total loss of the margin
deposit, before any deduction for the transaction costs, if the account were
then closed out, and a 15% decrease would result in a loss equal to 150% of the
original margin deposit. Thus, a purchase or sale of a futures contract may
result in losses in excess of the amount invested in the futures contract.
However, the Fund would presumably have sustained comparable losses if, instead
of entering into the futures contract, it had invested in the underlying
financial instrument. Furthermore, in order to be certain that the Fund has
sufficient assets to satisfy its obligations under a futures contract, the Fund
will establish a segregated account in connection with its futures contracts
which will hold cash or cash equivalents equal in value to the current value of
the underlying instruments or indices less the margins on deposit.
Most U.S. futures exchanges limit the amount of fluctuation permitted in
futures contract prices during a single trading day. The daily limit establishes
the maximum amount that the price of a futures contract may vary either up or
down from the previous day's settlement price at the end of a trading session.
Once the daily limit has been reached in a particular type of contract, no
trades may be made on that day at a price beyond that limit. The daily limit
governs only price movement during a particular trading day and therefore does
not limit potential losses because the limit may prevent the liquidation of
unfavorable positions. Futures contract prices have occasionally moved to the
daily limit for several consecutive trading days with little or no trading,
thereby preventing prompt liquidation of futures positions and subjecting some
futures traders to substantial losses.
Risks of Options on Futures Contracts
In addition to the risks described above for currency and other financial
futures contracts, there are several special risks relating to options on
futures contracts. The ability to establish and close out positions on such
options will be subject to the development and maintenance of a liquid secondary
market. There is no assurance that a liquid secondary market will exist for any
particular contract or at any particular time. The Fund will not purchase
options on any futures contract unless and until it believes that the market for
such options has developed sufficiently that the risks in connection with such
options are not greater than the risks in connection with the futures contracts.
Compared to the use of futures contracts, the purchase of options on such
futures involves less potential risk to the Fund because the maximum amount at
risk is the premium paid for the options (plus transaction costs). However,
there may be circumstances when the use of an option on a futures contract would
result in a loss to the Fund, even though the use of a futures contract would
not, such as when there is no movement in the level of the futures contract.
<PAGE>
A-22
FOREIGN CURRENCY TRANSACTIONS
The Fund may invest in securities of foreign issuers. When the Fund
invests in foreign securities they usually will be denominated in foreign
currencies and the Fund temporarily may hold funds in foreign currencies. Thus,
the Fund's share value will be affected by changes in exchange rates.
Forward Currency Contracts
As one way of managing exchange rate risk, the Fund may engage in forward
currency exchange contracts (agreements to purchase or sell currencies at a
specified price and date). Under the contract, the exchange rate for the
transaction (the amount of currency the Fund will deliver or receive when the
contract is completed) is fixed when the Fund enters into the contract. The Fund
usually will enter into these contracts to stabilize the U.S. dollar value of a
security it has agreed to buy or sell. The Fund also may use these contracts to
hedge the U.S. dollar value of a security it already owns, particularly if the
Fund expects a decrease in the value of the currency in which the foreign
security is denominated. Although the Fund will attempt to benefit from using
forward contracts, the success of its hedging strategy will depend on Keystone's
ability to predict accurately the future exchange rate between foreign
currencies and the U.S. dollar. The value of the Fund's investments denominated
in foreign currencies will depend on the relative strength of those currencies
and the U.S. dollar, and the Fund may be affected favorably or unfavorably by
changes in the exchange rate or exchange control regulations between foreign
currencies and the dollar. Changes in foreign currency exchange rates also may
affect the value of dividends and interest earned, gains and losses realized on
the sale of securities and net investment income and gains, if any, to be
distributed to shareholders by the Fund.
Currency Futures Contracts
Currency futures contracts are bilateral agreements under which two
parties agree to take or make delivery of a specified amount of a currency at a
specified future time for a specified price. Trading of currency futures
contracts in the United States is regulated under the Commodity Exchange Act by
the Commodity Futures Trading Commission ("CFTC") and National Futures
Association ("NFA"). Currently the only national futures exchange on which
currency futures are traded is the International Monetary Market of the Chicago
Mercantile Exchange. Foreign currency futures trading is conducted in the same
manner and subject to the same regulations as trading in interest rate and index
based futures. The Fund intends to only engage in currency futures contracts for
hedging purposes, and not for speculation. The Fund may engage in currency
futures contracts for other purposes if authorized to do so by the Board. The
hedging strategies that will
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A-23
be used by the Fund in connection with foreign currency futures contracts are
similar to those described above for forward foreign currency exchange
contracts.
Currently currency futures contracts for the British Pound Sterling,
Canadian Dollar, Dutch Guilder, Deutsche Mark, Japanese Yen, Mexican Peso, Swiss
Franc and French Franc can be purchased or sold for U.S. dollars through the
International Monetary Market. It is expected that futures contracts trading in
additional currencies will be authorized. The standard contract sizes are
L125,000 for the Pound, 125,000 for the Guilder, Mark and Swiss Francs,
C$100,000 for the Canadian Dollar, Y12,500,000 for the Yen, and 1,000,000 for
the Peso. In contrast to Forward Currency Exchange Contracts which can be traded
at any time, only four value dates per year are available, the third Wednesday
of March, June, September and December.
Foreign Currency Options Transactions
Foreign currency options (as opposed to futures) are traded in a variety
of currencies in both the United States and Europe. On the Philadelphia Stock
Exchange, for example, contracts for half the size of the corresponding futures
contracts on the Chicago Board Options Exchange are traded with up to nine
months maturity in marks, sterling, yen, Swiss francs and Canadian dollars.
Options can be exercised at any time during the contract life and require a
deposit subject to normal margin requirements. Since a futures contract must be
exercised, the Fund must continually make up the margin balance. As a result, a
wrong price move could result in the Fund losing more than the original
investment as it cannot walk away from the futures contract as it can an option
contract.
The Fund will purchase call and put options and sell such options to
terminate an existing position. Options on foreign currency are similar to
options on stocks except that an option on an interest rate and/or index based
futures contract gives the purchaser the right, in return for the premium paid,
to purchase or sell foreign currency, rather than to purchase or sell stock, at
a specified exercise price at any time during the period of the option.
The Fund intends to use foreign currency option transactions in connection
with hedging strategies.
Purchase of Put Options on Foreign Currencies
The purchase of protective put options on a foreign currency is analogous
to the purchase of protective puts on individual stocks, where an absolute level
of protection is sought below which no additional economic loss would be
incurred by the Fund. Put options may be purchased to hedge a portfolio of
foreign stocks or
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A-24
foreign debt instruments or a position in the foreign currency upon which the
put option is based.
Purchase of Call Options on Foreign Currencies
The purchase of a call option on foreign currency represents a means of
obtaining temporary exposure to market appreciation at limited risk. It is
analogous to the purchase of a call option on an individual stock which can be
used as a substitute for a position in the stock itself. Depending on the
pricing of the option compared to either the foreign currency upon which it is
based, or upon the price of the foreign stock or foreign debt instruments, the
purchase of a call option may be less risky than the ownership of the foreign
currency or the foreign securities. The Fund would purchase a call option on a
foreign currency to hedge against an increase in the foreign currency or a
foreign market advance when the Fund is not fully invested.
The Fund may employ new investment techniques involving forward foreign
currency exchange contracts, foreign currency futures contracts and options on
foreign currencies in order to take advantage of new techniques in these areas
which may be developed from time to time and which are consistent with the
Fund's investment objective. The Fund believes that no additional techniques
have been identified for employment by the Fund in the foreseeable future other
than those described above.
Currency Trading Risks
Currency exchange trading may involve significant risks. The four major
types of risk the Fund faces are exchange rate risk, interest rate risk, credit
risk and country risk.
Exchange Rate Risk
Exchange rate risk results from the movement up and down of foreign
currency values in response to shifting market supply and demand. When the Fund
buys or sells a foreign currency, an exposure called an open position is
created. Until the time that position can be "covered" by selling or buying an
equivalent amount of the same currency, the Fund is exposed to the risk that the
exchange rate might move against it. Since exchange rate changes can readily
move in one direction, a position carried overnight or over a number of days
involves greater risk than one carried a few minutes or hours. Techniques such
as foreign currency forward and futures contracts and options on foreign
currency are intended to be used by the Fund to reduce exchange rate risk.
Maturity Gaps and Interest Rate Risk
Interest rate risk arises whenever there are mismatches or gaps in the
maturity structure of the Fund's foreign exchange
<PAGE>
A-25
currency holdings, which is the total of its outstanding spot and forward or
futures contracts.
Foreign currency transactions often involve borrowing short-term and
lending longer term to benefit from the normal tendency of interest rates to be
higher for longer maturities. However in foreign exchange trading, while the
maturity pattern of interest rates for one currency is important, it is the
differential between interest rates for two currencies that is decisive.
Credit Risk
Whenever the Fund enters into a foreign exchange contract, it faces a
risk, however small, that the counterparty will not perform under the contract.
As a result there is a credit risk, although no extension of "credit" is
intended. To limit credit risk, the Fund intends to evaluate the
creditworthiness of each other party. The Fund does not intend to trade more
than 5% of its net assets under foreign exchange contracts with one party.
Credit risk exists because the Fund's counterparty may be unable or
unwilling to fulfill its contractual obligations as a result of bankruptcy or
insolvency or when foreign exchange controls prohibit payment. In any foreign
exchange transaction, each party agrees to deliver a certain amount of currency
to the other on a particular date. In establishing its hedges the Fund relies on
each contract being completed. If the contract is not performed, then the Fund's
hedge is eliminated, and the Fund is exposed to any changes in exchange rates
since the contract was originated. To put itself in the same position it would
have been in had the contract been performed, the Fund must arrange a new
transaction. However, the new transaction may have to be arranged at an adverse
exchange rate. The trustee for a bankrupt company may elect to perform those
contracts that are advantageous to the company but disclaim those contracts that
are disadvantageous, resulting in losses to the Fund.
Another form of credit risk stems from the time zone differences between
the U.S. and foreign nations. If the Fund sells sterling it generally must pay
pounds to a counterparty earlier in the day than it will be credited with
dollars in New York. In the intervening hours, the buyer can go into bankruptcy
or can be declared insolvent. Thus, the dollars may never be credited to the
Fund.
Country Risk
At one time or another, virtually every country has interfered with
international transactions in its currency. Interference has taken the form of
regulation of the local exchange market, restrictions on foreign investment by
residents or limits on inflows of investment funds from abroad. Governments take
such
<PAGE>
A-26
measures for example to improve control over the domestic banking system or to
influence the pattern of receipts and payments between residents and foreigners.
In those cases, restrictions on the exchange market or on international
transactions are intended to affect the level or movement of the exchange rate.
Occasionally a serious foreign exchange shortage may lead to payment
interruptions or debt servicing delays, as well as interference in the exchange
market. It has become increasingly difficult to distinguish foreign exchange or
credit risk from country risk.
Changes in regulations or restrictions usually do have an important
exchange market impact. Most disruptive are changes in rules that interfere with
the normal payments mechanism. If government regulations change and a
counterparty is either forbidden to perform or is required to do something
extra, then the Fund might be left with an unintended open position or an
unintended maturity mismatch. Dealing with such unintended long or short
positions could result in unanticipated costs to the Fund.
Other changes in official regulations influence international investment
transactions. If one of the factors affecting the buying or selling of a
currency changes, the exchange rate is likely to respond. Changes in such
controls often are unpredictable and can create a significant exchange rate
response.
Many major countries have moved toward liberalization of exchange and
payments restrictions in recent years or accepted the principle that
restrictions should be relaxed. A few industrial countries have moved in the
other direction. Important liberalizations were carried out by Switzerland, the
United Kingdom and Japan. They dismantled mechanisms for restricting either
foreign exchange inflows (Switzerland), outflows (Britain) or elements of both
(Japan). By contrast, France and Mexico have recently tightened foreign exchange
controls.
Overall, many exchange markets are still heavily restricted. Several
countries limit access to the forward market to companies financing documented
export or import transactions in an effort to insulate the market from purely
speculative activities. Some of these countries permit local traders to enter
into forward contracts with residents but prohibit certain forward transactions
with nonresidents. By comparison, other countries have strict controls on
exchange transactions by residents, but permit free exchange transactions
between local traders and non-residents. A few countries have established tiered
markets, funneling commercial transactions through one market and financial
transactions through another. Outside the major industrial countries, relatively
free foreign exchange markets are rare and control on foreign currency
transactions are extensive.
Another aspect of country risk has to do with the possibility that the
Fund may be dealing with a foreign trader whose home
<PAGE>
A-27
country is facing a payments problem. Even though the foreign trader intends to
perform on its foreign exchange contracts, the contracts are tied to other
external liabilities the country has incurred. As a result performance may be
delayed, and can result in unanticipated cost to the Fund. This aspect of
country risk is a major element in the Fund's credit judgment as to with whom it
will deal and in what amounts.
<PAGE>
A-28
EXHIBIT A
GLOSSARY OF TERMS
Class of Options. Options covering the same underlying security.
Clearing Corporation. The Options Clearing Corporation, Trans Canada
Options, Inc., The European Options Clearing Corporation B.V., or the London
Options Clearing House.
Closing Purchase Transaction. A transaction in which an investor who is
obligated as a writer of an option or seller of a futures contract terminates
his obligation by purchasing on an Exchange an option of the same series as the
option previously written or futures contract identical to the futures contract
previously sold, as the case may be. (Such a purchase does not result in the
ownership of an option or futures contract.)
Closing Sale Transaction. A transaction in which an investor who is the
holder or buyer of an outstanding option or futures contract liquidates his
position as a holder or seller by selling an option of the same series as the
option previously purchased or futures contract identical to the futures
contract previously purchased. (Such sale does not result in the investor
assuming the obligations of a writer or seller.)
Covered Call Option Writer. A writer of a call option who, so long as he
remains obligated as a writer, owns the shares of the underlying security or
holds on a share for share basis a call on the same security where the exercise
price of the call held is equal to or less than the exercise price of the call
written, or, if greater than the exercise price of the call written, the
difference is maintained by the writer in cash, U.S. Treasury bills or other
high grade, short term obligations in a segregated account with the writer's
broker or custodian.
Covered Put Option Writer. A writer of a put option who, so long as he
remains obligated as a writer, has deposited Treasury bills with a value equal
to or greater than the exercise price with a securities depository and has
pledged them to the Options Clearing Corporation for the account of the
broker-dealer carrying the writer's position or holds on a share for share basis
a put on the same security as the put written where the exercise price of the
put held is equal to or greater than the exercise price of the put written, or,
if less than the exercise price of the put written, the difference is maintained
by the writer in cash, U.S. Treasury bills or other high grade, short term
obligations in a segregated account with the writer's broker or custodian.
<PAGE>
A-29
Securities Exchange. A securities exchange on which call and put options
are traded. The U.S. Exchanges are as follows: The Chicago Board Options
Exchange; American Stock Exchange; New York Stock Exchange; Philadelphia Stock
Exchange; and Pacific Stock Exchange. The foreign securities exchanges in Canada
are the Toronto Stock Exchange and the Montreal Stock Exchange; in the
Netherlands, the European Options Exchange; and in the United Kingdom, the Stock
Exchange (London).
Those issuers whose common stocks have been approved by the Exchanges as
underlying securities for options transactions are published in various
financial publications.
Commodities Exchange. A commodities exchange on which futures contracts
are traded that is regulated by exchange rules that have been approved by the
Commodity Futures Trading Commission. The U.S. exchanges are as follows: The
Chicago Board of Trade of the City of Chicago; Chicago Mercantile Exchange,
International Monetary Market (a division of the Chicago Mercantile Exchange);
the Kansas City Board of Trade; and the New York Futures Exchange.
Exercise Price. The price per unit at which the holder of a call option
may purchase the underlying security upon exercise or the holder of a put option
may sell the underlying security upon exercise.
Expiration Date. The latest date when an option may be exercised or a
futures contract must be completed according to its terms.
Hedging. An action taken by an investor to neutralize an investment risk
by taking an investment position that will move in the opposite direction as the
risk being hedged so that a loss (or gain) on one will tend to be offset by a
gain (or loss) on the other.
Option. Unless the context otherwise requires, the term "option" means
either a call or put option issued by a Clearing Corporation, as defined above.
A call option gives a holder the right to buy from such Clearing Corporation the
number of shares of the underlying security covered by the option at the stated
exercise price by the filing of an exercise notice prior to the expiration time
of the option. A put option gives a holder the right to sell to a Clearing
Corporation the number of shares of the underlying security covered by the put
at the stated exercise price by the filing of an exercise notice prior to the
expiration time of the option. The Fund will sell ("write") and purchase puts
only on U.S. Exchanges.
Option Period. The time during which an option may be exercised, generally
from the date the option is written through its expiration date.
<PAGE>
A-30
Premium. The price of an option agreed upon between the buyer and writer
or their agents in a transaction on the floor of an Exchange.
Series of Options.Options covering the same underlying security and having
the same exercise price and expiration date.
Stock Index. A stock index assigns relative values to the common stocks
included in the index, and the index fluctuates with changes in the market
values of the common stocks so included.
Index Based Futures Contract. An index based futures contract is a
bilateral agreement pursuant to which a party agrees to buy or deliver at
settlement an amount of cash equal to $500 times the difference between the
closing value of an index on the expiration date and the price at which the
futures contract is originally struck. Index based futures are traded on
Commodities Exchanges. Currently index based stock index futures contracts can
be purchased or sold with respect to the Standard & Poor's Corporation (S&P) 500
Stock Index and S&P 100 Stock Index on the Chicago Mercantile Exchange, the New
York Stock Exchange Composite Index on the New York Futures Exchange and the
Value Line Stock Index and Major Market Index on the Kansas City Board of Trade.
Underlying Security. The security subject to being purchased upon the
exercise of a call option or subject to being sold upon the exercise of a put
option.
<PAGE>
Keystone International Fund Inc.
Schedule of Investments -- October 31, 1994
MARKET
SHARES VALUE
COMMON STOCKS/WARRANTS (74.3%)
ARGENTINA (1.8%)
Foods & Beverages (0.6%)
Ledesma Sociedad Anonima Agricola Industrial 233,000 $ 442,789
Molinos Rio de la Plata S.A. 52,838 461,368
904,157
Metals & Mining (0.3%)
Acindar Industria Argentina de Aceros S.A. 484,000 527,665
Oil (0.9%)
Yacimientos Petroliferos Fiscales S.A. (YPF) 58,736 1,415,821
Total Argentina 2,847,643
AUSTRALIA (2.0%)
Banking (1.1%)
National Australia Bank Ltd. 95,500 754,526
Westpac Banking Corp. 300,000 1,006,906
1,761,432
Foods & Beverages (0.2%)
Foster's Brewing Group Ltd. 270,000 238,583
Metals & Mining (0.7%)
Broken Hill Proprietary Co. Ltd. 72,000 1,103,497
TOTAL AUSTRALIA 3,103,512
BELGIUM (0.5%)
Industrials (0.5%)
Bekaert S.A. 1,110 861,578
CANADA (10.5%)
Advertising & Publishing (1.1%)
Quebecor, Inc. 147,906 1,804,265
Banking (0.6%)
Bank of Montreal 27,000 501,534
National Bank of Canada 68,500 481,110
982,644
Capital Goods (0.5%)
Bombardier, Inc. 48,000 $ 798,462
Conglomerates (2.5%)
Brascan Ltd. 26,400 409,877
Canadian Pacific Ltd. 58,800 940,079
Imasco Ltd. 73,200 2,157,955
Power Corp. of Canada 31,500 436,659
3,944,570
Foods & Beverages (0.3%)
Canada Malting Ltd. 13,800 142,836
Seagram Company Ltd. 9,000 277,875
420,711
Metals & Mining (2.5%)
Alcan Aluminum Ltd. 39,000 1,043,250
INCO Ltd. 37,200 1,120,730
Metall Mining Corp. 28,500 273,917
Potash Corp. of Saskatchewan, Inc. 40,380 1,429,242
3,867,139
Oil (1.4%)
Canadian Occidental Petroleum Ltd. 77,450 1,882,426
Chauvco Resources Ltd. 20,066 252,197
2,134,623
Paper & Packaging (0.8%)
MacMillan Bloedel Ltd. 62,100 872,320
Noranda Forest, Inc. 50,000 429,728
1,302,048
Retail (0.8%)
Canadian Tire Corp. Ltd. 48,164 396,144
Hudson's Bay Co. 43,100 860,343
1,256,487
TOTAL CANADA 16,510,949
FINLAND (0.2%)
Industrials (0.2%)
Fiskars Oy AB 4,600 314,521
<PAGE>
FRANCE (2.9%)
Capital Goods (0.2%)
Alcatel Alsthom Compagnie Generale
d'Electricite 4,001 $ 366,979
Consumer Goods (0.4%)
Skis Rossignol S.A. 1,740 689,778
Cosmetics (0.5%)
L'Oreal S.A. 3,500 760,396
Industrials (0.7%)
Michelin 26,200 1,097,182
Leisure/Tourism (0.4%)
Accor S.A. 5,500 653,032
Oil (0.7%)
Societe Nationale Elf Aquitaine 14,108 1,043,159
TOTAL FRANCE 4,610,526
GERMANY (0.2%)
Retail (0.2%)
Kaufhof Holding AG 1,000 339,208
HONG KONG (2.0%)
Banking (1.1%)
HSBC Holdings 139,277 1,649,155
Conglomerates (0.6%)
Jardine Matheson Holdings Ltd. 119,200 991,084
Telecommunications (0.3%)
Hongkong Telecommunications Ltd. 240,000 514,008
TOTAL HONG KONG 3,154,247
INDONESIA (1.6%)
Chemicals (0.6%)
P.T. Tri Polyta Indonesia, American
Depository Receipts 32,100 948,956
Drugs (0.4%)
Kalbe Farma 159,840 706,760
Textiles & Apparel (0.6%)
Indorama Synthetic 226,000 $ 905,613
TOTAL INDONESIA 2,561,329
ITALY (0.8%)
Telecommunications (0.8%)
Stet-Societa Finanziaria Telefonica P.A. 420,500 1,272,170
JAPAN (20.3%)
Automotive (1.5%)
Nissan Motor Co., Ltd. 140,000 1,195,272
Toyota Motor Corp. 55,000 1,215,093
2,410,365
Construction & Housing (1.2%)
Chudenko 28,000 1,029,061
Sekisui House, Ltd. 73,000 828,989
1,858,050
Consumer Goods (3.5%)
Sony Corp. 90,600 5,527,755
Electronics Products (5.2%)
Hitachi Ltd. 296,000 3,086,357
NEC Corp. 189,000 2,419,450
Toshiba Corp. 332,000 2,618,572
8,124,379
Financial Services (2.5%)
Japan Associates Finance Co. 8,000 1,181,025
Nichiei, Co., Ltd. 600 38,714
Nomura Securities Co. Ltd. 131,000 2,745,367
3,965,106
Industrials (2.4%)
Bridgestone Corp. 233,000 3,848,655
Insurance (0.6%)
Koa Fire & Marine Insurance Co. Ltd. (The) 70,000 491,406
Nichido Fire & Marine Insurance Co. Ltd. 60,000 525,886
1,017,292
<PAGE>
Metals & Mining (1.1%)
Sumitomo Metal Industries, Ltd. 460,000 $ 1,742,838
Office & Business Equipment (2.3%)
Canon, Inc. 194,000 3,605,017
TOTAL JAPAN 32,099,457
KOREA (1.7%)
Electronics Products (0.5%)
Samsung Electronics Co., Ltd., Global
Deposit Receipts (a) 532 31,388
Samsung Electronics Co., Ltd., Global
Depositary Shares (a) 12,859 758,681
790,069
Foods & Beverages (0.1%)
Oriental Brewery 6,400 154,952
Machinery (0.4%)
Daewoo Heavy Industries, Ordinary Shares 33,639 616,106
Daewoo Heavy Industries, New Shares 550 10,073
626,179
Metals & Mining (0.2%)
Pohang Iron & Steel Co., Ltd. 2,500 236,781
Textiles & Apparel (0.1%)
Pangrim Spinning 2,127 184,110
Utilities (0.4%)
Korea Electric Power 16,300 619,570
TOTAL KOREA 2,611,661
MALAYSIA (0.8%)
Foods & Beverages (0.2%)
Nestle Malay Berhad 54,000 363,522
Leisure/Tourism (0.6%)
Genting Berhad 98,500 878,686
TOTAL MALAYSIA 1,242,208
MEXICO (1.1%)
Foods & Beverages (0.3%)
Vitro S.A. de C.V. 55,700 $ 389,754
Metals & Mining (0.8%)
Industrias Penoles S.A. de C.V. 353,500 1,234,216
Retail (0.0%)
Grupo Casa Autrey S.A. de C.V. 9,100 70,163
TOTAL MEXICO 1,694,133
NETHERLANDS (7.1%)
Advertising & Publishing (1.5%)
Telegraaf 10,000 1,127,797
Wolters Kluwer N.V. 17,172 1,242,516
2,370,313
Consumer Goods (1.4%)
Philips Electronics N.V. 67,700 2,242,334
Foods & Beverages (0.9%)
Heineken N.V. 9,431 1,379,914
Health & Household Products (0.7%)
Unilever N.V. 9,615 1,145,445
Insurance (0.4%)
AEGON N.V. 10,768 665,370
Oil (1.8%)
Royal Dutch Petroleum Co. 23,740 2,764,758
Retail (0.4%)
Ahold 23,435 689,960
TOTAL NETHERLANDS 11,258,094
PERU (3.5%)
Banking (0.0%)
Banco de Credito del Peru 28,938 68,578
Foods & Beverages (0.8%)
Backus & Johnston Corp. 505,825 1,244,130
Metals & Mining (1.9%)
Minsur S.A. 100,651 1,185,857
<PAGE>
Metals & Mining--continued
Southern Peru Copper Corp., Treasury Shares 300,199 $ 1,845,927
3,031,784
Telecommunications (0.8%)
Compania Peruana de Telefonos 886,370 1,229,301
Tele 2000 3,512 9,616
1,238,917
TOTAL PERU 5,583,409
SINGAPORE (1.4%)
Foods & Beverages (1.4%)
Fraser & Neave 190,000 2,251,277
SPAIN (0.8%)
Oil (0.8%)
Repsol S.A. 37,300 1,192,659
SWEDEN (3.0%)
Automotive (0.9%)
Volvo AB 67,200 1,326,107
Consumer Goods (1.1%)
Electrolux AB 33,925 1,760,886
Drugs (0.4%)
AB Astra 20,900 564,920
Healthcare Services (0.5%)
Pharmacia AB 45,000 850,496
Transportation (0.1%)
Stena Line AB 38,000 208,066
TOTAL SWEDEN 4,710,475
SWITZERLAND (3.3%)
Aerospace (0.2%)
Oerlikon-Buhrle Holding AG 3,600 373,057
Chemicals (0.9%)
Ciba-Geigy AG 2,435 1,438,290
Drugs (0.3%)
Sandoz AG 825 $ 411,678
Foods & Beverages (1.6%)
Nestle S.A. 2,756 2,579,151
Miscellaneous (0.3%)
SGS Holding 340 493,264
TOTAL SWITZERLAND 5,295,440
UNITED KINGDOM (6.7%)
Building Materials (0.6%)
Pilkington PLC 285,000 897,326
Conglomerates (3.7%)
Antofagasta Holdings 567,000 3,153,091
Lonrho PLC 1,245,151 2,667,889
5,820,980
Metals & Mining (1.5%)
British Steel PLC 892,000 2,337,961
Oil (0.9%)
British Petroleum Co., PLC (The) 204,000 1,451,423
TOTAL UNITED KINGDOM 10,507,690
VENEZUELA (2.1%)
Banking (0.1%)
Banco Mercantil 71,047 163,115
Building Materials (0.3%)
Vencemos 240,000 397,010
Conglomerates (0.1%)
H.L. Boulton & Co. 1,649,500 97,103
Foreign Government (0.0%)
Republic of Venezuela, wts. 20,000 20
Metals & Mining (0.2%)
Sivensa 1,330,510 375,568
Venprecar, Depositary Shares 1,612 10,075
385,643
Paper & Packaging (0.2%)
Venezolana de Papeles 517,775 384,056
<PAGE>
Utilities (1.2%)
Electric de Caracas 949,300 $ 1,855,345
TOTAL VENEZUELA 3,282,292
TOTAL COMMON STOCKS/WARRANTS
(Cost--$96,443,659) 117,304,478
PREFERRED STOCKS (3.9%)
AUSTRALIA (0.4%)
Banking (0.4%)
Westpac Banking Corp. 120,000 668,300
BRAZIL (3.5%)
Banking (0.6%)
Banco Bradesco S.A. 47,187,500 441,156
Banco Itau S.A. 787,500 252,559
Banco Nacional S.A. 8,075,000 219,600
913,315
Energy Services (0.0%)
Petro Ipiranga S.A. 4,000,000 71,952
Foods & Beverages (0.6%)
Brahma S.A. 784,000 275,559
Ceval Alimentos S.A. 21,550,000 344,283
Sadia Concordia S.A.
Industria e Comercio 177,500 269,926
889,768
Metals & Mining (1.9%)
Cia Sidergica Nacional S.A. 6,000,000 275,502
Mangels Industrial S.A. 22,500,000 93,195
Usinas Siderurgicas de Minas Gerais
S.A.-Usiminas 167,500,000 275,370
Vale do Rio Doce Navegacao S.A. 10,800,000 2,338,935
2,983,002
Paper & Packaging (0.2%)
Klabin Fab Papel S.A. 167,000 292,497
Textiles & Apparel (0.2%)
Coteminas S.A. 655,000 279,045
Utilities (0.0%)
Electrobras S.A. 102,481 39,173
MARKET
VALUE
TOTAL BRAZIL $ 5,468,752
TOTAL PREFERRED STOCKS
(Cost--$5,149,441) 6,137,052
PAR
VALUE
FIXED INCOME (18.1%)
ARGENTINA (1.0%)
Telecommunications (0.5%)
Telecom Argentina, 8.375%, 10/18/00 $ 1,000,000 867,500
Oil (0.5%)
Yacimientos Petroliferos Fiscales S.A.
(YPF), 8.00%, 2/15/04 1,000,000 795,000
Total Argentina 1,662,500
BRAZIL (4.1%)
Telecommunications (4.1%)
Telecomunicacoes Brasileiras S.A.-Telebras,
10.00%, 10/22/97 (a) 2,000,000 2,005,000
Telecomunicacoes Brasileiras S.A.-Telebras,
10.00%, 6/16/97 1,500,000 1,511,250
Telecomunicacoes Brasileiras S.A.-Telebras,
10.375%, 9/9/97 3,000,000 3,015,000
total Brazil 6,531,250
CANADA (1.2%)
Conglomerates (1.2%)
Brascan Ltd., 7.00%, 10/15/02 2,318,000 1,850,835
INDONESIA (1.2%)
Banking (1.2%)
Indah Kiat International Finance Co. BV,
11.375%, 6/15/99 2,000,000 1,970,000
MEXICO (0.3%)
<PAGE>
Foods & Beverages (0.3%)
Fomento Economico Mexico, 9.50%, 7/22/97 400,000 404,000
UNITED STATES (9.1%)
United States Government Issues (9.1%)
U.S. Treasury Notes, 5.875%, 5/31/96 $10,000,000 $ 9,889,100
U.S. Treasury Notes, 6.00%, 6/30/96 4,500,000 4,454,280
Total United States 14,343,380
VENEZUELA (1.2%)
Foreign Government (1.2%)
Republic of Venezuela, 6.75%, 3/31/20 4,000,000 1,900,000
(Cost--$29,499,694) 28,661,965
MATURITY MARKET
VALUE VALUE
SHORT-TERM INVESTMENTS (2.8%)
REPURCHASE AGREEMENTS (2.8%)
HSBC Securities, Inc., 4.70%, purchased
10/31/94, maturing 11/1/94 (Collateralized
by $4,360,000 U.S. Treasury
Notes, 6.00%, due 11/15/94)
(Cost--$4,383,000) $ 4,383,572 $ 4,383,000
TOTAL INVESTMENTS
(Cost--$135,475,794) (b) 156,486,495
FOREIGN CURRENCY HOLDINGS (0.6%)
New Taiwan Dollar (Cost--$1,000,000) 1,002,488
OTHER ASSETS AND LIABILITIES--NET (0.3%) 439,600
NET ASSETS (100%) $157,928,583
See Notes to Financial Statements
NOTES TO SCHEDULE OF INVESTMENTS:
(a) Securities that may be resold to "qualified institutional buyers" under Rule
144A of the Federal Securities Act of 1933. These securities have been
determined to be liquid under guidelines established by the Board of
Directors.
(b) The cost of investments for income tax purposes amounted to $135,661,072.
Gross unrealized appreciation and depreciation of investments, based on
identified tax cost at October 31, 1994 are as follows:
Gross unrealized appreciation $24,628,434
Gross unrealized depreciation (3,803,011)
Net unrealized appreciation $20,825,423
<PAGE>
SCHEDULE OF INVESTMENTS-September 30, 1994
<TABLE>
<CAPTION>
MARKET
SHARES VALUE
<S> <C> <C>
COMMON STOCKS/WARRANTS (70.5%)
ARGENTINA (1.6%)
Foods & Beverages (0.6%)
Ledesma Sociedad Anonima Agricola Industrial 233,000 $ 442,789
Molinos Rio de la Plata S.A. 52,838 502,061
944,850
Oil (1.0%)
Yacimientos Petroliferos Fiscales S.A. (YPF) 58,736 1,477,506
TOTAL ARGENTINA 2,422,356
AUSTRALIA (1.6%)
Banking (1.1%)
National Australia Bank Ltd. 95,500 729,558
Westpac Banking Corp. 300,000 932,712
1,662,270
Foods & Beverages (0.1%)
Foster's Brewing Group Ltd. 270,000 227,848
Metals & Mining (0.4%)
Broken Hill Proprietary Co. Ltd. 38,000 552,461
TOTAL AUSTRALIA 2,442,579
BELGIUM (0.5%)
Industrials (0.5%)
Bekaert S.A. 1,110 824,077
CANADA (10.2%)
Advertising & Publishing (0.9%)
Quebecor Inc. 110,106 1,447,359
Banking (0.6%)
Bank of Montreal 27,000 478,259
National Bank of Canada 68,500 478,959
957,218
Capital Goods (0.5%)
Bombardier Inc. 48,000 809,964
Conglomerates (2.2%)
Brascan Ltd. 26,400 $ 381,489
Canadian Pacific Ltd. 58,800 986,724
Imasco Ltd. 55,700 1,578,610
Power Corp. of Canada 31,500 463,995
3,410,818
Foods & Beverages (0.3%)
Canada Malting Ltd. 13,800 138,947
Seagram Company Ltd. 9,000 272,250
411,197
Metals & Mining (2.6%)
Alcan Aluminum Ltd. 39,000 1,028,625
INCO Ltd. 37,200 1,113,253
Metall Mining Corp. 28,500 276,328
Potash Corp. of Saskatchewan Inc. 40,380 1,660,164
4,078,370
Oil (1.3%)
Canadian Occidental Petroleum Ltd. 77,450 1,711,259
Chauvco Resources Ltd. 20,066 246,934
1,958,193
Paper & Packaging (0.9%)
MacMillan Bloedel Ltd. 62,100 932,102
Noranda Forest Inc. 50,000 452,155
1,384,257
Retail (0.9%)
Canadian Tire Corp., Ltd. 48,164 404,120
Hudson's Bay Co. 43,100 936,223
1,340,343
TOTAL CANADA 15,797,719
FINLAND (0.2%)
Industrials (0.2%)
Fiskars Oy AB 4,600 283,676
See Notes to Schedule of Investments.
<PAGE>
FRANCE (2.9%)
Capital Goods (0.2%)
Alcatel Alsthom Compagnie Generale d'Electricite 4,001 $ 369,619
Consumer Goods (0.4%)
Skis Rossignol S.A. 1,740 676,749
Cosmetics (0.5%)
L'Oreal S.A. 3,500 722,270
Industrials (0.7%)
Michelin 26,200 1,067,985
Leisure/Tourism (0.4%)
Accor S.A. 5,500 631,360
Keystone International Fund, Inc.
Oil (0.7%)
Societe Nationale Elf Aquitaine 14,108 1,012,185
TOTAL FRANCE 4,480,168
GERMANY (0.2%)
Retail (0.2%)
Kaufhof Holding AG 1,000 317,874
HONG KONG (2.4%)
Air Transportation (0.5%)
Cathay Pacific Airways Ltd. 464,000 735,583
Banking (1.0%)
HSBC Holdings 139,277 1,554,592
Conglomerates (0.6%)
Jardine Matheson Holdings Ltd. 119,200 1,010,405
Telecommunications (0.3%)
Hongkong Telecommunications Ltd. 240,000 479,863
TOTAL HONG KONG 3,780,443
INDONESIA (1.6%)
Chemicals (0.6%)
P.T. Tri Polyta Indonesia, American Depository
Receipts 32,100 866,700
Drugs (0.4%)
Kalbe Farma 159,840 $ 624,361
Textiles & Apparel (0.6%)
Indorama Synthetic 226,000 913,949
TOTAL INDONESIA 2,405,010
ITALY (0.8%)
Telecommunications (0.8%)
Stet-Societa Finanziaria Telefonica P.A. 420,500 1,303,322
JAPAN (20.2%)
Automotive (1.5%)
Nissan Motor Co., Ltd. 140,000 1,142,886
Toyota Motor Corp. 55,000 1,126,640
2,269,526
Construction & Housing (1.3%)
Chudenko 28,000 1,090,615
Sekisui House, Ltd. 73,000 861,857
1,952,472
Consumer Goods (3.4%)
Sony Corp. 90,600 5,265,954
Electronics Products (4.9%)
Hitachi, Ltd. 296,000 2,855,459
NEC Corp. 189,000 2,269,526
Toshiba Corp. 332,000 2,495,862
7,620,847
Financial Services (2.8%)
Japan Associates Finance Co. 8,000 1,227,043
Nichiei Co., Ltd. 6,600 458,204
Nomura Securities Co., Ltd. 131,000 2,709,889
4,395,136
Industrials (2.4%)
Bridgestone Corp. 233,000 3,644,298
<PAGE>
Insurance (0.6%)
Koa Fire & Marine Insurance Co. Ltd. (The) 70,000 $ 472,553
Nichido Fire & Marine Insurance Co. Ltd. 60,000 520,686
993,239
Metals & Mining (1.1%)
Sumitomo Metal Industries, Ltd. 460,000 1,624,622
Office & Business Equipment (2.2%)
Canon, Inc. 194,000 3,406,256
TOTAL JAPAN 31,172,350
KOREA (1.6%)
Electronics Products (0.5%)
Samsung Electronics Co., Ltd., Global Deposit Receipts
(a) 532 34,846
Samsung Electronics Co., Ltd., Global Depositary
Shares (a) 12,859 842,264
877,110
Foods & Beverages (0.1%)
Oriental Brewery 6,400 140,228
Machinery (0.5%)
Daewoo Heavy Industries, Ordinary Shares 33,639 741,263
Daewoo Heavy Industries, New Shares 550 12,120
753,383
Metals & Mining (0.2%)
Pohang Iron & Steel Co., Ltd. 2,500 277,639
Textiles & Apparel (0.1%)
Pangrim Spinning 2,127 174,964
Utilities (0.2%)
Korea Electric Power 6,300 291,849
TOTAL KOREA 2,515,173
MALAYSIA (0.5%)
Foods & Beverages (0.2%)
Nestle Malay Berhad 54,000 332,826
Leisure/Tourism (0.3%)
Genting Berhad 43,500 $ 395,988
TOTAL MALAYSIA 728,814
MEXICO (0.9%)
Foods & Beverages (0.3%)
Vitro S.A. 55,700 475,578
Metals & Mining (0.5%)
Industrias Penoles, S.A. de C.V. 268,500 774,709
Retail (0.1%)
Grupo Casa Autrey S.A. de C.V. 9,100 75,018
TOTAL MEXICO 1,325,305
NETHERLANDS (6.9%)
Advertising & Publishing (1.5%)
Telegraaf 10,000 1,123,886
Wolters Kluwer N.V. 17,172 1,219,168
2,343,054
Consumer Goods (1.4%)
Philips Electronics N.V. 67,700 2,066,611
Foods & Beverages (0.8%)
Heineken N.V. 9,431 1,286,563
Health & Household Products (0.7%)
Unilever N.V. 9,615 1,097,751
Insurance (0.4%)
AEGON N.V. 10,768 620,266
Oil (1.7%)
Royal Dutch Petroleum Co. 23,740 2,554,831
Retail (0.4%)
Ahold 23,435 660,141
TOTAL NETHERLANDS 10,629,217
PERU (2.8%)
Banking (0.0%)
Banco de Credito del Peru 28,938 61,724
See Notes to Schedule of Investments.
<PAGE>
Foods & Beverages (0.4%)
Backus & Johnston Corp. 264,776 $ 549,401
Metals & Mining (1.5%)
Minsur S.A. 100,651 803,950
Southern Peru Copper Corp., Treasury Shares 300,199 1,582,039
2,385,989
Telecommunications (0.9%)
Compania Peruana de Telefonos 886,370 1,348,738
Tele 2000 3,512 10,508
1,359,246
TOTAL PERU 4,356,360
SINGAPORE (0.5%)
Foods & Beverages (0.5%)
Fraser & Neave 64,000 759,541
SPAIN (0.7%)
Oil (0.7%)
Repsol S.A. 37,300 1,136,983
SWEDEN (2.5%)
Automotive (0.8%)
Volvo AB 67,200 1,225,000
Consumer Goods (1.0%)
Electrolux AB 33,925 1,603,826
Healthcare Services (0.5%)
Pharmacia AB 45,000 802,284
Transportation (0.2%)
Stena Line AB 38,000 215,678
TOTAL SWEDEN 3,846,788
SWITZERLAND (3.4%)
Aerospace (0.2%)
Oerlikon-Buhrle Holding AG 3,600 369,088
Chemicals (0.9%)
Ciba-Geigy AG 2,435 1,376,839
Drugs (0.3%)
Sandoz AG 825 $ 418,427
Foods & Beverages (1.6%)
Nestle S.A. 2,756 2,502,341
Miscellaneous (0.4%)
SGS Holding 340 528,155
TOTAL SWITZERLAND 5,194,850
UNITED KINGDOM (6.4%)
Building Materials (0.5%)
Pilkington PLC 285,000 843,646
Conglomerates (3.8%)
Antofagasta Holdings 567,000 3,303,259
Lonrho PLC 1,230,000 2,556,447
5,859,706
Metals & Mining (1.6%)
British Steel PLC 892,000 2,426,279
Oil (0.5%)
British Petroleum Co., PLC (The) 125,000 787,278
TOTAL UNITED KINGDOM 9,916,909
VENEZUELA (2.1%)
Banking (0.1%)
Banco Mercantil 61,248 185,688
Building Materials (0.3%)
Vencemos 240,000 416,789
Conglomerates (0.1%)
H.L. Boulton & Co. 1,649,500 111,668
Foreign Government (0.0%)
Republic of Venezuela, wts. 20,000 20
Metals & Mining (0.2%)
Sivensa 1,330,510 375,961
Sivensa, Global Depository Shares 1,612 13,919
389,880
<PAGE>
Paper & Packaging (0.2%)
Venezolana de Papeles 517,775 $ 374,912
Utilities (1.2%)
Electric de Caracas 949,300 1,789,682
TOTAL VENEZUELA 3,268,639
TOTAL COMMON STOCKS/WARRANTS
(Cost--$91,151,095) 108,908,153
PREFERRED STOCKS (4.0%)
AUSTRALIA (0.5%)
Banking (0.5%)
Westpac Banking Corp. 120,000 666,223
BRAZIL (3.5%)
Banking (0.6%)
Banco Bradesco S.A. 47,187,500 464,372
Banco Itau S.A. 787,500 267,574
Banco Nacional S.A. 8,075,000 235,104
967,050
Energy Services (0.1%)
Petro Ipiranga S.A. 14,000,000 237,832
Foods & Beverages (0.5%)
Brahma S.A. 784,000 238,828
Ceval Alimentos S.A. 21,550,000 300,450
Sadia Concordia S.A.
Industria e Comercio 177,500 266,198
805,476
Metals & Mining (1.9%)
Mangels Industria S.A. 22,500,000 93,307
Cia Sidergica Nacional S.A. 6,000,000 263,616
Usinas Siderurgicas de Minas Gerais S.A.--Usiminas 167,500,000 274,700
Vale do Rio Doce Navegacao S.A. 10,800,000 2,252,243
2,883,866
Paper & Packaging (0.2%)
Klabin Fab Papel S.A. 167,000 305,237
Textiles & Apparel (0.2%)
Coteminas S.A. 655,000 245,577
Utilities (0.0%)
Electrobras S.A. 2,950,000 3,455
MARKET
VALUE
TOTAL BRAZIL $ 5,448,493
TOTAL PREFERRED STOCKS
(Cost--$5,245,839) 6,114,716
PAR
VALUE
FIXED INCOME (18.6%)
ARGENTINA (1.1%)
Telecommunications (0.6%)
Telecom Argentina, 8.375%, 10/18/00 $ 1,000,000 907,500
Oil (0.5%)
Yacimientos Petroliferos Fiscales
S. A. (YPF), 8.00%, 2/15/04 1,000,000 855,000
Total Argentina 1,762,500
BRAZIL (4.2%)
Telecommunications (4.2%)
Telecomunicacoes Brasileiras
S.A.-Telebras, 10.00%,
10/22/97 (a) 2,000,000 1,990,000
Telecomunicacoes Brasileiras S.A.-Telebras, 10.00%,
6/16/97 1,500,000 1,496,250
Telecomunicacoes Brasileiras
S.A.-Telebras, 10.375%, 9/9/97 3,000,000 3,018,750
Total Brazil 6,505,000
CANADA (1.2%)
Conglomerates (1.2%)
Brascan Ltd., 7.00%, 10/15/02 2,318,000 1,797,971
INDONESIA (1.3%)
Banking (1.3%)
Indah Kiat International Finance Co. BV, 11.375%,
6/15/99 2,000,000 2,010,000
MEXICO (0.2%)
<PAGE>
Foods & Beverages (0.2%)
Fomento Economico Mexico, 9.50%, 7/22/97 400,000 402,000
PAR MARKET
VALUE VALUE
United States Government Issues (9.3%)
U.S. Treasury Notes, 5.875%, 5/31/96 $10,000,000 $ 9,912,500
U.S. Treasury Notes, 6.00%, 6/30/96 4,500,000 4,465,530
Total United States 14,378,030
VENEZUELA (1.3%)
Foreign Government (1.3%)
Republic of Venezuela, 6.75%, 3/31/20 4,000,000 1,975,000
TOTAL FIXED INCOME
(Cost--$29,486,422) 28,830,501
MATURITY MARKET
VALUE VALUE
SHORT-TERM INVESTMENTS (7.8%)
CERTIFICATE OF DEPOSIT (0.0%)
State Street Bank & Trust Co., 3.25%, 10/31/94
(Cost--$11,700) $ 11,700 $ 11,700
REPURCHASE AGREEMENTS (7.8%)
HSBC Securities, Inc., 4.80%, purchased 9/30/94, maturing 10/3/94
(Collateralized by $12,270,000 U.S.
Treasury Notes, 5.50%, due 4/30/96)
(Cost--$12,110,000) 12,114,844 12,110,000
TOTAL SHORT-TERM INVESTMENTS
(Cost--$12,121,700) 12,121,700
TOTAL INVESTMENTS
(Cost--$138,005,056) (b) 155,975,070
OTHER ASSETS AND
LIABILITIES--NET (-0.9%) (1,445,842)
NET ASSETS (100%) $154,529,228
</TABLE>
NOTES TO SCHEDULE OF INVESTMENTS:
(a) Securities that may be resold to "qualified institutional buyers" under Rule
144A of the Federal Securities Act of 1933. These securities have been
determined to be liquid under guidelines established by the Board of
Directors.
(b) The cost of investments for income tax purposes amounted to $138,261,792.
Gross unrealized appreciation and depreciation of investments, based on
identified tax cost at September 30, 1994 are as follows:
Gross unrealized appreciation $20,795,763
Gross unrealized depreciation (3,082,485)
Net unrealized appreciation $17,713,278
See Notes to Financial Statements.
<PAGE>
FINANCIAL HIGHLIGHTS
(For a share outstanding throughout the period)
<TABLE>
<CAPTION>
One Month
Ended Year Ended September 30,
10/31/94(f) 1994(f) 1993(f) 1992(f) 1991 1990 1989 1988 1987 1986 1985
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net asset value
beginning of
period $ 7.67 $ 7.08 $ 6.01 $ 5.91 $ 5.35 $ 7.51 $ 6.66 $ 9.53 $ 8.05 $ 5.35 $ 4.94
Income from
investment
operations
Investment
income--net 0 0 (0.03) (0.01) (0.01) (0.07) (0.14) 0.03 0 0.11 0.12
Net gains (losses)
on investments
and foreign
currency related
transactions 0.10 0.62 1.14 0.34 0.83 (1.74) 1.06 (1.60) 2.65 3.25 0.63
Commissions paid
on fund share
sales--net (a) 0 0 0 0 0 0 0 0 0 (0.07) (0.03)
Total from
investment
operations 0.10 0.62 1.11 0.33 0.82 (1.81) 0.92 (1.57) 2.65 3.29 0.72
Less distributions
Dividends from
investment
income--net 0 (0.02) 0 0 0 0 (0.07) (0.08) (0.06) (0.13) (0.11)
Distributions in
excess of
investment
income--net (b) 0 (0.01) (0.04) (0.23) (0.03) 0 0 0 0 0 0
Distributions from
realized gains on
investments and
foreign currency
related
transactions 0 0 0 0 (0.23) (0.35) 0 (1.22) (1.11) (0.46) (0.20)
Total
distributions 0 (0.03) (0.04) (0.23) (0.26) (0.35) (0.07) (1.30) (1.17) (0.59) (0.31)
Net asset value,
end of period $ 7.77 $ 7.67 $ 7.08 $ 6.01 $ 5.91 $ 5.35 $ 7.51 $ 6.66 $ 9.53 $ 8.05 $ 5.35
Total return (c) 1.30%(e) 8.75% 18.59% 5.78% 15.59% (25.12%) 13.55% (15.55%) 39.96% 67.76% 15.58%
Ratios/supplemental
data
Ratios to average
net assets:
Operating and
management
expenses 2.52%(d) 2.54% 2.94% 3.41% 3.14% 2.92% 2.65% 2.04% 2.17% 1.49% 1.70%
Investment
income--net (0.20%)(d) 0.01% (0.46%) (0.09%) (0.07%) (0.51%) (0.79%) 0.33% (0.04%) 1.53% 2.42%
Portfolio turnover
rate 2% 121% 68% 74% 85% 42% 42% 60% 61% 97% 73%
Net assets,
end of period
(thousands) $157,929 $154,529 $111,752 $64,135 $72,923 $73,768 $121,047 $115,712 $173,319 $89,895 $31,396
</TABLE>
(a) Prior to June 30, 1987, net commissions paid on new sales of shares under
the Fund's Rule 12b-1 Distribution plan had been treated for both financial
statement and tax purposes as capital charges. On June 11, 1987, the Securities
and Exchange Commission adopted a Rule which required for financial statements
for periods ended on or after June 30, 1987, that net commissions paid under
Rule 12b-1 Distribution Plans be treated as operating expenses rather than
capital charges. Accordingly, beginning with the fiscal year ended September 30,
1987, the Fund's financial statements reflect 12b-1 Distribution Plan expenses
(i.e., shareholder service fees plus commissions paid net of deferred sales
charges received by the Fund) as a component of net investment income.
(b) Effective October 1, 1993 the Fund adopted Statement of Position 93-2:
Determination, Disclosure and Financial Statement Presentation of Income,
Capital Gain and Return of Capital Distributions by Investment Companies. As a
result, distribution amounts exceeding book basis net investment income (or tax
basis net income on a temporary basis) are presented as "Distributions in excess
of investment income--net". Similarly, capital gain distributions in excess of
book basis capital gains (or tax basis capital gains on a temporary basis) are
presented as "Distributions in excess of realized capital gains". Prior to the
adoption of this Statement of Position, distribution amounts exceeding book
basis investment income--net were presented as "distributions from paid-in
capital."
(c) Excluding contingent deferred sales charges (CDSC).
(d) Annualized.
(e) Total return indicated is not annualized.
(f) Calculation based on average shares outstanding.
<PAGE>
STATEMENTS OF ASSETS AND LIABILITIES
<TABLE>
<CAPTION>
October 31, September 30,
1994 1994
<S> <C> <C>
Assets:
Investments at market value (identified cost--$135,475,794 and
$138,005,056, respectively) (Note 1) $156,486,495 $155,975,070
Foreign currency holdings (identified cost--$1,000,000) (Note 1) 1,002,488 0
Total investments and foreign currency holdings 157,488,983 155,975,070
Cash 1,832 896
Receivable for:
Investments sold 586,650 30,222
Fund shares sold 128,760 134,863
Interest and dividends 882,332 1,025,030
Refundable foreign tax withheld 95,644 98,790
Forward foreign currency exchange contracts (Notes 1 and 5) 20,796,200 20,796,200
Prepaid expenses 13,253 15,016
Total assets 179,993,654 178,076,087
Liabilities:
Payable for:
Investments purchased 0 1,913,723
Fund shares redeemed 84,065 91,686
Forward foreign currency exchange contracts (Notes 1 and 5) 21,837,424 21,316,533
Foreign tax withholding 22,918 47,983
Accrued reimbursable expenses (Note 4) 1,444 4,171
Other accrued expenses 119,220 172,763
Total liabilities 22,065,071 23,546,859
Net assets $157,928,583 $154,529,228
Net assets represented by (Notes 1, 2 and 5):
Paid-in capital $122,538,097 $126,434,637
Undistributed investment income--net (accumulated distributions in
excess of investment income--net) 1,266,496 (3,808,221)
Accumulated realized gains on investment and foreign currency
related transactions--net 14,147,979 14,454,637
Net unrealized appreciation (depreciation) on:
Investments and foreign currency holdings 21,013,189 17,970,014
Foreign currency related transactions (1,037,178) (521,839)
Total net assets applicable to outstanding shares of beneficial interest (at
10/31/94, $7.77 a share on 20,320,147 shares outstanding and at 9/30/94,
$7.67 a share on 20,159,590 shares
outstanding) (Note 2) $157,928,583 $154,529,228
</TABLE>
See Notes to Financial Statements.
<PAGE>
Keystone International Fund, Inc.
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
One Month Year
Ended Ended
10/31/94 9/30/94
<S> <C> <C>
Investment income (Note 1):
Dividends (net of foreign withholding taxes of
$7,159 and $268,047, respectively) $ 63,457 $ 1,762,760
Interest (net of foreign withholding taxes of $0
and $1,371, respectively) 241,521 1,959,054
Total income 304,978 3,721,814
Expenses (Notes 2 and 4):
Management fee 98,556 1,094,303
Transfer agent fees 57,040 667,589
Accounting, auditing and legal 4,929 62,315
Custodian fees--foreign 13,950 200,721
Custodian fees--domestic 9,052 99,318
Distribution Plan expenses 112,726 1,452,632
Registration fees 3,844 47,159
Miscellaneous expenses 31,460 88,176
Total expenses 331,557 3,712,213
Investment income (loss)--net (26,579) 9,601
Realized and unrealized gain (loss) on
investments and foreign currency related
transactions (Notes 1, 3, and 5):
Realized gain (loss) on:
Investments and foreign currency holdings--net (306,658) 15,414,366
Foreign currency related transactions (19,297) (4,041,040)
Realized gain (loss) on investments and foreign
currency related transactions--net (325,955) 11,373,326
Net change in unrealized appreciation
(depreciation) on:
Investments and foreign currency holdings 3,043,175 (2,044,618)
Foreign currency related transactions (515,339) (207,812)
Net change in unrealized appreciation or
depreciation 2,527,836 (2,252,430)
Net gain on investments and foreign currency
related transactions 2,201,881 9,120,896
Net increase in net assets resulting from
operations $2,175,302 $ 9,130,497
</TABLE>
See Notes to Financial Statements.
<PAGE>
STATEMENTS OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
One Month
Ended Year Ended Year Ended
10/31/94 9/30/94 9/30/93
<S> <C> <C> <C>
Operations:
Investment income (loss)--net (Note 1) $ (26,579) $ 9,601 $ (356,833)
Realized gain (loss) on investments and foreign
currency related transactions--net (Notes 1 and 3) (325,955) 11,373,326 955,676
Net change in unrealized appreciation or depreciation 2,527,836 (2,252,430) 12,881,104
Net increase in net assets resulting from
operations 2,175,302 9,130,497 13,479,947
Distributions to shareholders from (Note 1):
Investment income--net 0 (385,197) 0
In excess of investment income--net 0 (214,920) (431,822)
Total distributions to shareholders 0 (600,117) (431,822)
Capital share transactions (Note 2):
Proceeds from shares sold 11,958,676 146,821,752 71,255,741
Payments for shares redeemed (10,734,623) (113,073,728) (37,059,530)
Net asset value of shares issued in reinvestment of
distributions from investment income--net and in
excess of investment income--net 0 499,199 372,504
Net increase in net assets resulting from capital
share transactions 1,224,053 34,247,223 34,568,715
Total increase in net assets 3,399,355 42,777,603 47,616,840
Net assets:
Beginning of period 154,529,228 111,751,625 64,134,785
End of period [including undistributed investment
income--net (accumulated distributions in excess of
investment income--net) as follows:
October 31, 1994--$1,266,496
September 30, 1994--($3,808,221)
September 30, 1993--($174,657)] (Note 1) $157,928,583 $ 154,529,228 $111,751,625
</TABLE>
See Notes to Financial Statements.
<PAGE>
NOTES TO FINANCIAL STATEMENTS
(1.) Significant Accounting Policies
Keystone International Fund Inc. (the "Fund") is a Massachusetts corporation
for which Keystone Management, Inc. ("KMI") is the Investment Manager and
Keystone Custodian Funds, Inc. ("Keystone") is the Investment Adviser. The
Fund is registered under the Investment Company Act of 1940 as a diversified,
open-end investment company.
Keystone International Fund Inc. Keystone is a wholly-owned subsidiary of
Keystone Group, Inc. ("KGI"), a Delaware corporation. KGI is privately owned by
an investor group consisting of members of current and former management of
Keystone. Keystone Investor Resource Center, Inc. ("KIRC"), a wholly-owned
subsidiary of Keystone, is the Fund's transfer agent.
The following is a summary of significant accounting policies consistently
followed by the Fund in the preparation of its financial statements. The
policies are in conformity with generally accepted accounting principles. A.
Investments, including American Depository Receipts ("ADRs"), are usually valued
at the closing sales price or, in the absence of sales and for over-the-counter
securities, the mean of bid and asked quotations. Management values the
following securities at prices it deems in good faith to be fair: (a) securities
(including restricted securities) for which complete quotations are not readily
available and (b) listed securities if, in the opinion of management, the last
sales price does not reflect a current value or if no sale occurred. ADRs, which
are certificates representing shares of foreign securities deposited in domestic
and foreign banks, are traded and valued in United States dollars. Those
securities traded in foreign currency amounts are translated into United States
dollars as follows: market value of investments, assets, and liabilities at the
daily rate of exchange; and purchases and sales of investments, income, and
expenses
<PAGE>
at the rate of exchange prevailing on the respective dates of such
transactions.
Short-term investments maturing in sixty days or less are valued at amortized
cost (original purchase cost as adjusted for amortization of premium or
accretion of discount) which, when combined with accrued interest approximates
market. Short-term investments maturing in more than sixty days for which market
quotations are readily available are valued at current market value. Short-term
investments maturing in more than sixty days when purchased which are held on
the sixtieth day prior to maturity are valued at amortized cost (market value on
the sixtieth day adjusted for amortization of premium or accretion of discount)
which, when combined with accrued interest, approximates market. Investments
denominated in a foreign currency are adjusted daily to reflect changes in
exchange rates. B. A futures contract is an agreement between two parties to buy
and sell a specific amount of a commodity, security, financial instrument, or,
in the case of a stock index, cash at a set price on a future date. Upon
entering into a futures contract the Fund is required to deposit with a broker
an amount ("initial margin") equal to a certain percentage of the purchase price
indicated in the futures contract. Subsequent payments ("variation margin") are
made or received by the Fund each day, as the value of the underlying instrument
or index fluctuates, and are recorded for book purposes as unrealized gains or
losses by the Fund. For federal tax purposes, any futures contracts which remain
open at fiscal year-end are marked-to-market and the resultant net gain or loss
is included in federal taxable income. In addition to market risk, the Fund is
subject to the credit risk that the other party will not complete the
obligations of the contract. C. Securities transactions are accounted for on the
trade date. Realized gains and losses are recorded on
<PAGE>
the identified cost basis. Interest income is recorded on the accrual
basis and dividend income is recorded on the ex-dividend date. Distributions to
shareholders are recorded on the ex-dividend date. D. The Fund has qualified,
and intends to qualify in the future, as a regulated investment company under
the Internal Revenue Code of 1986, as amended ("Internal Revenue Code"). Thus,
the Fund expects to be relieved of any federal income tax liability by
distributing all of its net taxable investment income and net taxable capital
gains, if any, to its shareholders. The Fund intends to avoid excise tax
liability by making the required distributions under the Internal Revenue Code.
E. When the Fund enters into a repurchase agreement (a purchase of securities
whereby the seller agrees to repurchase the securities at a mutually agreed upon
date and price) the repurchase price of the securities will generally equal the
amount paid by the Fund plus a negotiated interest amount. The seller under the
repurchase agreement will be required to provide securities ("collateral") to
the Fund whose value will be maintained at an amount not less than the
repurchase price, and which generally will be maintained at 101% of the
repurchase price. The Fund monitors the value of collateral on a daily basis,
and if the value of the collateral falls below required levels, the Fund intends
to seek additional collateral from the seller or terminate the repurchase
agreement. If the seller defaults, the Fund would suffer a loss to the extent
that the proceeds from the sale of the underlying securities were less than the
repurchase price. Any such loss would be increased by any cost incurred on
disposing of such securities. If bankruptcy proceedings are commenced against
the seller under the repurchase agreement, the realization on the collateral may
be delayed or limited. Repurchase agreements entered into by the Fund will be
limited to transactions with dealers or domestic banks believed to present
minimal credit risks, and the Fund will take constructive receipt of all
securities underlying repurchase agreements until such agreements expire. F. In
connection with portfolio purchases and sales of securities denominated in a
foreign currency, the Fund may enter into forward foreign currency exchange
contracts ("contracts"). Additionally, from time to time the Fund may enter into
contracts to hedge certain foreign currency assets. Contracts are recorded at
market value and marked-to-market daily. Realized gains and losses arising from
such transactions are included in net realized gain (loss) on foreign currency
related transactions. In addition to market risk, the Fund is subject to the
credit risk that the other party will not complete the obligations of the
contract. G. The Fund distributes net investment income and net capital gains,
if any, to shareholders annually. Distributions are determined in accordance
with income tax regulations. Distributions from taxable net investment income
and net capital gains can exceed book basis net investment income and net
capital gains. Effective October 1, 1993, the Fund adopted Statement of Position
93-2: Determination, Disclosure, and Financial Statement Presentation of Income,
Capital Gain and Return of Capital Distributions by Investment Companies. As a
result of this statement, the Fund changed the classification of distributions
to shareholders to better disclose the differences between financial statement
amounts and distributions determined in accordance with income tax regulations.
Accordingly, the following reclassifications were made as of September 30, 1993:
a decrease in paid-in capital of $37,415,807 and increases in undistributed
investment income--net and accumulated realized gains on investment and foreign
currency related transactions--net of $819,323 and $36,596,484, respectively.
Differences between book basis investment income--net available for distribution
and tax basis investment income--net
<PAGE>
available for distribution are primarily attributable to differences in the
treatment of 12b-1 Distribution Plan charges and foreign currency gains and
losses.
Keystone International Fund Inc.
(2.) Capital Share Transactions
One hundred million shares of the Fund with a par value of $1.00 are authorized
for issuance. Transactions in shares of the Fund were as follows:
One Month Year Year
Ended Ended Ended
10/31/94 9/30/94 9/30/93
Shares sold 1,555,441 18,905,283 10,751,496
Shares redeemed (1,394,884) (14,595,196) (5,701,552)
Shares issued in
reinvestment of
distributions from
investment income--
net and distributions
in excess of
investment
income--net 0 64,579 62,501
Net increase 160,557 4,374,666 5,112,445
The Fund bears some of the costs of selling its shares under a Distribution Plan
adopted pursuant to Rule 12b-1 under the Investment Company Act of 1940. Under
the Distribution Plan, the Fund pays Keystone Distributors, Inc. ("KDI"), the
principal underwriter and a wholly-owned subsidiary of Keystone, amounts which
in total may not exceed the Distribution Plan maximum.
In connection with the Distribution Plan and subject to the limitations
discussed below, Fund shares are offered for sale at net asset value without any
initial sales charge. From the amounts received by KDI in connection with the
Distribution Plan, and subject to the limitations discussed below, KDI generally
pays brokers or others a commission equal to 4% of the price paid to the Fund
for each sale of Fund shares as well as a shareholder service fee at a rate of
0.25% per annum of the net asset value of shares sold by such brokers or others
and remaining outstanding on the books of the Fund for specified periods.
To the extent Fund shares purchased prior to July 8, 1992 are redeemed within
four calendar years of original issuance, the Fund may be eligible to receive a
deferred sales charge from the investor as partial reimbursement for sales
commissions previously paid on those shares. This charge is based on declining
rates, which begin at 4.0%, applied to the lesser of the net asset value of
shares redeemed or the total cost of such shares.
Since July 8, 1992, contingent deferred sales charges applicable to shares of
the Fund issued after January 1, 1992 have, to the extent permitted by the NASD
Rule, been paid to KDI rather than to the Fund.
The Distribution Plan provides that the Fund may incur certain expenses which
may not exceed a maximum amount equal to 0.3125% of the Fund's average daily net
assets for any calendar quarter (approximately 1.25% annually) occurring after
the inception of the Distribution Plan. A rule of the National Association of
Securities
<PAGE>
Dealers, Inc. ("NASD Rule") limits the annual expenditures which the Fund may
incur under the Distribution Plan to 1%, of which 0.75% may be used to pay such
distribution expenses and 0.25% may be used to pay shareholder service fees. The
NASD Rule also limits the aggregate amount which the Fund may pay for such
distribution costs to 6.25% of gross share sales since the inception of the
Fund's 12b-1 Distribution Plan, plus interest at the prime rate plus 1% on
unpaid amounts thereof (less any contingent deferred sales charges paid by the
shareholders to KDI).
The Fund has operated its Distribution Plan in accordance with both the Plan and
the NASD Rule since July 8, 1992, except that until July 7, 1993, maximum annual
payments with respect to Net Asset Value as represented by shares sold prior to
January 1, 1992 remained at the then current rate of 0.3125% quarterly
(approximately 1.25% annually).
KDI intends, but is not obligated, to continue to pay or accrue distribution
charges which exceed current annual payments permitted to be received by KDI
from the Fund. KDI intends to seek full payment of such charges from the Fund
(together with annual interest thereon at the prime rate plus 1%) at such time
in the future as, and to the extent that, payment thereof by the Fund would be
within permitted limits. KDI currently intends to seek payment of interest only
on such charges paid or accrued by KDI since January 1, 1992.
During the one-month period ended October 31, 1994 and the year ended September
30, 1994, the Fund recovered $801 and $7,861, respectively, in deferred sales
charges. During the one-month period and the fiscal year, the Fund paid KDI
$113,527 and $1,460,493, respectively, under the Distribution Plan. The amount
paid by the Fund under its Distribution Plan, net of contingent deferred sales
charges, was $112,726 and $1,452,632 (0.07% and 1.00%, respectively, of the
Fund's average daily net asset value during the one-month period and fiscal
year). During the one-month period ended October 31, 1994 and the fiscal year
ended September 30, 1994, KDI received $36,343 and $0, respectively, after
payments of commissions on new sales and service fees to dealers and others of
$77,184 and $1,709,228, respectively. During the one-month period and fiscal
year, KDI also received $22,063 and $183,020 respectively, in contingent
deferred sales charges. At October 31, 1994 and September 30, 1994, KDI's total
unreimbursed Distribution expenses amounted to $2,213,911 and $2,258,471,
respectively (1.40% and 1.46% of the Fund's net asset value as of October 31,
1994 and September 30, 1994, respectively). The right to certain portions of
this amount, if and when receivable, was assigned by KDI in 1988 in connection
with a financial transaction. As of October 31, 1994 and September 30, 1994,
$51,270 and $92,780, respectively, of the amount assigned remained outstanding.
(3.) Securities Transactions
As of October 31, 1994 the Fund had a capital loss carryover for federal income
tax purposes of approximately $307,000 which will expire in the year 2002. For
the one-month period ended October 31, 1994, purchases and sales of investment
securities were as follows:
<PAGE>
Cost of Proceeds
Purchases from Sales
Portfolio securities $ 8,595,384 $ 3,092,558
Short-term investments 100,796,000 108,534,700
$109,391,384 $111,627,258
For the year ended September 30, 1994, purchases and sales of investment
securities were as follows:
Cost of Proceeds
Purchases from Sales
Portfolio securities $ 179,390,109 $ 149,245,358
Short-term investments 4,158,015,013 4,157,769,932
$4,337,405,122 $4,307,015,290
(4.) Investment Management and Transactions with Affiliates
Under the terms of the Investment Management Agreement between KMI and the Fund,
dated December 29, 1989, KMI provides investment management and administrative
services to the Fund. In return, KMI is paid a management fee computed and paid
daily. The management fee is calculated by applying percentage rates, which
start at 0.75% and decline, as net assets increase, to 0.45% per annum, to the
net asset value of the Fund. KMI has entered into an Investment Advisory
Agreement with Keystone, dated December 30, 1989, under which Keystone provides
investment advisory and management services to the Fund and receives for its
services an annual fee representing 85% of the management fee received by KMI.
Keystone International Fund Inc. During the one-month period ended October 31,
1994 and the year ended September 30, 1994, the Fund paid or accrued to KMI
investment management and administrative services fees of $98,556 and
$1,094,303, respectively, which represented 0.75% of the Fund's average net
assets on an annualized basis. Of such amounts paid to KMI, $83,773 and
$930,158, respectively, were paid to Keystone for its investment advisory
services to the Fund.
During the one-month ended October 31, 1994 and the year ended September 30,
1994, the Fund paid or accrued to KIRC and KGI $2,108 and $24,705,
respectively, for certain accounting and printing services and to KIRC
$57,040 and $667,589 for transfer agent fees.
(5.) Forward Foreign Currency Exchange Contracts
At October 31, 1994, the Fund had entered into the following currency exchange
contracts that obligate the Fund to deliver currencies at specified future
dates. The unrealized depreciation of $1,041,224 on these contracts is included
in the accompanying financial statements. The terms of the open contracts are as
follows:
<TABLE>
<CAPTION>
Exchange Currency to U.S. $ value Currency to U.S. $ value
date be delivered as of 10/31/94 be received as of 10/31/94
<S> <C> <C> <C> <C>
11/10/94 80,839,340 645,007 617,000 617,000
Spanish Peseta U.S. $
11/10/94 1,265,958,000 823,027 795,000 795,000
Italian Lira U.S. $
11/10/94 1,614,720,000 16,679,969 16,000,000 16,000,000
Japanese Yen U.S. $
11/22/94 26,586,275 3,689,421 3,384,200 3,384,200
Spanish Krona U.S. $
$21,837,424 $20,796,200
</TABLE>
At September 30, 1994, the Fund had entered into the following currency exchange
contracts that obligate the Fund to deliver currencies at specified future
dates. The unrealized depreciation of $520,333 on these contracts is included in
the accompanying financial statements. The terms of the open contracts are as
follows:
<TABLE>
<CAPTION>
Exchange Currency to U.S. $ value Currency to U.S. $ value
date be delivered as of 9/30/94 be received as of 9/30/94
<S> <C> <C> <C> <C>
11/10/94 80,839,340 626,877 617,000 617,000
Spanish Peseta U.S. $
11/10/94 1,265,958,000 808,866 795,000 795,000
Italian Lira U.S. $
11/10/94 1,614,720,000 16,341,743 16,000,000 16,000,000
Japanese Yen U.S. $
11/22/94 26,586,275 3,539,047 3,384,200 3,384,200
Spanish Krona U.S. $
$21,316,533 $20,796,200
</TABLE>
(6.) Distributions to Shareholders
A distribution of net investment income of $0.035 per share and a distribution
of long-term capital gains of $0.74 per share were declared payable by December
6, 1994 to shareholders of record November 21, 1994. These distributions are not
reflected in the accompanying financial statements.
Federal Tax Status--Fiscal 1994
Distributions (Unaudited)
For the fiscal year ended September 30, 1994 a dividend of $.03 per share was
paid. This dividend is taxable to shareholders as ordinary income and 2% is
eligible for the corporate dividend received deduction.
In January 1995 we will send you complete information on the distributions paid
during the calendar year to help you in completing your federal tax return.
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Directors and Shareholders of
Keystone International Fund Inc.
We have audited the accompanying statements of assets and liabilities of
Keystone International Fund Inc., including the schedules of investments, as of
September 30, 1994 and October 31, 1994, and the related statements of
operations for the year ended September 30, 1994 and the one-month period ended
October 31, 1994, the statements of changes in net assets for each of the years
in the two-year period ended September 30, 1994 and the one- month period ended
October 31, 1994, and the financial highlights for each of the years in the
ten-year period ended September 30, 1994 and the one-month period ended October
31, 1994. These financial statements and financial highlights are the
responsibility of the Fund's management. Our responsibility is to express an
opinion on these financial statements and financial highlights based on our
audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned as of
September 30, 1994 and October 31, 1994, by correspondence with the custodian
and brokers. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of
Keystone International Fund Inc. as of September 30, 1994 and October 31, 1994,
the results of its operations for the year ended September 30, 1994 and the
one-month period ended October 31, 1994, the changes in its net assets for each
of the years in the two-year period September 30, 1994 and the one-month period
ended October 31, 1994, and the financial highlights for each of the periods
specified in the first paragraph above in conformity with generally accepted
accounting principles.
KPMG PEAT MARWICK LLP
Boston, Massachusetts
December 2, 1994
