<PAGE>
- ------------------------------------------------------------------------------
PROSPECTUS JANUARY 24, 1996
AS SUPPLEMENTED OCTOBER 30, 1996
- ------------------------------------------------------------------------------
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.
In pursuing its investment objectives, the Fund invests primarily in equity
securities issued by well- established, quality companies located in countries
with developed markets. The Fund may, however, invest a portion of its assets in
equity securities of companies located in certain emerging market countries.
Under normal circumstances, the Fund invests at least 65% of its total assets in
the securities of companies in at least three different countries (other than
the United States). While the Fund focuses on equity securities, it may invest a
portion of its assets in debt securities issued by public or private 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 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 January 24, 1996, as supplemented October 30, 1996,
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.
<TABLE>
- --------------------------------------------------------------------------------------------------------------
TABLE OF CONTENTS
- --------------------------------------------------------------------------------------------------------------
<CAPTION>
Page Page
<S> <C> <C> <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 ........................... 16
Investment Restrictions ............................ 5 Performance Data ............................... 18
Risk Factors ....................................... 6 Fund Shares .................................... 18
Pricing Shares ..................................... 8 Additional Information ......................... 18
Dividends and Taxes ................................ 9 Additional Investment Information ............. (i)
Fund Management and Expenses ....................... 9
</TABLE>
- --------------------------------------------------------------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
- --------------------------------------------------------------------------------
<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"; "How to Buy Shares"; "Distribution Plan"; and "Shareholder
Services."
SHAREHOLDER TRANSACTION EXPENSES
Deferred Sales Load(1) ............................... 4.00%
(as a percentage of the lesser of original purchase
price or redemption proceeds, as applicable)
Exchange Fee(2) ...................................... $10.00
(per exchange)
ANNUAL FUND OPERATING EXPENSES(3)
(as a percentage of average net assets)
Management Fee ....................................... 0.75%
12b-1 Fees(4) ........................................ 1.00%
Other Expenses ....................................... 0.82%
----
Total Fund Operating Expenses ........................ 2.57%
====
<TABLE>
<CAPTION>
1 YEAR 3 YEARS 5 YEARS 10 YEARS
------ ------- ------- --------
<S> <C> <C> <C> <C>
EXAMPLE(5)
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 $100 $137 $290
You would pay the following expenses on the same investment,
assuming no redemption ........................................ $26 $ 80 $137 $290
</TABLE>
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 load 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 are for the Fund's fiscal year ended 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 year)
The following table contains important financial information relating 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 independent auditors' report, in the Fund's Annual
Report. The Fund's financial statements, related notes, and independent
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 ENDED
OCTOBER OCTOBER YEAR ENDED SEPTEMBER 30,
31, 31, -----------------------------------------------------------------------------------
1995 1994(E) 1994(E) 1993(E) 1992(E) 1991 1990 1989 1988 1987 1986
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
NET ASSET VALUE
BEGINNING OF PERIOD $ 7.77 $ 7.67 $ 7.08 $ 6.01 $ 5.91 $ 5.35 $ 7.51 $ 6.66 $ 9.53 $ 8.05 $ 5.35
------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Income from investment
operations:
Net investment income .. 0.07 0 0 (0.03) (0.01) (0.01) (0.07) (0.14) 0.03 0 0.11
Net gains (losses) on
investments and foreign
currency related
transactions .......... 0.05 0.10 0.62 1.14 0.34 0.83 (1.74) 1.06 (1.60) 2.65 3.25
Net commissions paid on
fund share sales (a)... 0 0 0 0 0 0 0 0 0 0 (0.07)
------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Total from investment
operations ............ 0.12 0.10 0.62 1.11 0.33 0.82 (1.81) 0.92 (1.57) 2.65 3.29
------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Less distributions from:
Net investment income... (0.04) 0 (0.02) 0 0 0 0 (0.07) (0.08) (0.06) (0.13)
In excess of net
investment income...... 0 0 (0.01) (0.04) (0.23) (0.03) 0 0 0 0 0
Net realized gains on
investments and foreign
currency related
transactions........... (0.74) 0 0 0 0 (0.23) (0.35) 0 (1.22) (1.11) (0.46)
------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Total distributions..... (0.78) 0 (0.03) (0.04) (0.23) (0.26) (0.35) (0.07) (1.30) (1.17) (0.59)
------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ------
NET ASSET VALUE END OF
PERIOD $ 7.11 $ 7.77 $ 7.67 $ 7.08 $ 6.01 $ 5.91 $ 5.35 $ 7.51 $ 6.66 $ 9.53 $ 8.05
====== ====== ====== ====== ====== ====== ====== ====== ====== ====== ======
TOTAL RETURN (C)........ 2.19% 1.30% 8.75% 18.59% 5.78% 15.59% (25.12%) 13.55% (15.55%) 39.96% 67.76%
RATIOS/SUPPLEMENTAL DATA
Ratios to average net assets:
Total expenses ....... 2.57%(b) 2.52%(d) 2.54% 2.94% 3.41% 3.14% 2.92% 2.65% 2.04% 2.17% 1.49%
Net investment income 0.88% (0.20%)(d) 0.01% (0.46%) (0.09%) (0.07%) (0.51%) (0.79%) 0.33% (0.04%) 1.53%
Portfolio turnover rate. 76% 2% 121% 68% 74% 85% 42% 42% 60% 61% 97%
Net assets end of period
(thousands)............. $128,674 $157,929 $154,529 $111,752 $64,135 $72,923 $73,768 $121,047 $115,712 $173,319 $89,895
(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 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.
(b) "Ratio of total expenses to average net assets" for the year ended October 31, 1995 includes indirectly paid expenses.
Excluding indirectly paid expenses for the year ended October 31, 1995, the expense ratio would have been 2.56%.
(c) Excluding contingent deferred sales charges (CDSC).
(d) Annualized.
(e) Calculation based on average shares outstanding.
</TABLE>
<PAGE>
- ------------------------------------------------------------------------------
FUND DESCRIPTION
- ------------------------------------------------------------------------------
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 approximately
twenty funds managed by Keystone Management, Inc. ("Keystone Management"), the
Fund's investment manager, and is one of more than thirty funds managed or
advised by Keystone Investment Management Company ("Keystone"), the Fund's
investment adviser. Keystone and Keystone Management are, from time to time,
collectively referred to as "Keystone."
- ------------------------------------------------------------------------------
FUND OBJECTIVES AND POLICIES
- ------------------------------------------------------------------------------
The Fund's primary objective is long-term growth of capital. As a secondary
objective, the Fund seeks modest income from its investments.
The Fund's objectives are fundamental and cannot be changed without the
approval of a majority of the Fund's outstanding shares (as defined in the
1940 Act, which means the lesser of (1) 67% of the shares represented at a
meeting at which more than 50% of the outstanding shares are represented or
(2) more than 50% of the outstanding shares).
Any investment involves risk, and there is no assurance that the Fund will
achieve its investment objectives.
PRINCIPAL INVESTMENTS
In pursuing its investment objectives, the Fund invests primarily in equity
securities issued by well-established, quality companies located in countries
with developed markets. The Fund may invest a portion of its assets in equity
securities of companies located in certain emerging market countries 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 (the World Bank).
Under normal circumstances, the Fund invests at least 65% of its total
assets in the securities of companies in at least three different countries
(other than the United States ("U.S.")). For this purpose, a company is deemed
to be in a particular country if (i) it is organized under the laws of that
country; (ii) its principal securities trading market is in that country;
(iii) it derives at least 50% of its revenues or profits from goods produced
or sold, investments made, or services performed in that country; or (iv) it
has at least 50% of its assets located in that country.
Excluding repurchase agreements, the Fund currently follows a policy of
investing solely in securities of non-U.S. issuers.
OTHER ELIGIBLE INVESTMENTS
While the Fund focuses on equity securities, it may invest a portion of its
assets in debt securities issued by public or private issuers with any rating
or that are unrated; provided, however, that the Fund may only invest up to
10% of its total assets in debt securities rated below investment grade; i.e.,
BB or lower by Standard & Poor's Corporation ("S&P") or Ba or lower by Moody's
Investor's Service ("Moody's").
The Fund may also invest in payment-in-kind ("PIK") securities issued by
public or private issuers, as well as preferred stocks, convertible
securities, and rights and warrants to purchase common stocks, when Keystone
determines that such investment is consistent with the Fund's investment
objectives.
When market conditions warrant, the Fund may invest up to 100% of its assets
for temporary or defensive purposes in money market instruments. Such money
market instruments, which must mature within one year of their purchase,
consist of the following: (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 given 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. When the Fund invests for
defensive purposes, its seeks to limit the loss of principal and is not
pursuing its investment objectives.
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
which 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 the
investment on its books and (2) limiting its holdings of such securities to
15% of net assets.
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 Keystone determines the
liquidity of the Fund's Rule 144A securities. The Board 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.
The Fund may enter into repurchase and reverse repurchase agreements, lend
portfolio securities, purchase and sell securities and currencies on a when
issued and delayed delivery basis and purchase or sell securities on a forward
commitment basis, write covered call and put options, and purchase call and
put options to close out existing positions. The Fund may also enter into
currency and other financial futures contracts and related options
transactions for hedging purposes and not for speculation. The Fund may also
employ new investment techniques with respect to options or financial futures
contracts and related options.
For further information about the types of investments and investment
techniques available to the Fund, including the associated risks, see the
"Risk Factors" and "Additional Investment Information" sections of this
prospectus and the statement of additional information.
- ------------------------------------------------------------------------------
INVESTMENT RESTRICTIONS
- ------------------------------------------------------------------------------
The Fund has adopted the fundamental restrictions summarized below, which
may not be changed without the approval of a majority (as defined in the 1940
Act) of the Fund's outstanding shares. These restrictions and certain other
fundamental and nonfundamental restrictions are set forth in the statement of
additional information.
The Fund may not do the following: (1) generally, invest more than 5% of its
total assets, computed at market value at the time of purchase, in the
securities of any one issuer; and (2) borrow money, except from banks and/or
enter into reverse repurchase agreements for emergency or extraordinary
purposes in aggregate amounts up to 10% of the Fund's gross assets, provided
that no additional investments shall be made at any time that outstanding
borrowings (including amounts payable under reverse repurchase agreements)
exceed 5% of the Fund's gross assets.
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.
- ------------------------------------------------------------------------------
RISK FACTORS
- ------------------------------------------------------------------------------
Like any investment, your investment in the Fund involves some degree of
risk. Before you buy shares of the Fund, you should carefully evaluate your
ability to assume the risks your investment in the Fund poses. YOU CAN LOSE
MONEY BY INVESTING IN THE FUND. YOUR INVESTMENT IS NOT GUARANTEED. A DECREASE
IN THE VALUE OF THE FUND'S PORTFOLIO SECURITIES CAN RESULT IN A DECREASE IN
THE VALUE OF YOUR INVESTMENT.
The Fund seeks to provide long-term growth of capital and modest income
through an internationally varied portfolio of investments.
The Fund is best suited for investors who can afford to maintain their
investment over a relatively long period of time, and who are seeking a fund
that is growth oriented and has the potential for returns. The Fund involves
risk and is not an appropriate investment for conservative investors who are
seeking preservation of capital and/or income.
Certain risks related to the Fund are discussed below. To the extent not
discussed in this section, specific risks attendant to individual securities or
investment practices are discussed in "Additional Investment Information."
FUND RISKS. Investing in the Fund involves the risk common to investing in
any security, that is that the value of the securities held by the Fund will
fluctuate in response to changes in economic conditions or public expectations
about those securities. The net asset value of the Fund's shares will change
accordingly.
FOREIGN RISK. Investing in securities of foreign issuers generally involves
more risk than investing in securities of domestic issuers for the following
reasons: (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 much less liquid and much more volatile than the
securities of comparable U.S. companies; (4) foreign securities transactions
may involve higher brokerage commissions; (5) there may be less government
regulation of stock markets, brokers, listed companies, and banks in foreign
countries than in the U.S.; (6) the Fund may incur fees on currency exchanges
when it changes investments from one country to another; (7) the Fund's
foreign investments could be affected by expropriation, confiscatory taxation,
nationalization, establishment of currency exchange controls, political or
social instability, or diplomatic developments; (8) fluctuations in foreign
exchange rates will affect the value of the Fund's investments, 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; and (9) interest and dividends on foreign securities may be
subject to withholding taxes in a foreign country that could result in a
reduction of net investment income available for distribution.
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. These risks are carefully considered by
Keystone prior to the purchase of these securities.
BELOW-INVESTMENT GRADE BONDS
The Fund currently has the authority to invest up to 10% of its assets in
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.
Investment in higher yielding, higher risk securities involves the following
risks:
(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.
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.
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.
*UNRATED
SECURITIES
OF COMPARABLE
RATED SECURITIES QUALITY AS
AS PERCENTAGE OF PERCENTAGE OF
RATING FUND'S ASSETS FUND'S ASSETS
- ------ ------------- -------------
AAA 1.73% 0.00%
AA- 0.00% 0.00%
A 0.00% 0.00%
BBB 0.00% 0.00%
BB+ 0.00% 0.00%
BB and below 3.96% 5.51%
CCC 0.00% 0.00%
CC and below 0.00% 0.00%
Unrated* 5.51%
Cash, equities and
others 88.80%
-----
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.
OTHER CONSIDERATIONS. The Fund does not, by itself, constitute a balanced
investment plan. The Fund may be appropriate as part of an overall investment
program. Investors may wish to consult their financial advisers when
considering what portion of their total assets to invest in international
securities.
Past performance should not be considered representative of results for any
future period of time.
- ------------------------------------------------------------------------------
PRICING SHARES
- ------------------------------------------------------------------------------
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:
(1) 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;
(2) Money market investments with maturities of more than sixty days for which
market quotations are readily available are valued at market value; and
(3) 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.
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.
- ------------------------------------------------------------------------------
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. If the Fund qualifies and if it distributes 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 net
capital gains, if any, at least annually.
Distributions are payable in shares of the Fund or, at the shareholder's
option (which must be exercised before the record date for the distribution),
in cash. Fund distributions in the form of additional shares are made at net
asset value without the imposition of a sales charge.
Dividends and distributions are taxable whether they are received in cash or
in shares. Income dividends and net short-term gains distributions are taxable
as ordinary income. Net long-term gains dividends are taxable as capital gains
regardless of how long the Fund's shares are held. If Fund shares held for
less than six months are sold at a loss, however, 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. Dividends and distributions may also be
subject to state and local taxes.
Any taxable dividend declared in October, November, or December to
shareholders of record in such a month, and paid by the following January 31,
will be includable in the taxable income of the shareholders as if paid on
December 31 of the year in which the dividend was declared.
The Fund advises its shareholders annually as to the federal tax status of
all distributions made during the year.
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.
- ------------------------------------------------------------------------------
FUND MANAGEMENT AND EXPENSES
- ------------------------------------------------------------------------------
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, 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. 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 funds in the
Keystone Fund Family and certain other funds in the Keystone Investments
Family of Funds.
Pursuant to its Investment Management Agreement with the Fund (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
with Keystone (the "Advisory Agreement") 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; and (3) providing services to the Fund's shareholders
in connection with federal and state taxation and distributions of income and
capital gains.
The Fund pays Keystone Management a fee for its services at the annual rate
set forth below:
AGGREGATE NET ASSET VALUE
MANAGEMENT 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.
computed as of the close of business each business day and payable daily.
INVESTMENT ADVISER
Keystone has provided investment advisory and management services to
investment companies and private accounts since 1932. Keystone is a wholly-
owned subsidiary of Keystone Investments, Inc. ("Keystone Investments"). Both
Keystone and Keystone Investments are located at 200 Berkeley Street, Boston,
Massachusetts 02116-5034.
Keystone Investments is a private corporation predominantly owned by current
and former members of management of Keystone and its affiliates. The shares of
Keystone Investments 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, Edward F. Godfrey, Ralph J. Spuehler, Jr., and Rosemary D. Van
Antwerp. Keystone Investments provides accounting, bookkeeping, legal,
personnel, and general corporate services to Keystone Management, Keystone,
their affiliates, and the Keystone Investments Family of Funds.
Pursuant to the Advisory Agreement, Keystone receives for its services an
annual fee equal to 85% of the management fee received by Keystone Management
under the Management Agreement with the Fund.
During the fiscal year ended October 31, 1995, the Fund paid or accrued to
Keystone Management investment management and administrative service fees of
$985,652, which represented 0.75% of the Fund's average daily net assets. Of
such amount paid to Keystone Management, $837,804 was paid to Keystone for its
services to the Fund. 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.
Keystone Investments has recently entered into an Agreement and Plan of
Acquisition and Merger with First Union Corporation ("First Union"), pursuant
to which Keystone Investments is to be merged with and into a wholly-owned
subsidiary of First Union National Bank of North Carolina ("FUNB-NC") (the
"Merger"). The surviving corporation will assume the name "Keystone
Investments, Inc." Subject to a number of conditions being met, it is
currently anticipated that the Merger will take place on or around December
11, 1996. Thereafter, Keystone Investments, Inc. would be a subsidiary of
FUNB-NC.
If consummated, the proposed Merger will be deemed to cause an assignment,
within the meaning of the 1940 Act, of the Advisory Agreement and the
Management Agreement. Consequently, the completion of the transaction is
contingent upon, among other things, the approval of the Fund's shareholders
of a new investment advisory and management agreement between the Fund and
Keystone (the "New Advisory Agreement"). The Fund's Trustees have approved the
terms of the New Advisory Agreement, subject to, among other things, the
approval of shareholders and the completion of the Merger, and have called a
special meeting of shareholders to obtain their approval of the New Advisory
Agreement. The meeting is expected to be held in December 1996. The proposed
New Advisory Agreement has terms, including the fees payable thereunder, that
are substantively identical to those in the current agreements.
In addition to an assignment of the Fund's Management Agreement and Advisory
Agreement, the Merger, if consummated, will also be deemed to cause an
assignment, as defined by the 1940 Act, of the Principal Underwriting
Agreement between the Fund and the Fund's principal underwriter, Keystone
Investment Distributors Company (the "Principal Underwriter"). As a result,
the Fund's Trustees have approved the following agreements, subject to the
Merger's completion: (i) a principal underwriting agreement between Evergreen
Funds Distributor, Inc. ("EFD") and the Fund; (ii) a marketing services
agreement between the Principal Underwriter and EFD with respect to the Fund;
and (iii) a subadministration agreement between Keystone and EFD with respect
to the Fund. EFD is a wholly-owned subsidiary of Furman Selz LLC. It is
currently anticipated that on or about January 2, 1997, Furman Selz LLC will
transfer EFD, and Furman Selz's related services, to BISYS Group, Inc.
("BISYS") (the "Transfer"). The Fund's Trustees have also approved, subject to
completion of the Transfer, (i) a new principal underwriting agreement between
EFD and the Fund; (ii) a new marketing services agreement between the
Principal Underwriter and EFD with respect to the Fund; and (iii) a
subadministration agreement between Keystone and BISYS with respect to the
Fund. The terms of such agreements will be substantively identical to the
terms of the agreements to be executed upon completion of the Merger.
The Fund has adopted a Code of Ethics incorporating policies on personal
securities trading as recommended by the Investment Company Institute.
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; 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 fiscal year ended
October 31, 1995, the Fund paid 2.57% of its average net assets in expenses.
During the fiscal year ended October 31, 1995, the Fund paid or accrued to
Keystone Investor Resource Center, Inc. ("KIRC"), the Fund's transfer and
dividend disbursing agent, and to Keystone Investments, $62,044 for the cost
of certain accounting services and $616,119 for shareholder services. KIRC is
a wholly-owned subsidiary of Keystone.
PORTFOLIO MANAGER
Gilman C. Gunn has been the Fund's portfolio manager since 1991. Mr. Gunn is
a Keystone Senior Vice President and Senior Portfolio Manager. An investment
professional with 23 years of experience, he has spent over ten years in
London, Kuwait, and Thailand.
SECURITIES TRANSACTIONS
Under policies established by the Fund's Board of Directors, 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 consider 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 Management, Keystone, the Fund's principal
underwriter, or their affiliates. The Fund may pay higher commissions to
broker-dealers that provide research services. Keystone may use these services
in advising the Fund as well as in advising its other clients.
PORTFOLIO TURNOVER
The Fund's portfolio turnover rates for the fiscal year ended October 31,
1995, the one month period ended October 31, 1994, and the twelve month period
ended September 30, 1994 were 76%, 2%, and 121%, respectively. High portfolio
turnover may involve correspondingly greater brokerage commissions and other
transaction costs, which would be borne directly by the Fund, as well as
additional realized gains and/or losses to shareholders. For further
information about brokerage and distributions, see the statement of additional
information.
- ------------------------------------------------------------------------------
HOW TO BUY SHARES
- ------------------------------------------------------------------------------
You may purchase shares of the Fund from any broker-dealer that has a
selling agreement with the Principal Underwriter. The Principal Underwriter, a
wholly-owned subsidiary of Keystone, is located at 200 Berkeley Street,
Boston, Massachusetts 02116-5034.
In addition, you may purchase 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. You may also 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, direct deposit, or by an electronic funds
transfer ("EFT").
The Fund's shares are sold at 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 deferred sales charge is imposed on amounts redeemed
thereafter or on shares purchased through reinvestment of dividends. If
imposed, the deferred sales charge is deducted from the redemption proceeds
otherwise payable to the shareholder. Deferred sales charges are, to the
extent permitted by the NASD, paid to the Principal Underwriter.
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.
Upon request for redemption, shares not subject to the contingent deferred
sales charge will be redeemed first. Thereafter, shares held the longest will
be the first to be redeemed. No deferred sales charge is payable on permitted
exchanges of shares between the funds in the Keystone Fund Family that have
adopted distribution plans pursuant to Rule 12b-1 under the 1940 Act. For
purposes of computing deferred sales charges, when shares of one fund are
exchanged for shares of another fund, the date of purchase of the shares being
acquired by exchange is deemed to be the date the shares being tendered for
exchange were originally purchased.
WAIVER OF DEFERRED SALES CHARGE
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; (5) automatic withdrawals under Systematic Income Plan of up
to 1% per month of the shareholder's initial account balance; (6) withdrawals
consisting of loan proceeds to a retirement plan participant; (7) financial
hardship withdrawals made by a retirement plan participant; or (8) withdrawals
consisting of returns of excess contributions or excess deferral amounts made
to a retirement plan participant.
Shares also may be sold, to the extent permitted by applicable law, at net
asset value without the payment of commissions or the imposition of a deferred
sales charge to (1) certain Directors, Trustees, officers, and employees of
the Fund, Keystone Management, Keystone, and certain of their affiliates; (2)
registered representatives of firms with dealer agreements with the Principal
Underwriter; and (3) a bank or trust company acting as trustee for a single
account. For more details, see the statement of additional information.
- ------------------------------------------------------------------------------
DISTRIBUTION PLAN
- ------------------------------------------------------------------------------
The Fund bears some of the costs of selling its shares under a Distribution
Plan adopted 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 limits the amount that the Fund may pay
annually in distribution costs for the sale of its shares and shareholder
service fees. The NASD limits annual expenditures to 1% of the aggregate
average daily net asset value of its shares, of which 0.75% may be used to pay
such distribution costs and 0.25% may be used to pay shareholder services
fees. The NASD also limits 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 such amounts (less any contingent deferred sales charges paid by
shareholders to the Principal Underwriter) remaining unpaid from time to time.
Payments under the Distribution Plan are currently made to the Principal
Underwriter (which may reallow all or part to others, such as broker-dealers)
(1) as commissions for Fund shares sold, and (2) as shareholder service fees
in respect of shares maintained by the recipients and outstanding on the
Fund's books for specified periods. Amounts paid or accrued to the Principal
Underwriter under (1) and (2) in the aggregate may not exceed the annual
limitations referred to above.
The Principal Underwriter generally reallows to broker-dealers or others a
commission equal to 4% of the price paid for each Fund share sold. In
addition, the Principal Underwriter generally reallows to broker-dealers or
others a shareholder service fee at a rate of 0.25% per annum of the net asset
value of shares maintained by such recipients and outstanding on the books of
the Fund for specified periods. See also "Arrangements with Broker-Dealers and
Others" below.
If the Fund is unable to pay the Principal Underwriter a commission on a new
sale because the annual maximum (0.75% of average daily net assets) has been
reached, the Principal Underwriter 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 broker-dealers in excess of the amount it
currently receives from the Fund. While the Fund is under no contractual
obligation to pay the Principal Underwriter for advances made by the Principal
Underwriter in excess of the Distribution Plan limitation, the Principal
Underwriter intends to seek full payment of such amounts from the Fund
(together with interest at the rate of prime plus 1%) at such time in the
future as, and to the extent that, payment thereof by the Fund would be within
permitted limits. 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.
During the fiscal year ended October 31, 1995, the Fund recovered $1,380 in
deferred sales charges. During the year, the Fund paid the Principal
Underwriter under the Distribution Plan $1,316,980. The amount paid by the
Fund under its Distribution Plan, net of deferred sales charges received by
the Fund, was $1,315,600 (1.00% of the Fund's average daily net asset value
during the year). During the year, the Principal Underwriter also received
$375,704 in deferred sales charges. Unpaid distribution costs at October 31,
1995 were $1,721,992 (1.31% of the Fund's net assets).
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. If the Distribution Plan is terminated, the Principal
Underwriter will ask the Independent Directors to take whatever action they
deem appropriate under the circumstances with respect to payment of advances.
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.
ARRANGEMENTS WITH BROKER-DEALERS AND OTHERS
Upon written notice to broker-dealers, the Principal Underwriter may, at its
own expense, 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 broker-dealers or to selected broker-dealers who have
sold or are expected to sell significant amounts of shares. Additional
compensation may also include financial assistance to broker-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.
The Principal Underwriter may, at its own expense, pay concessions in
addition to those described above to broker-dealers that satisfy certain
criteria established from time to time by the Principal Underwriter. These
conditions relate to increasing sales of shares of the Keystone funds over
specified periods and certain other factors. Such payments, depending on the
broker-dealer's satisfaction of the required conditions, may be periodic and
may be up to 0.25% of the value of shares sold by such broker-dealer.
Beginning November 1, 1996 through December 10, 1996 (the "Offering
Period"), the Principal Underwriter will reallow to broker-dealers or others a
commission equal to 5% of the price paid for each Fund share sold during the
Offering Period. Such payments will be made to those broker-dealers and others
selling such shares who pay their registered representatives making such sales
a portion of the additional amount payable under this special offer,
determined in accordance with their regular payment arrangements with such
persons for sales not made under a special dealer offer.
The Principal Underwriter may also pay banks and other financial services
firms that facilitate transactions in shares of the Fund for their clients a
transaction fee up to the level of payments allowed to broker-dealers for the
sale of shares, as described above.
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 broker-dealers pursuant to state
law.
- ------------------------------------------------------------------------------
HOW TO REDEEM SHARES
- ------------------------------------------------------------------------------
You may redeem Fund shares for cash at the redemption value upon written
order by the shareholder(s) to the Fund, c/o KIRC, Inc., Box 2121, Boston,
Massachusetts 02106-2121, and presentation to the Fund of a properly endorsed
share certificate (if certificates have been issued). Your signature(s) on the
written order and certificates must be guaranteed, as discribed below.
You may also redeem your shares through your broker-dealer. The Principal
Underwriter, acting as agent for the Fund, stands ready to repurchase Fund
shares upon orders from broker-dealers and will calculate the net asset value
on the same terms as those orders for the purchase of shares received from
broker-dealers and described under "How to Buy Shares." If the Principal
Underwriter has received proper documentation, it will pay the redemption
proceeds, less any applicable deferred sales charge, to the broker-dealer
placing the order within seven days thereafter. The Principal Underwriter
charges no fee for this service. Your broker-dealer, however, may charge a
service fee.
The redemption value equals the net asset value adjusted for fractions of a
cent and may be more or less than your cost depending upon changes in the
value of the Fund's portfolio securities between purchase and redemption. The
Fund may impose a deferred sales charge at the time of redemption of certain
shares as explained under "How to Buy Shares." If imposed, the Fund deducts
the deferred sales charge from the redemption proceeds otherwise payable to
you.
REDEMPTION OF SHARES IN GENERAL
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 amount due you at the close of the Exchange at the end
of the day on which it has received all proper documentation from you. Payment
of the amount due on redemption, less any applicable deferred sales charge,
will be made within seven days thereafter except as discussed herein.
For your protection, 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, however, 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 REDEMPTIONS
Under ordinary circumstances, you may redeem up to $50,000 from your account
by calling toll free 1-800-343-2898.You must complete the Telephone Redemption
section of the application to enjoy telephone redemption privileges.
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 you cannot reach the Fund by telephone, you should follow the procedures
for redeeming by mail or through a broker-dealer 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 the Principal
Underwriter 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 the Principal Underwriter 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 so orders.
- ------------------------------------------------------------------------------
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 other funds in the Keystone Fund
Family, 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. (See "How to Redeem Shares" for additional information with
respect to telephone transactions.)
Fund shares purchased by check may be exchanged for shares of the funds in
the Keystone Fund Family, other than Keystone Precious Metals Holdings
("KPMH"). In order to exchange Fund shares for shares of KPMH, a shareholder
must have held Fund shares for a period of at least six months. You may
exchange your shares for another Keystone fund for a $10 fee by calling or
writing to Keystone. The exchange 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 Keystone Liquid Trust
("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 retirement plans available to investors, including
Individual Retirement Accounts (IRAs); Rollover IRAs; Simplified Employee
Pension Plans (SEPs); Salary Reduction Plans (SARSEPs); Tax Sheltered Account
Plans (TSAs); 403(b)(7) Plans; 401(k) Plans; Keogh Plans; Corporate Profit-
Sharing Plans; and Money Purchase Pension 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
With a Keystone Automatic Investment Plan, you can automatically transfer as
little as $100 per month or quarter from your bank account or KLT to the
Keystone fund of your choice. Your bank account will be debited for each
transfer. You will receive confirmation with your next account statement.
To establish or terminate an Automatic Investment Plan or to change the
amount or schedule of your automatic investments, you may write to or call
Keystone. Please include your account numbers. Termination of an Automatic
Investment Plan may take up to 30 days.
SYSTEMATIC INCOME PLAN
Under a Systematic Income 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 Systematic Income
Plan was 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.
- ------------------------------------------------------------------------------
PERFORMANCE DATA
- ------------------------------------------------------------------------------
From time to time, the Fund may advertise "total return" and "current
yield." BOTH FIGURES ARE BASED ON HISTORICAL EARNINGS. PAST PERFORMANCE SHOULD
NOT BE CONSIDERED REPRESENTATIVE OF RESULTS FOR ANY FUTURE PERIOD OF TIME.
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., Standard & Poor's Corporation, Ibbotson Associates,
or other industry publications.
- ------------------------------------------------------------------------------
FUND SHARES
- ------------------------------------------------------------------------------
The Fund currently issues one class of shares, which participate equally 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.
- ------------------------------------------------------------------------------
ADDITIONAL INFORMATION
- ------------------------------------------------------------------------------
KIRC, located at 200 Berkeley Street, Boston, Massachusetts 02116-5034, is a
wholly-owned subsidiary of Keystone.
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.
<PAGE>
- ------------------------------------------------------------------------------
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. 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. 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.
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.
DERIVATIVES
The Fund may use derivatives in furtherance of its investment objective.
Derivatives are financial contracts whose value depends on, or is derived
from, the value of an underlying asset, reference rate or index. These assets,
rates, and indices may include bonds, stocks, mortgages, commodities, interest
rates, currency exchange rates, bond indices and stock indices. Derivatives
can be used to earn income or protect against risk, or both. For example, one
party with unwanted risk may agree to pass that risk to another party who is
willing to accept the risk, the second party being motivated, for example, by
the desire either to earn income in the form of a fee or premium from the
first party, or to reduce its own unwanted risk by attempting to pass all or
part of that risk to the first party.
Derivatives can be used by investors such as the Fund to earn income and
enhance returns, to hedge or adjust the risk profile of the portfolio, and
either in place of more traditional direct investments or to obtain exposure
to otherwise inaccessible markets. The Fund is permitted to use derivatives
for one or more of these purposes. Each of these uses entails greater risk
than if derivatives were used solely for hedging purposes. The Fund uses
futures contracts and related options for hedging purposes. Derivatives are a
valuable tool which, when used properly, can provide significant benefit to
Fund shareholders. Keystone is not an aggressive user of derivatives with
respect to the Fund. However, the Fund may take positions in those derivatives
that are within its investment policies if, in Keystone's judgement, this
represents an effective response to current or anticipated market conditions.
Keystone's use of derivatives is subject to continuous risk assessment and
control from the standpoint of the Fund's investment objectives and policies.
Derivatives may be (1) standardized, exchange-traded contracts or (2)
customized, privately negotiated contracts. Exchange-traded derivatives tend
to be more liquid and subject to less credit risk than those that are
privately negotiated.
There are four principal types of derivative instruments -- options,
futures, forwards, and swaps -- from which virtually any type of derivative
transaction can be created. Further information regarding options and futures,
is provided later in this section and is provided in the Fund's statement of
additional information. The Fund does not presently engage in the use of
swaps.
While the judicious use of derivatives by experienced investment managers
such as Keystone can be beneficial, derivatives also involve risks different
from, and, in certain cases, greater than, the risks presented by more
traditional investments. Following is a general discussion of important risk
factors and issues concerning the use of derivatives that investors should
understand before investing in the Fund.
* Market Risk -- This is the general risk attendant to all investments that
the value of a particular investment will decline or otherwise change in a
way detrimental to the Fund's interest.
* Management Risk -- Derivative products are highly specialized instruments
that require investment techniques and risk analyses different from those
associated with stocks and bonds. The use of a derivative requires an
understanding not only of the underlying instrument, but also of the
derivative itself, without the benefit of observing the performance of the
derivative under all possible market conditions. In particular, the use and
complexity of derivatives require the maintenance of adequate controls to
monitor the transactions entered into, the ability to assess the risk that a
derivative adds to the Fund's portfolio and the ability to forecast price,
interest rate or currency exchange rate movements correctly.
* Credit Risk -- This is the risk that a loss may be sustained by the Fund as
a result of the failure of a another party to a derivative (usually referred
to as a "counterparty") to comply with the terms of the derivative contract.
The credit risk for exchange traded derivatives is generally less than for
privately negotiated derivatives, since the clearing house, which is the
issuer or counterparty to each exchange-traded derivative, provides a
guarantee of performance. This guarantee is supported by a daily payment
system (i.e., margin requirements) operated by the clearing house in order
to reduce overall credit risk. For privately negotiated derivatives, there
is no similar clearing agency guarantee. Therefore, the Fund considers the
creditworthiness of each counterparty to a privately negotiated derivative
in evaluating potential credit risk.
* Liquidity Risk -- Liquidity risk exists when a particular instrument is
difficult to purchase or sell. If a derivative transaction is particularly
large or if the relevant market is illiquid (as is the case with many
privately negotiated derivatives), it may not be possible to initiate a
transaction or liquidate a position at an advantageous price.
* Leverage Risk -- Since many derivatives have a leverage component, adverse
changes in the value or level of the underlying asset, rate or index can
result in a loss substantially greater than the amount invested in the
derivative itself. In the case of swaps, the risk of loss generally is
related to a notional principal amount, even if the parties have not made
any initial investment. Certain derivatives have the potential for unlimited
loss, regardless of the size of the initial investment.
* Other Risks -- Other risks in using derivatives include the risk of
mispricing or improper valuation and the inability of derivatives to
correlate perfectly with underlying assets, rates and indices. Many
derivatives, in particular privately negotiated derivatives, are complex and
often valued subjectively. Improper valuations can result in increased cash
payment requirements to counterparties or a loss of value to a Fund.
Derivatives do not always perfectly or even highly correlate or track the
value of the assets, rates or indices they are designed to closely track.
Consequently, the Fund's use of derivatives may not always be an effective
means of, and sometimes could be counterproductive to, furthering the Fund's
investment objective.
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.
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, usually the Fund 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 may also 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.
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 (interest) "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. These bonds
mature on the payment dates of the interest or principal which they represent.
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.
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.
<PAGE>
--------------------------------------
KEYSTONE
FUND FAMILY
+
Quality Bond Fund (B-1)
Diversified Bond Fund (B-2)
High Income Bond Fund (B-4)
Balanced Fund (K-1)
Strategic Growth Fund (K-2)
Growth and Income Fund (S-2)
Mid-Cap Growth Fund (S-3)
Small Company Growth Fund (S-4)
International Fund
Precious Metals Holdings
Tax Free Fund
Liquid Trust
--------------------------------------
[Logo] KEYSTONE
INVESTMENTS
Keystone Investment Distributors Company
200 Berkeley Street
Boston, Massachusetts 02116-5034
[Recycle Logo]
KIF-P Sup. 10/96
15M
--------------------------------------
KEYSTONE
--------------------------------
[Graphic Omitted]
--------------------------------
INTERNATIONAL
FUND
--------------------------------------
[Logo]
PROSPECTUS AND
APPLICATION
<PAGE>
STATEMENT OF ADDITIONAL INFORMATION
KEYSTONE INTERNATIONAL FUND INC.
January 24, 1996
As Supplemented October 30, 1996
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 January 24, 1996, as supplemented
October 30, 1996. A copy of the prospectus may be obtained from Keystone
Investment Distributors Company (the "Principal Underwriter"), the Fund's
principal underwriter, located at 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 6
Sales Charges 8
Shareholder Services 11
Distribution Plan 13
Redemptions in Kind 16
Investment Manager and
Investment Adviser 17
Directors and Officers 23
Principal Underwriter 28
Brokerage 30
Standardized Total Return
and Yield Quotations 33
Additional Information 34
Appendix A-1
Financial Statements F-1
Independent Auditors' Report F-16
THE FUND'S OBJECTIVES AND POLICIES
The Fund is an open-end, diversified management investment company. The
Fund's primary investment objective is long-term growth of capital. As a
secondary objective, the Fund seeks modest income on its investments. 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 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.
If a percentage limit is satisfied at the time of investment or borrowing,
a later increase or decrease resulting from a change in the value of a security
or a decrease in Fund assets is not a violation of the limit.
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.
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:
(1) 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.)
(2) 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;
(3) 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 determined by the Board of Directors; and
(4) The Fund's Board of Directors 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; (b) 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 (c) other
assets; and
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
The Fund distributes to its shareholders dividends from net investment
income and net realized long-term and short-term capital gains annually in
shares or, at the option of the shareholder, in cash. (Distributions of ordinary
income may be eligible in whole or in part for the corporate 70% dividends
received deduction.) Shareholders who have not opted, prior to the record date
for any distribution, to receive cash will have the number of distributed shares
determined on the basis of the Fund's net asset value per share computed at the
end of the day on the record date after adjustment for the distribution. Net
asset value is used in computing the number of shares in both gains and income
distribution reinvestments. Account statements and/or checks as appropriate will
be mailed to shareholders by the 15th of November of each year. Unless the Fund
receives instructions to the contrary from a shareholder before the record date,
it will assume that the shareholder wishes to receive that distribution and
future gains and income distributions in shares. Instructions continue in effect
until changed in writing.
Distributed long-term capital gains are taxable as such to the shareholder
regardless of the period of time Fund shares have been held by the shareholder.
However, if such shares are held less than six months and redeemed at a loss,
the shareholder will recognize a long-term capital loss on such shares to the
extent of the long-term capital gain distribution received in connection with
such shares. If the net asset value of the Fund's shares is reduced below a
shareholder's cost by a capital gains distribution, such distribution, to the
extent of the reduction, would be a return of investment though taxable as
stated above. Since distributions of capital gains depend upon profits actually
realized from the sale of securities by the Fund, 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 the
Fund's net capital gains and such income as has been predetermined to the best
of the Fund's ability to be taxable as ordinary income. Shareholders of the Fund
will be advised annually of the federal income tax status of distributions.
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.
SALES CHARGES
In order to reimburse the Fund for certain expenses relating to the sale of
its shares (see "Distribution Plan"), a deferred sales charge may be imposed at
the time of redemption of certain Fund shares within four calendar years after
their purchase. If imposed, the deferred sales charge is deducted from the
redemption proceeds otherwise payable to the shareholder. For the fiscal year
ended October 31, 1995, the Fund recovered $1,380 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 contingent 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 contingent 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 contingent 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 1995 and on a given date in 1996 the value of the investor's
account has grown through investment performance and reinvestment of
distributions to $12,000. On such date in 1996, 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 contingent deferred sales
charge on permitted exchanges of shares between Funds in the Keystone Fund
Family 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, the calendar year of the exchange, for purposes of any
future deferred sales charge, 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 to (1) officers, Directors, Trustees,
full-time employees and sales representatives of the Fund, Keystone, Keystone
Management, Keystone Investments, Inc. ("Keystone Investments"), Harbor Capital
Management Company, Inc., their subsidiaries and the Principal Underwriter, who
have been such for not less than ninety days; and (2) the pension and
profit-sharing plans established by such companies, their subsidiaries and
affiliates, for the benefit of their officers, Directors, Trustees, full-time
employees and sales representatives, provided, however, that 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.
No contingent 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 other Fund in the Keystone Fund Family (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.
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 591/2 years old; (4) involuntary redemptions of an account having an
aggregate net asset value of less than $1,000; (5) automatic withdrawals under a
Systematic Income Plan of up to 1% per month of the shareholder's initial
account balance; (6) withdrawals consisting of loan proceeds to a retirement
plan participant; (7) financial hardship withdrawals made by a retirement plan
participant; or (8) withdrawals consisting of returns of excess contributions or
excess deferral amounts made to a retirement plan participant.
Redemption of Shares
The Fund has obligated itself under the 1940 Act to 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 assets in any 90 day period.
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
credit 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 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 by the Fund's Principal Underwriter. These plans may be
restated in compliance with changes mandated by applicable law.
Systematic Income 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 a Systematic Income 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").
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 1.0%, 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 the Principal Underwriter).
Payments under the Distribution Plan are currently made to the Principal
Underwriter (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
specific periods. Amounts paid or accrued to the Principal Underwriter under (1)
and (2) in the aggregate may not exceed the limitation referred to above. The
Principal Underwriter 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 and outstanding on the books of the Fund for
specified periods.
If the Fund is unable to pay the Principal Underwriter a commission on a
new sale because the annual maximum (0.75% of average daily net assets) has been
reached, the Principal Underwriter intends, but is not obligated, to continue to
accept new orders for the purchase of Fund shares and to pay commissions and
service fees for dealers in excess of the amount it currently receives from the
Fund. While the Fund is under no contractual obligation to pay the Principal
Underwriter for advances made by the Principal Underwriter in excess of the
Distribution Plan limitation, the Principal Underwriter 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. The Principal
Underwriter currently intends to seek payment of interest only on such charges
paid or accrued by the Principal Underwriter 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, the Principal Underwriter 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 Independent Directors quarterly. The Fund's Independent 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
Independent 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 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 will be required to
commit the selection and nomination of candidates for Independent Directors to
the discretion of the Independent Directors.
During the fiscal year ended October 31, 1995, the Fund paid the Principal
Underwriter $1,316,980 under the Distribution Plan. For said year, the Principal
Underwriter received $524,433 after payments of commissions on new sales and
shareholder service fees to dealers and others of $792,547.
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. 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.
The Independent Directors have determined that the sales of the Fund's
shares resulting from payments under the Distribution Plan have benefited the
Fund.
REDEMPTIONS IN KIND
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 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.
INVESTMENT MANAGER AND INVESTMENT ADVISER
Investment Manager
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. 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 funds in the Keystone Fund Family and to
certain other funds in the Keystone Investments Family of Funds.
Except as otherwise noted below, pursuant to an Investment Management
Agreement with the Fund (the "Management Agreement") and subject to the
supervision of the Fund's Board of Trustees, Keystone Management manages and
administers the operation of the Fund and manages the investment and
reinvestment of the Fund's assets in conformity with the Fund's investment
objectives and restrictions. The Management Agreement stipulates that Keystone
Management shall provide office space, all necessary office facilities,
equipment and personnel in connection with its services under the Management
Agreement and shall pay or reimburse the Fund for the compensation of Fund
officers and Trustees who are affiliated with the investment manager as well as
pay all expenses of Keystone Management incurred in connection with the
provision of its services. All charges and expenses other than those
specifically referred to as being borne by Keystone Management will be paid by
the Fund, including, but not limited to, custodian charges and expenses;
bookkeeping and auditors' charges and expenses; transfer agent charges and
expenses; fees of Independent Trustees; brokerage commissions, brokers' fees and
expenses; issue and transfer taxes; costs and expenses under the Distribution
Plan; taxes and trust fees payable to governmental agencies; the cost of share
certificates; fees and expenses of the registration and qualification of the
Fund and its shares with the Securities and Exchange Commission (sometimes
referred to herein as the "SEC" or the "Commission") or under state or other
securities laws; expenses of preparing, printing and mailing prospectuses,
statements of additional information, notices, reports and proxy materials to
shareholders of the Fund; expenses of shareholder's and Trustees' meetings;
charges and expenses of legal counsel for the Fund and for the Trustees of the
Fund on matters relating to the Fund; charges and expenses of filing annual and
other reports with the SEC and other authorities; and all extraordinary charges
and expenses of the Fund.
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
set forth below:
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
computed as of the close of business each business day and payable daily.
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 Fund's 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 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.
The Management Agreement 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.
Investment Adviser
Pursuant to the Management Agreement, Keystone Management has entered into
an Investment Advisory Agreement with Keystone (the "Advisory Agreement"), under
which Keystone Management has delegated all of its investment management
functions, except for certain administrative and management services, to
Keystone. As a result, subject to the supervision of the Fund's Board of
Trustees, Keystone performs services on behalf of the Fund that are
substantially similar to those described above with respect to Keystone
Management.
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 Investments, Inc. ("Keystone Investments"), located at
200 Berkeley Street, Boston, Massachusetts 02116-5034.
Keystone Investments is a corporation primarily owned by current and former
members of management and certain employees of Keystone and its affiliates. The
shares of Keystone Investments 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, Edward F. Godfrey, Rosemary D. Van Antwerp and Ralph J.
Spuehler, Jr. Keystone Investments provides accounting, bookkeeping, legal,
personnel and general corporate services to Keystone Management, Keystone, their
affiliates and the Keystone Investments Family of 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.
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.
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, 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.
During the year ended October 31, 1995, the Fund paid or accrued to
Keystone Management investment management and administrative services fees of
$985,652 which represented 0.75% of the Fund's average net assets. Of such
amount paid to Keystone Management, $837,804 was paid to Keystone for its
services to the Fund.
Keystone Investments has recently entered into an Agreement and Plan of
Acquisition and Merger with First Union Corporation ("First Union"), pursuant to
which Keystone Investments will be merged with and into a wholly-owned
subsidiary of First Union National Bank of North Carolina ("FUNB-NC")(the
"Merger"). The surviving corporation will assume the name "Keystone Investments,
Inc." Subject to a number of conditions being met, it is currently anticipated
that the Merger will take place on or around December 11, 1996. Thereafter,
Keystone Investments, Inc. would be a subsidiary of FUNB-NC.
If consummated, the proposed Merger will be deemed to cause an assignment,
within the meaning of the 1940 Act, of both the Management Agreement and the
Advisory Agreement. Consequently, the completion of the Merger is contingent
upon, among other things, the approval of the Fund's shareholders of a new
investment advisory and management agreement between the Fund and Keystone (the
"New Advisory Agreement"). The Fund's Trustees have approved the terms of the
New Advisory Agreement, subject to the approval of shareholders and the
completion of the Merger, and have called a special meeting of shareholders to
obtain their approval of, among other things, the New Advisory Agreement. The
meeting is expected to be held in December 1996. The proposed New Advisory
Agreement has terms, including fees payable thereunder, that are substantively
identical to those in the current agreements.
DIRECTORS AND OFFICERS
The Directors and officers of the Fund, their positions with the Fund and
their principal occupations during the past five years are as follows:
*ALBERT H. ELFNER, III: President, Chief Executive Officer and Director of the
Fund; Chairman of the Board, President, Director and Chief Executive
Officer of Keystone Investments, Inc. ("Keystone Investments"), Keystone
Management, Inc. ("Keystone Management") and Keystone Software Inc.
("Keystone Software"); President, Chief Executive Officer and Trustee or
Director of all other Keystone Investments Funds; Chairman of the Board,
Director and Chief Executive Officer of Keystone Investment Management
Company ("Keystone"); Chairman of the Board and Director of Keystone
Institutional Company, Inc. ("Keystone Institutional") (formerly named
Keystone Investment Management Corporation) and Keystone Fixed Income
Advisors ("KFIA"); Director and President of Keystone Asset Corporation,
Keystone Capital Corporation and Keystone Trust Company; Director of
Keystone Investment Distributors Company ("the Principal Underwriter"),
Keystone Investor Resource Center, Inc. ("KIRC") and Fiduciary Investment
Company, Inc. ("FICO"); Director of Boston Children's Ser vices
Association; Trustee of Anatolia College, Middlesex School and Middlebury
College; Member, Board of Governors, New England Medical Center; former
Director and President of Hartwell Keystone Advisers, Inc. ("Hartwell
Keystone"); former Director and Vice President of Robert Van Partners,
Inc.; and former Trustee of Neworld Bank.
FREDERICK AMLING: Director of the Fund; Trustee or Director of all other
Keystone Investments 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 Investments Funds; Investment Counselor to Appleton Partners,
Inc.; former Managing Director, Seaward Management Corporation (investment
ad vice); and former Director, Executive Vice President and Treasurer,
State Street Research & Management Company (investment advice).
*GEORGE S. BISSELL: Chairman of the Board and Director of the Fund; Director of
Keystone Investments; Chairman of the Board and Trustee or Director of all
other Keystone Investments Funds; 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 Investments; former Chief Executive Officer of the
Fund; and former Director and Chairman of the Board of Hartwell Keystone;
EDWIND. CAMPBELL: Director of the Fund; Trustee or Director of all other
Keystone Investments 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 Investments Funds; former Group Vice President, Textron Corp.; and
former Director, Peoples Bank (Charlotte, N.C).
LEROYKEITH, JR.: Director of the Fund; Trustee or Director of all other
Keystone Investments 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 Investments 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 Investments and Keystone.
F. RAY KEYSER, JR.: Director of the Fund; Trustee or Director of all other
Keystone Investments 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 Corpora tion, 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 Marble Company; former Director of Keystone; and former
Director and Chairman of the Board, Green Mountain Bank.
DAVIDM. RICHARDSON: Director of the Fund; Trustee or Director of all other
Keystone Investments Funds; Executive Vice President, DHR International,
Inc. (executive recruitment); former Senior Vice President, Boyden
International Inc. (executive recruitment); 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 Investments Funds; Chairman, Environmental Warranty, Inc., and
Consultant, Drake Beam Morin, Inc. (executive outplacement); Director of
Connect icut 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 Investments Funds; Partner, Farrell, Fritz, Caemmerer, Cleary,
Barnosky & Armentano, P.C.; former President, Nassau County Bar
Association; and former Asso ciate 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 Investments Funds; Director, Senior Vice President,
Chief Financial Officer and Treasurer of Keystone Investments, the
Principal Underwriter, Keystone Asset Corporation, Keystone Capital
Corporation and Keystone Trust Company; Treasurer of Keystone Institutional
and FICO; Treasurer and Director of Keystone Management and Keystone
Software, Inc.; Director of KIRC; former Treasurer and Director of Hartwell
Keystone; and former Treasurer of Robert Van Partners, Inc.,
JAMESR. McCALL: Senior Vice President of the Fund; Senior Vice President of all
other Keystone Investments Funds; and President of Keystone.
J. KEVIN KENELY: Treasurer of the Fund; Treasurer of all other Keystone
Investments Funds; Vice President of Keystone Investments, and former Vice
President and Controller of Keystone Investments and certain of its
affiliated operating companies.
ROSEMARY D. VAN ANTWERP: Senior Vice President and Secretary of the Fund; Senior
Vice President and Secretary of all other Keystone Investments Funds;
Senior Vice President, General Counsel and Secretary of Keystone; Senior
Vice President, General Counsel, Secretary and Director of the Principal
Underwriter, Keystone Management and Keystone Software; Senior Vice
President and General Counsel of Keystone Institutional; Senior Vice
President, General Counsel and Director of FICO and KIRC; Vice President
and Secretary of KFIA; Senior Vice President, General Counsel and Secretary
of Keystone Investments, Keystone Asset Corporation, Keystone Capital
Corporation and Keystone Trust Company; and former Senior Vice President
and Secretary of Hartwell Keystone and Robert Van Partners, Inc.
* 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 Investments and several of
its affiliates including Keystone, the Principal Underwriter and KIRC. Mr.
Elfner and Mr. Bissell own shares of Keystone Investments. Mr. Elfner is
Chairman of the Board, Chief Executive Officer and a Director of Keystone
Investments. Mr. Bissell is a Director of Keystone Investments.
During the fiscal year ended October 31, 1995, no Director affiliated with
Keystone or any officer received any direct remuneration from the Fund. During
the same period, the unaffiliated Directors received $7,300 in retainers and
fees from the Fund. Annual retainers and meeting fees paid by all funds in the
Keystone Investments Family of Funds (which includes 30 mutual funds) for the
fiscal year ended October 31, 1995, totaled approximately $462,686. On December
31, 1995, the Fund's Directors and officers beneficially owned less than 1.0% of
the Fund's then outstanding shares.
The address of all the Fund's Directors and officers and the address of the
Fund is 200 Berkeley Street, Boston, Massachusetts 02116-5034.
PRINCIPAL UNDERWRITER
Pursuant to a Principal Underwriting Agreement with the Fund (the
"Underwriting Agreement"), the Principal Underwriter acts as the Fund's
principal underwriter. The Principal Underwriter, located at 200 Berkeley
Street, Boston, Massachusetts 02116-5034, is a Delaware corporation wholly-owned
by Keystone. The Principal Underwriter, as agent, has agreed to use its best
efforts to find purchasers for the shares. The Principal Underwriter 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 the Principal
Underwriter will bear the expense of preparing, printing and distributing
advertising and sales literature and prospectuses used by it. In its capacity as
principal underwriter, the Principal Underwriter may receive payments from the
Fund pursuant to the Fund's Distribution Plan.
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 the Principal Underwriter's judgment it could
benefit the sales of Fund shares, the Principal Underwriter 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 the
Principal Underwriter $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, the Principal Underwriter
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, the Principal Underwriter also received $183,020 and $22,063,
respectively, in contingent deferred sales charges. At October 31, 1994, the
Principal Underwriter'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 the Principal
Underwriter in 1988 in connection with a financing transaction. As of October
31, 1994, $51,270 of the amount assigned remained outstanding.
For the fiscal year ended October 31, 1995, the Principal Underwriter
earned commissions of $524,433, after allowing commissions and service fees of
$792,547 to retail dealers under the distribution plan.
The Principal Underwriter 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 the Principal Underwriter 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.
In addition to an assignment of the Fund's Management Agreement and
Advisory Agreement, the Merger, if consummated, will also be deemed to cause an
assignment, as defined by the 1940 Act, of the Underwriting Agreement. As a
result, the Fund's Trustees have approved the following agreements, subject to
the Merger's completion: (i) a principal underwriting agreement between
Evergreen Funds Distributor, Inc. ("EFD") and the Fund; (ii) a marketing
services agreement between the Principal Underwriter and EFD with respect to the
Fund; and (iii) a subadministration agreement between Keystone and EFD with
respect to the Fund. EFD is a wholly-owned subsidiary of Furman Selz LLC. It is
currently anticipated that on or about January 2, 1997, Furman Selz LLC will
transfer EFD, and Furman Selz's related services, to BISYS Group, Inc. ("BISYS")
(the "Transfer"). The Fund's Trustees have also approved, subject to completion
of the Transfer, (i) a new principal underwriting agreement between EFD and the
Fund; (ii) a new marketing services agreement between the Principal Underwriter
and EFD with respect to the Fund; and (iii) a subadministration agreement
between Keystone and BISYS with respect to the Fund. The terms of such
agreements will be substantively identical to the terms of the agreements to be
executed upon completion of the Merger.
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 Management or Keystone is
considered to be in addition to and not in lieu of services required to be
performed by Keystone Management under the Management Agreement or Keystone
under the Advisory Agreement. The cost, value and specific application of such
information are indeterminable and cannot be practicably allocated among the
Fund and other clients of Keystone Management or Keystone 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 a
dealer's mark-up or reflect a dealer's mark-down. 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 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 by Keystone
Management or Keystone from those of the other funds and investment accounts
managed by Keystone Management or Keystone. 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.
In no instance are portfolio securities purchased from or sold to Keystone
Management, Keystone, the Principal Underwriter or any of their affiliated
persons, as defined in the 1940 Act and rules and regulations issued thereunder.
During the fiscal year ended September 30, 1993, the twelve month period
ended September 30, 1994 and the one month period ended October 31, 1994, the
Fund paid approximately $14,827,$923,756 and $0, respectively, in brokerage
fees. During the fiscal year ended October 31, 1995, the Fund paid approximately
$707,000 in brokerage fees.
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.
The cumulative total return of the Fund for the one, five and ten year
periods ended October 31, 1995 was (0.56%) (including contingent deferred sales
charges), 49.04% and 154.29%, respectively. The compounded average rate of
return for the five and ten year periods ended October 31, 1995 were 8.31% and
9.78%, 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, 99 High Street, Boston, Massachusetts 02110,
Certified Public Accountants, are the independent auditors for the Fund.
KIRC, located at 200 Berkeley Street, Boston, Massachusetts 02116-5034, is
a wholly-owned subsidiary of Keystone. KIRC acts as transfer agent and dividend
disbursing agent for the Fund.
As of December 29, 1995, Merrill Lynch Pierce Fenner & Smith, Attn: Book
Entry, 4800 Deer Lake Dr E 3rd Fl, Jacksonville, FL 32246-6484 owned 5.22% of
the outstanding shares of 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. 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 principal office in Washington, D.C. upon
payment of the fee prescribed by the rules and regulations promulgated by the
SEC.
<PAGE>
------------------------------------------------------------------------------
APPENDIX
------------------------------------------------------------------------------
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 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.
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:
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 and C 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.
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.
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.
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.
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.
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 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 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 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 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.
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").
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.
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, 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.
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
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.
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
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.
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 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 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 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 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 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>
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.
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.
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, 1995
NUMBER OF MARKET
SHARES VALUE
================================================================================
COMMON STOCKS (82.8%)
(bullet) ARGENTINA (0.3%)
Beverages & Tobacco (0.3%)
Nobleza Piccardo 108,746 $ 418,630
================================================================================
(bullet) AUSTRALIA (3.9%)
Banking (1.8%)
National Australia Bank Ltd. 155,500 1,331,368
Westpac Banking Corp. 231,000 948,423
- --------------------------------------------------------------------------------
2,279,791
- --------------------------------------------------------------------------------
Business & Public Services (0.2%)
Memtec Ltd. 170,000 279,708
- --------------------------------------------------------------------------------
Beverages & Tobacco (0.2%)
Foster's Brewing Group Ltd. 270,000 257,084
- --------------------------------------------------------------------------------
Energy Sources (1.7%)
Broken Hill Proprietary Co. Ltd. 162,765 2,204,419
- --------------------------------------------------------------------------------
(bullet) TOTAL AUSTRALIA 5,021,002
================================================================================
(bullet) BELGIUM (1.2%)
Industrial Components (1.2%)
Bekaert S.A. 2,180 1,600,726
================================================================================
(bullet) CANADA (4.6%)
Advertising & Publishing (1.8%)
Quebecor, Inc. 147,906 2,249,264
- --------------------------------------------------------------------------------
Conglomerates (0.5%)
Brascan Ltd. 26,400 413,793
Imasco Ltd. 15,000 268,697
- --------------------------------------------------------------------------------
682,490
- --------------------------------------------------------------------------------
Beverages & Tobacco (0.5%)
Canada Malting Ltd. 43,800 662,002
- --------------------------------------------------------------------------------
Fertilizer (1.8%)
Potash Corp. of Saskatchewan, Inc. 32,380 2,271,772
- --------------------------------------------------------------------------------
(bullet) TOTAL CANADA 5,865,528
================================================================================
(bullet) CHILE (2.0%)
Conglomerates (2.0%)
Antofagasta Holdings 519,000 $2,502,688
================================================================================
(bullet) FINLAND (0.3%)
Industrial Components (0.3%)
Fiskars Oy AB, Series K 4,400 207,176
Fiskars Oy AB 3,533 178,829
- --------------------------------------------------------------------------------
(bullet) TOTAL FINLAND 386,005
================================================================================
(bullet) FRANCE (5.0%)
Building Materials (0.7%)
Lafarge 13,200 874,853
- --------------------------------------------------------------------------------
Cosmetics (0.7%)
L'Oreal S.A. 3,500 855,299
- --------------------------------------------------------------------------------
Banking (1.5%)
Credit Commerce de France 39,888 1,982,124
- --------------------------------------------------------------------------------
Industrial Components (0.8%)
Michelin 26,200 1,058,158
- --------------------------------------------------------------------------------
Leisure/Tourism (0.5%)
Accor S.A. 5,651 671,404
- --------------------------------------------------------------------------------
Energy Sources (0.8%)
Societe Nationale Elf Aquitaine 14,555 991,148
- --------------------------------------------------------------------------------
(bullet) TOTAL FRANCE 6,432,986
================================================================================
(bullet) HONG KONG (3.4%)
Banking (2.3%)
HSBC Holdings 175,677 2,556,186
Wing Hang Bank 117,700 379,054
- --------------------------------------------------------------------------------
2,935,240
- --------------------------------------------------------------------------------
Beverages & Tobacco (0.1%)
Tsingtao Brewery 535,000 141,851
- --------------------------------------------------------------------------------
Merchandising (0.5%)
Giordano Holdings 771,000 638,204
- --------------------------------------------------------------------------------
See Notes to Schedule of Investments.
<PAGE>
- --------------------------------------------------------------------------------
SCHEDULE OF INVESTMENTS--October 31, 1995
NUMBER OF MARKET
SHARES VALUE
================================================================================
Telecommunications (0.5%)
Hong Kong Telecommunications Ltd. 378,000 $ 660,010
- --------------------------------------------------------------------------------
(bullet) TOTAL HONG KONG 4,375,305
================================================================================
(bullet) INDONESIA (1.6%)
Health and Personal (0.4%)
Kalbe Farma 159,840 506,758
- --------------------------------------------------------------------------------
Merchandising (0.4%)
Matahari Putra 240,750 503,550
- --------------------------------------------------------------------------------
Textiles & Apparel (0.8%)
Indorama Synthetic 300,500 992,404
- --------------------------------------------------------------------------------
(bullet) TOTAL INDONESIA 2,002,712
================================================================================
(bullet) ITALY (1.8%)
Chemicals (0.1%)
Saes Getters 4,500 85,822
- --------------------------------------------------------------------------------
Food & Household Products (0.2%)
Industrie Natuzzi 7,400 296,000
- --------------------------------------------------------------------------------
Telecommunications (1.5%)
Telecom Italia MOB 630,000 1,057,246
Telecom Italia 630,000 956,462
- --------------------------------------------------------------------------------
2,013,708
- --------------------------------------------------------------------------------
(bullet) TOTAL ITALY 2,395,530
================================================================================
(bullet) JAPAN (20.2%)
Appliances/Household Durables (2.8%)
Sharp Corp. 79,000 1,096,632
Sony Corp. 56,700 2,549,685
- --------------------------------------------------------------------------------
3,646,317
- --------------------------------------------------------------------------------
Beverages & Tobacco (0.1%)
Kita Kyushu Coca Cola 7,000 136,175
- --------------------------------------------------------------------------------
Chemicals (0.4%)
Rohm 9,000 546,361
- --------------------------------------------------------------------------------
Electrical/Electronics (4.4%)
Hitachi Ltd. 141,000 1,447,285
- --------------------------------------------------------------------------------
Electrical/Electronics (Continued)
NEC Corp. 207,000 $ 2,731,805
Toshiba Corp. 203,000 1,470,482
- --------------------------------------------------------------------------------
5,649,572
- --------------------------------------------------------------------------------
Electronic Components (2.7%)
Advantest 20,500 1,162,325
Fanuc 16,000 692,898
Kyocera Corp. 8,000 655,360
Murata Manufacturing Co. 8,000 280,757
Tokyo Electronics 16,000 694,462
- --------------------------------------------------------------------------------
3,485,802
- --------------------------------------------------------------------------------
Financial Services (0.6%)
Nichiei Co. 12,000 744,904
- --------------------------------------------------------------------------------
Food & Household Products (0.0%)
Plenus 2,000 94,433
- --------------------------------------------------------------------------------
Industrial Components (1.7%)
Bridgestone Corp. 93,000 1,290,972
NGK Spark Plug Co. 63,000 862,212
- --------------------------------------------------------------------------------
2,153,184
- --------------------------------------------------------------------------------
Insurance (3.3%)
Mitsui Marine and Fire 108,000 649,299
Nichido Fire and Marine 181,000 1,353,585
Sumitomo Marine and Fire 305,000 2,176,548
- --------------------------------------------------------------------------------
4,179,432
- --------------------------------------------------------------------------------
Leisure & Tourism (0.4%)
Fuji Photo Film Co. 19,000 469,915
- --------------------------------------------------------------------------------
Office & Business Equipment (3.8%)
Canon, Inc. 283,000 4,841,390
- --------------------------------------------------------------------------------
(bullet) TOTAL JAPAN 25,947,485
================================================================================
(bullet) KOREA (1.8%)
Electronic Components (0.2%)
Chung Ho Computer 2,390 221,774
- --------------------------------------------------------------------------------
Electric/Electronics (0.9%)
Samsung Electronics Co., Ltd., Global
Depository Shares 5,500 1,207,606
- --------------------------------------------------------------------------------
See Notes to Schedule of Investments. (continued on next page)
<PAGE>
- --------------------------------------------------------------------------------
Keystone International Fund Inc.
SCHEDULE OF INVESTMENTS--October 31, 1995
NUMBER OF MARKET
SHARES VALUE
================================================================================
Metals & Mining (0.2%)
Pohang Iron & Steel Co., Ltd. 2,500 $ 217,604
- --------------------------------------------------------------------------------
Utilities (0.5%)
Korea Electric Power 16,300 671,045
- --------------------------------------------------------------------------------
(bullet) TOTAL KOREA 2,318,029
================================================================================
(bullet) MALAYSIA (1.3%)
Wholesale/International (0.2%)
Sime Darby BHD 88,000 219,913
- --------------------------------------------------------------------------------
Foods & Household Products (0.4%)
Nestle Malay Berhad 90,000 634,002
- --------------------------------------------------------------------------------
Leisure & Tourism (0.7%)
Genting Berhad 98,500 857,431
- --------------------------------------------------------------------------------
(bullet) TOTAL MALAYSIA 1,711,346
================================================================================
(bullet) MEXICO (0.3%)
Metals & Mining (0.3%)
Industrias Penoles S.A. de C.V. 96,500 362,975
================================================================================
(bullet) NETHERLANDS (8.9%)
Advertising & Publishing (2.4%)
Telegraaf N.V. 10,000 1,438,712
Wolters Kluwer N.V. 17,424 1,585,807
- --------------------------------------------------------------------------------
3,024,519
- --------------------------------------------------------------------------------
Appliances/Household Durables (0.5%)
Philips Electronics N.V. 17,350 670,776
- --------------------------------------------------------------------------------
Beverages & Tobacco (1.6%)
Heineken N.V. 11,788 2,091,925
- --------------------------------------------------------------------------------
Health & Personal Products (0.6%)
Unilever N.V. 5,615 735,594
- --------------------------------------------------------------------------------
Insurance (0.8%)
AEGON N.V. 26,920 1,021,998
- --------------------------------------------------------------------------------
Energy Sources (2.3%)
Royal Dutch Petroleum Co. 23,740 $ 2,947,564
- --------------------------------------------------------------------------------
Merchandising (0.7%)
Ahold 24,383 924,137
- --------------------------------------------------------------------------------
(bullet) TOTAL NETHERLANDS 11,416,513
================================================================================
(bullet) NEW ZEALAND (0.2%)
Forest Products (0.2%)
Fletcher Challenge 12,769 17,616
Fletcher Challenge Forest 90,000 238,234
- --------------------------------------------------------------------------------
(bullet) TOTAL NEW ZEALAND 255,850
================================================================================
(bullet) SINGAPORE (1.5%)
Business & Public Services (0.1%)
Venture Manufacturing 38,500 114,437
- --------------------------------------------------------------------------------
Conglomerates (0.6%)
Jardine Matheson 128,166 781,813
- --------------------------------------------------------------------------------
Beverages & Tobacco (0.8%)
Fraser & Neave 89,000 1,051,875
- --------------------------------------------------------------------------------
(bullet) TOTAL SINGAPORE 1,948,125
================================================================================
(bullet) SPAIN (0.9%)
Energy Sources (0.9%)
Repsol S.A. 37,300 1,113,912
================================================================================
(bullet) SWEDEN (7.5%)
Appliances & Household Durables (1.1%)
Electrolux AB 33,925 1,450,878
- --------------------------------------------------------------------------------
Automotive (1.6%)
Volvo AB 93,200 2,098,214
- --------------------------------------------------------------------------------
Business & Public Services (0.9%)
Esselte AB 79,500 1,167,251
- --------------------------------------------------------------------------------
Electrical & Electronics (0.4%)
Asea AB 5,000 493,178
- --------------------------------------------------------------------------------
See Notes to Schedule of Investments.
<PAGE>
- --------------------------------------------------------------------------------
SCHEDULE OF INVESTMENTS--October 31, 1995
NUMBER OF MARKET
SHARES VALUE
================================================================================
Health & Personal Products (3.1%)
AB Astra 20,900 $ 767,943
Elekta 21,425 887,250
Pharmacia AB 67,000 2,330,663
- --------------------------------------------------------------------------------
3,985,856
- --------------------------------------------------------------------------------
Capital Goods (0.4%)
Assa Abloy (c) 69,000 457,188
- --------------------------------------------------------------------------------
(bullet) TOTAL SWEDEN 9,652,565
================================================================================
(bullet) SWITZERLAND (6.7%)
Business & Public Services (0.7%)
SGS Holding 475 897,450
- --------------------------------------------------------------------------------
Chemicals (1.6%)
Ciba-Geigy AG 2,435 2,101,911
- --------------------------------------------------------------------------------
Food/Household Products (3.9%)
Nestle S.A. 4,731 4,958,945
- --------------------------------------------------------------------------------
Health and Personal Products (0.5%)
Sandoz AG 825 680,899
- --------------------------------------------------------------------------------
(bullet) TOTAL SWITZERLAND 8,639,205
================================================================================
(bullet) TAIWAN, PROVINCE OF CHINA (0.6%)
Electronic Components (0.1%)
Taiwan Semiconductor (c) 14,400 44,822
United Micro Electric 16,500 40,353
- --------------------------------------------------------------------------------
85,175
- --------------------------------------------------------------------------------
Finance (0.5%)
Chronicle 2001 Mutual Fund 1,653,374 628,585
- --------------------------------------------------------------------------------
Transportation (0.0%)
Evergreen Marine 30,800 46,223
- --------------------------------------------------------------------------------
(bullet) TOTAL TAIWAN, PROVINCE OF CHINA 759,983
================================================================================
(bullet) UNITED KINGDOM (7.5%)
Advertising/Publishing (1.1%)
Blenheim Group PLC 60,000 $ 242,846
Pearson 132,000 1,311,652
- --------------------------------------------------------------------------------
1,554,498
- --------------------------------------------------------------------------------
Miscellaneous Materials (0.7%)
Pilkington PLC 285,000 851,621
- --------------------------------------------------------------------------------
Conglomerates (2.4%)
Lonrho PLC 1,253,184 3,100,764
- --------------------------------------------------------------------------------
Health and Personal Products (0.3%)
Takare PLC 110,000 356,522
- --------------------------------------------------------------------------------
Metals & Mining (1.8%)
British Steel PLC 892,000 2,302,277
- --------------------------------------------------------------------------------
Oil (1.2%)
British Petroleum Co., PLC 204,000 1,499,763
- --------------------------------------------------------------------------------
(bullet) TOTAL UNITED KINGDOM 9,665,445
================================================================================
(bullet) VENEZUELA (1.3%)
Building Materials (0.2%)
Venezolana de Ceme 126,390 241,190
- --------------------------------------------------------------------------------
Conglomerates (0.1%)
H L Boulton & Co. 1,351,329 32,632
- --------------------------------------------------------------------------------
Forest Products (0.2%)
Venezolana de Papeles 377,775 322,739
- --------------------------------------------------------------------------------
Utilities (0.8%)
La Electricidad de Caracas C.A. 945,266 1,080,081
- --------------------------------------------------------------------------------
(bullet) TOTAL VENEZUELA 1,676,642
================================================================================
(bullet) TOTAL COMMON STOCKS
(Cost--$88,194,222) 106,469,187
================================================================================
See Notes to Schedule of Investments. (continued on next page)
<PAGE>
- --------------------------------------------------------------------------------
Keystone International Fund Inc.
SCHEDULE OF INVESTMENTS--October 31, 1995
Maturity Market
Value Value
================================================================================
SHORT-TERM INVESTMENTS (10.6%)
REPURCHASE AGREEMENTS (10.6%)
Keystone Joint Repurchase
Agreement (Investments in
repurchase agreements, in a
joint trading account,
purchased 10/31/95, 5.870
to 5.8750%, maturing
11/01/95) (d) $13,666,229 $ 13,664,000
================================================================================
TOTAL SHORT-TERM INVESTMENTS
(Cost--$13,664,000) 13,664,000
================================================================================
TOTAL INVESTMENTS
(Cost--$101,858,222) (e) 120,133,187
================================================================================
FOREIGN CURRENCY HOLDINGS (3.6%)
Japanese Yen $ 4,343,267
New Taiwan Dollar (a) 14,070
Venezuelan Bolivar (a) 263,122
- --------------------------------------------------------------------------------
TOTAL FOREIGN CURRENCY HOLDINGS
(Cost--$4,716,137) 4,620,459
================================================================================
OTHER ASSETS AND LIABILITIES--NET
(3.0%) 3,920,009
- --------------------------------------------------------------------------------
NET ASSETS (100%) $128,673,655
================================================================================
NOTES TO SCHEDULE OF INVESTMENTS:
(a) Investments denominated in the local currency and/or foreign currency
holdings of certain countries are considered illiquid due to foreign
exchange restrictions of these markets.
(b) 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.
(c) Non-income-producing security.
(d) The repurchase agreements are fully collateralized by U.S. government
and/or agency obligations based on market prices at October 31, 1995.
(e) The cost of investments for income tax purposes amounted to $101,953,236.
Gross unrealized appreciation and depreciation of investments, based on
identified tax cost at October 31, 1995 are as follows:
Gross unrealized appreciation $21,445,442
Gross unrealized depreciation (3,361,169)
-----------
Net unrealized appreciation $18,084,273
===========
See Notes to Financial Statements.
<PAGE>
- --------------------------------------------------------------------------------
FINANCIAL HIGHLIGHTS
(For a share outstanding throughout the period)
<TABLE>
<CAPTION>
One Month
Year Ended Ended
October October
31, 31, Year Ended September 30,
1995 1994(e) 1994(e) 1993(e) 1992(e) 1991 1990 1989 1988 1987 1986
===================================================================================================================================
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net asset value beginning
of period $ 7.77 $ 7.67 $ 7.08 $ 6.01 $ 5.91 $ 5.35 $ 7.51 $ 6.66 $ 9.53 $ 8.05 $ 5.35
- -----------------------------------------------------------------------------------------------------------------------------------
Income from investment operations
Net investment income 0.07 0 0 (0.03) (0.01) (0.01) (0.07) (0.14) 0.03 0 0.11
Net gains (losses) on
investments and foreign
currency related
transactions 0.05 0.10 0.62 1.14 0.34 0.83 (1.74) 1.06 (1.60) 2.65 3.25
Net commissions paid on
fund share sales (a) 0 0 0 0 0 0 0 0 0 0 (0.07)
- -----------------------------------------------------------------------------------------------------------------------------------
Total from investment
operations 0.12 0.10 0.62 1.11 0.33 0.82 (1.81) 0.92 (1.57) 2.65 3.29
- -----------------------------------------------------------------------------------------------------------------------------------
Less distributions from:
Net investment income (0.04) 0 (0.02) 0 0 0 0 (0.07) (0.08) (0.06) (0.13)
In excess of net
investment income 0 0 (0.01) (0.04) (0.23) (0.03) 0 0 0 0 0
Net realized gains on
investments and foreign
currency related
transactions (0.74) 0 0 0 0 (0.23) (0.35) 0 (1.22) (1.11) (0.46)
- -----------------------------------------------------------------------------------------------------------------------------------
Total distributions (0.78) 0 (0.03) (0.04) (0.23) (0.26) (0.35) (0.07) (1.30) (1.17) (0.59)
- -----------------------------------------------------------------------------------------------------------------------------------
Net asset value end of
period $ 7.11 $ 7.77 $ 7.67 $ 7.08 $ 6.01 $ 5.91 $ 5.35 $ 7.51 $ 6.66 $ 9.53 $ 8.05
===================================================================================================================================
Total return (c) 2.19% 1.30% 8.75% 18.59% 5.78% 15.59% (25.12%) 13.55% (15.55%) 39.96% 67.76%
Ratios/supplemental data
Ratios to average net assets:
Total expenses 2.57%(b) 2.52%(d) 2.54% 2.94% 3.41% 3.14% 2.92% 2.65% 2.04% 2.17% 1.49%
Net investment income 0.88% (0.20%)(d) 0.01% (0.46%) (0.09%) (0.07%) (0.51%) (0.79%) 0.33% (0.04%) 1.53%
Portfolio turnover rate 76% 2% 121% 68% 74% 85% 42% 42% 60% 61% 97%
- -----------------------------------------------------------------------------------------------------------------------------------
Net assets end of period
(thousands) $128,674 $157,929 $154,529 $111,752 $64,135 $72,923 $73,768 $121,047 $115,712 $173,319 $89,895
===================================================================================================================================
</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) "Ratio of total expenses to average net assets" for the year ended
October 31, 1995 includes indirectly paid expenses. Excluding indirectly
paid expenses for the year ended October 31, 1995, the expense ratio
would have been 2.56%.
(c) Excluding contingent deferred sales charges (CDSC).
(d) Annualized.
(e) Calculation based on average shares outstanding.
See Notes to Financial Statements.
<PAGE>
- --------------------------------------------------------------------------------
Keystone International Fund Inc.
STATEMENTS OF ASSETS AND LIABILITIES--
October 31, 1995
================================================================================
Assets:
Investments at market value (identified cost--
$88,194,222) (Note 1) $106,469,187
Repurchase Agreements (identified cost--
$13,664,000) (Note 1) 13,664,000
Foreign currency holdings (identified cost--
$4,716,137) (Note 1) 4,620,459
- --------------------------------------------------------------------------------
Total investments and foreign currency holdings
(identified cost--$106,574,359) 124,753,646
- --------------------------------------------------------------------------------
Cash 271
Receivable for:
Unrealized appreciation on open foreign currency
contracts
(Notes 1 and 5) 654,349
Investments sold 4,270,517
Fund shares sold 338,050
Interest and dividends 190,714
Refundable foreign tax withheld 100,125
Prepaid expenses 13,072
- --------------------------------------------------------------------------------
Total assets 130,320,744
- --------------------------------------------------------------------------------
Liabilities:
Payable for:
Unrealized depreciation on open foreign currency
contracts
(Notes 1 and 5) 1,328,394
Fund shares redeemed 121,169
Foreign tax withholding 23,689
Other accrued expenses 173,837
- --------------------------------------------------------------------------------
Total liabilities 1,647,089
- --------------------------------------------------------------------------------
Net assets $128,673,655
================================================================================
Net assets represented by (Notes 1, 2 and 5):
Paid-in capital $108,440,042
Undistributed net investment income 1,985,964
Accumulated net realized gains on investments
and foreign currency related transactions 744,780
Net unrealized appreciation (depreciation) on:
Investments, foreign currency holdings and
other assets and liabilities 18,176,914
Foreign currency contracts (674,045)
- --------------------------------------------------------------------------------
Total net assets applicable to outstanding
shares of beneficial interest at 10/31/95
($7.11 a share on 18,088,843 shares
outstanding) $128,673,655
================================================================================
STATEMENT OF OPERATIONS--
For the Year Ended October 31, 1995
==========================================================================
Investment income (Note 1):
Dividends (net of foreign
withholding taxes of $305,494) $ 2,327,124
Interest 2,200,392
- --------------------------------------------------------------------------
Total income 4,527,516
- --------------------------------------------------------------------------
Expenses (Notes 2 and 4):
Management fee $ 985,652
Transfer agent fees 616,119
Accounting, auditing and legal 65,683
Custodian fees--foreign 154,575
Custodian fees--domestic 89,856
Distribution Plan expenses 1,315,600
Printing expense 40,526
Registration fees 48,734
Other foreign investment taxes 50,579
Miscellaneous expenses 22,959
- --------------------------------------------------------------------------
Total expenses 3,390,283
Less: Expenses paid indirectly
(Note 4) (19,366)
- --------------------------------------------------------------------------
Net expenses 3,370,917
- --------------------------------------------------------------------------
Net investment income 1,156,599
- --------------------------------------------------------------------------
Net realized and unrealized gain
(loss) on investments and foreign
currency related transactions
(Notes 1, 3 and 5):
Realized gain (loss) on:
Investments 3,055,864
Foreign currency holdings (352,786)
- --------------------------------------------------------------------------
Net realized gain (loss) on
investments and foreign currency
related transactions 2,703,078
- --------------------------------------------------------------------------
Net change in unrealized
appreciation (depreciation) on:
Investments foreign currency
holdings and other assets and
liabilities (2,836,275)
Foreign currency contracts 363,133
- --------------------------------------------------------------------------
Net change in unrealized
appreciation or depreciation (2,473,142)
- --------------------------------------------------------------------------
Net gain on investments and foreign
currency related transactions 229,936
- --------------------------------------------------------------------------
Net increase in net assets resulting
from operations $ 1,386,535
==========================================================================
See Notes to Financial Statements.
<PAGE>
- --------------------------------------------------------------------------------
STATEMENTS OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
One Month
Period
Year Ended Ended Year Ended
October 31, 1995 October 31, 1994 September 30, 1994
===================================================================================================================
<S> <C> <C> <C>
Operations (Notes 1 and 3):
Net investment income (loss) $ 1,156,599 $ (26,579) $ 9,601
Net realized gain (loss) on investments and foreign
currency related transactions 2,703,078 (325,955) 11,373,326
Net change in unrealized appreciation or depreciation (2,473,142) 2,527,836 (2,252,430)
- -------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in net assets resulting from
operations 1,386,535 2,175,302 9,130,497
- -------------------------------------------------------------------------------------------------------------------
Distributions to shareholders from (Note 1):
Net investment income (701,392) 0 (385,197)
In excess of net investment income 0 0 (214,920)
Net realized gains on investments and foreign currency
related transactions (14,792,324) 0 0
- -------------------------------------------------------------------------------------------------------------------
Total distributions to shareholders (15,493,716) 0 (600,117)
- -------------------------------------------------------------------------------------------------------------------
Capital share transactions (Note 2):
Proceeds from shares sold 84,005,110 11,958,676 146,821,752
Payments for shares redeemed (112,505,516) (10,734,623) (113,073,728)
Net asset value of shares issued in reinvestment of
dividends and distributions 13,352,659 0 499,199
- -------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in net assets resulting from
capital share transactions (15,147,747) 1,224,053 34,247,223
- -------------------------------------------------------------------------------------------------------------------
Total increase (decrease) in net assets (29,254,928) 3,399,355 42,777,603
- -------------------------------------------------------------------------------------------------------------------
Net assets:
Beginning of period 157,928,583 154,529,228 111,751,625
- -------------------------------------------------------------------------------------------------------------------
End of period [including undistributed net investment
income (accumulated distributions in excess of net
investment income) as follows:
October 31, 1995--$1,985,964
October 31, 1994--$1,266,496
September 30, 1994--($3,808,221)] (Note 1) $ 128,673,655 $157,928,583 $ 154,529,228
===================================================================================================================
</TABLE>
See Notes to Financial Statements.
<PAGE>
- --------------------------------------------------------------------------------
Keystone International Fund Inc.
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 Investment Management Company (formerly 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 is a wholly-owned subsidiary of Keystone Investments, Inc.
("KII") (formerly Keystone Group, Inc.), a Delaware corporation. KII is
privately owned by an investor group consisting of current and former members
of 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 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 no later than the day after the
trade date. Realized gains and losses are recorded on the identified cost
basis. Interest
<PAGE>
- --------------------------------------------------------------------------------
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 any 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.
Pursuant to an exemptive order issued by the Securities and Exchange
Commission, the Fund, along with certain other Keystone funds, may transfer
uninvested cash balances into a joint trading account. These balances are
invested in one or more repurchase agreements that are fully collateralized
by U.S. Treasury and/or Federal Agency obligations.
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,
annually. Distributions are determined in accordance with income tax
regulations. The significant difference between financial statement amounts
available for distribution and distributions made in accordance with income
tax regulations is due to the differing treatment of 12b-1 expenses and
foreign currency gains and losses for financial statement and federal income
tax purposes.
(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:
<PAGE>
- --------------------------------------------------------------------------------
Keystone International Fund Inc.
<TABLE>
<CAPTION>
Year One Month Year
Ended Ended Ended
10/31/95 10/31/94 9/30/94
====================================================================
<S> <C> <C> <C>
Shares sold 12,460,964 1,555,441 18,905,283
Shares redeemed (16,703,211) (1,394,884) (14,595,196)
Shares issued in
reinvestment of
dividends and
distributions 2,010,943 0 64,579
- --------------------------------------------------------------------
Net increase (decrease) (2,231,304) 160,557 4,374,666
====================================================================
</TABLE>
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 Investment
Distributors Company (formerly Keystone Distributors, Inc.) ("KIDC"), 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 KIDC in connection
with the Distribution Plan, and subject to the limitations discussed below,
KIDC generally pays brokers or others a commission equal to 4.0% 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.
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 Dealers, Inc. ("NASD Rule") limits the
annual expenditures which the Fund may incur under the Distribution Plan to
1.0%, 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 1.0% on unpaid amounts thereof
(less any contingent deferred sales charges paid by the shareholders to
KIDC).
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).
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 KIDC rather than to the Fund.
KIDC intends, but is not obligated, to continue to pay or accrue
distribution charges which exceed current annual payments permitted to be
received by KIDC from the Fund. KIDC intends to seek full payment of such
charges from the Fund (together with annual interest thereon at the prime
rate plus 1.0%) at such time in the future as, and to the extent that, pay-
<PAGE>
- --------------------------------------------------------------------------------
ment thereof by the Fund would be within permitted limits. KIDC currently
intends to seek payment of interest only on such charges paid or accrued by
KIDC since January 1, 1992.
During the year ended October 31, 1995, the Fund recovered $1,380 in
deferred sales charges. During the period, the Fund paid KDI $1,316,980 under
the Distribution Plan. The amount paid by the Fund under its Distribution
Plan, net of contingent deferred sales charges, was $1,315,600 (1.00% of the
Fund's average daily net asset value during the period.) During the year
ended October 31, 1995, KIDC received $524,433 after payments of commissions
on new sales and service fees to dealers and others of $792,547. During the
same period, KIDC received $375,704 in contingent deferred sales charges. At
October 31, 1995, KIDC's total unreimbursed Distribution expenses amounted to
$1,721,992 (1.31% of the Fund's net asset value as of October 31, 1995).
(3.) Securities Transactions
For the year ended October 31, 1995, purchases and sales of investment
securities were as follows:
<TABLE>
<CAPTION>
Cost of Proceeds
Purchases from Sales
===========================================================
<S> <C> <C>
Portfolio securities $ 94,396,748 $ 140,495,266
Short-term investments 1,548,344,495 1,539,065,000
- -----------------------------------------------------------
$1,642,741,243 $1,679,560,266
===========================================================
</TABLE>
(4.) Investment Management and Transactions with Affiliates
Under the terms of the Investment Management Agreement between KMI and the
Fund, Keystone 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 an Investment Advisory Agreement with
Keystone, 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.
For the year ended October 31, 1995, the Fund paid or accrued to KMI
investment management and administrative services fees of $985,652, which
represented 0.75% of the Fund's average net assets on an annualized basis. Of
this amount paid to KMI, $837,804 was paid to Keystone for its investment
advisory services to the Fund.
During the year ended October 31, 1995, the Fund paid or accrued to KII
$62,044 for certain accounting and printing services, and $616,119 to KIRC
for transfer agent fees.
The Fund has entered into an expense offset arrangement with its
custodian. For the year ended October 31, 1995, the Fund paid custody fees in
the amount of $225,065 and received a credit of $19,366 pursuant to the
expense offset arrangement, resulting in a total expense of $244,431. The
assets deposited with the custodian under the expense offset arrangement
could have been invested in income-producing assets.
(5.) Forward Foreign Currency Exchange Contracts
At October 31, 1995, the Fund had open currency exchange contracts that
obligate the Fund to deliver currencies at specified future dates. The
unrealized depreciation of $674,045 on these contracts is included in the
accompanying financial statements. The terms of the open contracts are as
follows:
<PAGE>
- --------------------------------------------------------------------------------
Keystone International Fund Inc.
<TABLE>
<CAPTION>
Exchange Currency to U.S. $ value Currency to U.S. $ value
date be delivered as of 10/31/95 be received as of 10/31/95
================================================================================
<S> <C> <C> <C> <C>
01/05/96 3,321,160 2,522,555 2,535,374 2,535,374
Australian $ U.S. $
01/25/96 6,351,864 4,738,652 4,589,000 4,589,000
Canadian $ U.S. $
11/01/95 81,306 84,535 84,579 84,579
Brazilian U.S. $
11/01/95 620,365 645,004 645,340 645,340
Brazilian U.S. $
11/01/95 651,254 677,120 677,473 677,473
Brazilian U.S. $
11/01/95 677,184 704,080 704,446 704,446
Brazilian U.S. $
11/01/95 3,852 4,005 4,007 4,007
Brazilian U.S. $
11/01/95 677,391 704,295 704,661 704,661
Brazilian U.S. $
11/03/95 1,608,649 1,608,649 8,142,337 1,664,957
U.S. $ French Franc
11/03/95 10,333,084 2,112,924 2,164,994 2,164,994
French Franc U.S. $
11/03/95 5,386,500 1,101,439 1,050,000 1,050,000
French Franc U.S. $
11/20/95 16,860,671 583,185 558,485 558,485
Belgian Franc U.S. $
11/20/95 8,868,200 306,738 290,000 290,000
Belgian Franc U.S. $
11/20/95 1,923,000 1,923,000 2,253,660 1,989,565
U.S. $ Swiss Franc
11/20/95 2,876,603 2,539,508 2,365,627 2,365,627
Swiss Franc U.S. $
11/20/95 1,830,272 1,615,791 1,515,000 1,515,000
Swiss Franc U.S. $
11/10/95 73,918,520 604,989 608,784 608,784
Spanish Peseta U.S. $
11/20/95 507,907 119,604 117,102 117,102
Finnish Markka U.S. $
11/20/95 444,120 104,583 100,000 100,000
Finnish Markka U.S. $
11/20/95 3,183,000 3,183,000 2,052,158 3,242,950
U.S. $ Pound Sterling
11/20/95 2,439,475 3,855,013 3,782,650 3,782,650
Pound Sterling U.S. $
11/20/95 1,657,709 2,619,616 2,560,000 2,560,000
Pound Sterling U.S. $
</TABLE>
<PAGE>
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Exchange Currency to U.S. $ value Currency to U.S. $ value
date be delivered as of 10/31/95 be received as of 10/31/95
================================================================================
<S> <C> <C> <C> <C>
11/20/95 1,615,184,140 $ 1,010,564 987,639 $ 987,639
Italian Lira U.S. $
11/20/95 178,871,000 111,913 110,000 110,000
Italian Lira U.S. $
11/20/95 3,201,000 3,201,000 5,239,077 3,324,218
U.S. $ Netherland
11/20/95 6,980,789 4,429,342 4,247,901 4,247,901
Netherlands U.S. $
11/20/95 3,561,281 2,259,649 2,140,000 2,140,000
Netherlands U.S. $
11/22/95 8,147,303 1,224,546 1,100,095 1,100,095
Swedish Krona U.S. $
11/22/95 13,824,192 2,077,788 1,920,000 1,920,000
Swedish Krona U.S. $
11/22/95 9,241,213 1,388,963 1,325,000 1,325,000
Swedish Krona U.S. $
12/29/95 719,352,928 7,099,594 7,301,000 7,301,000
Japanese Yen U.S. $
12/29/95 317,881,800 3,137,307 3,182,000 3,182,000
Japanese Yen U.S. $
12/29/95 198,283,410 1,956,941 1,989,000 1,989,000
Japanese Yen U.S. $
- --------------------------------------------------------------------------------
$60,255,892 $59,581,847
================================================================================
</TABLE>
<PAGE>
- --------------------------------------------------------------------------------
Keystone International Fund Inc.
(6.) Distributions to Shareholders
A distribution of net investment income of $0.10 per share and a distribution
of long-term capital gains of $0.05 per share were declared payable by
December 6, 1995 to shareholders of record November 24, 1995. These
distributions are not reflected in the accompanying financial statements.
================================================================================
Federal Tax Status--Fiscal 1995
Distributions (Unaudited)
A distribution of $0.74 per share of net long-term capital gains and $0.04
per share of net investment income was paid during the fiscal year ended
October 31, 1995.
In January of 1996 we will send you complete information on distributions
paid during the calendar year 1995 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 statement of assets and liabilities of
Keystone International Fund Inc., including the schedule of investments, as
of October 31, 1995, and the related statement of operations for the year
then ended, the statements of changes in net assets for the year then ended,
the period from October 1, 1994 to October 31, 1994 and the year ended
September 30, 1994, and the financial highlights for the year then ended, the
period from October 1, 1994 to October 31, 1994 and for each of the years in
the nine-year period ended September 30, 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 October 31, 1995 by correspondence with the custodian.
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 October 31, 1995, the results of its
operations for the year then ended, the changes in its net assets for the
year then ended, the period from October 1, 1994 to October 31, 1994 and the
year ended September 30, 1994, and the financial highlights for each of the
years or periods specified in the first paragraph above in conformity with
generally accepted accounting principles.
KPMG Peat Marwick LLP
Boston, Massachusetts
December 8, 1995
